Q) How are price and output determined under a perfect competitive market?
Ans: A perfect competitive market is a market where there are a large number of small firms producing
homogenous products, where both buyers and sellers have perfect information, and there are no barriers to
entry or exit.
Determination of Price and output
The price is fixed and determined by industry at the equilibrium condition (Market demand = Market
supply). The firm must satisfy the following two conditions to be in equilibrium.
1. MR=MC.
2. The MC curve must intersect the MR curve from below.
Short-run Equilibrium of firm and industry:
There are three possible cases in the short run.
1. Normal profit: Average revenue = Average cost (AR = AC)
2. Supernormal (Excess) profit: AR > AC
3. Loss: AR < AC
Fig: Short-run equilibrium of firms and industry under perfect competition market
In figure ‘a’, industry equilibrium is shown where the price P and output Q M are determined at the
interaction between market demand and supply curves. As the firms are price takers, all the firms must sell
their products at the price P determined by the industry. Figure ‘b’, ‘c’, and ‘d’ show the equilibrium of the
firms in the short run.
Figure ‘b’ shows the case of excess profit. The firm is earning excess profit equal to AEPC A as the
equilibrium price P is higher than the average cost AC.
Figure ‘c’ shows the case of normal profit as the equilibrium price P is equal to the average cost. Here, the
total revenue and the total cost are both OQBEP.
Figure ‘d’ shows the case of loss equal to EACCP. The equilibrium price P is less than the average cost.
Long-Run Equilibrium:
In the long run, the firms will be earning just normal profits under a perfect competition market. Some
firms will leave the industry as they can't cover the loss. Likewise, when some firms are getting super
normal profits, it will attract more firms into the industry.
Fig: Long-run equilibrium of firms and industry under perfect competition market
In the figure, the price is determined by the industry at P and the firm is earning normal profit as the price
equals the average cost.
Q) How are price and output determined under a monopoly market?
Ans: A monopoly market is a market structure where there is only one seller of a commodity in a market.
The seller has sole control over the supply and price of the commodity.
Price and output determination (Equilibrium of firm and industry) under a monopoly market
The firm must satisfy the following two conditions to be in equilibrium.
1. Marginal revenue must be equal to marginal cost, i.e., MR=MC.
2. The MC curve must intersect the MR curve from below.
Short-Run Equilibrium:
There are three possible cases in the short run.
1. Normal profit: Average revenue = Average cost (AR = AC)
2. Supernormal (Excess) profit: AR > AC
3. Loss: AR < AC
Figure 'a' represents the case of supernormal profit equal to PP 1BA. The average revenue (AQ) is greater
than the average cost (BQ).
Figure 'b' represents the case of normal profit. The average revenue (AQ) is equal to the average cost (AQ).
Figure 'c' represents the case of loss equal to PP 1BA. The average revenue (AQ) is lower than the average
cost (BQ).
'a' b' 'c'
Fig: Short-run equilibrium of monopoly market
Long-run equilibrium:
The long run is the period where all the factors of production are variable. Monopolist will earn
supernormal profit in the long run because it is the single seller of the product. The figure below shows the
long-run equilibrium of monopolists. Here monopolist gets super normal profit equal to PP 1AB as average
revenue is greater than long run average cost.
Fig: Long-run equilibrium of monopoly market
