Course Title: Introduction to Economics
Course ID: ECN 200
Coordinator: Dr. A.K. Monaw-War Uddin Ahmed
“An Economic Analysis on the Short-Run Supply Curve of a Competitive Firm”
Name: Shariful Alam Chowdhury
Student ID: 1120023
Perfect competition – a pure market
Perfect competition describes a market structure whose assumptions are extremely strong and highly unlikely to exist in most real-time and real-world markets. The reality is that most markets are imperfectly competitive. Nonetheless, there is some value in understanding how price, output and equilibrium is established in both the short and the long run in a market that holds true to the tough assumptions of a world of ...view middle of the document...
Some suppliers may exert some control over market supply and seek to exploit their monopoly power. On the demand-side, some consumers may have monopsony power against suppliers because they purchase a high percentage of total demand. There are nearly always some barriers to the contestability of the market and far from being homogeneous; most markets are full of heterogeneous products due to product differentiation.
Consumers nearly always have imperfect information and their preferences and choices can be influenced by the effects of persuasive marketing and advertising. In every industry there is always asymmetric information where the seller knows more about quality of good than buyer. The real world is one in which negative and positive externalities from both production and consumption are numerous – both of which can lead to a divergence between private and social costs and benefits. Finally there may be imperfect competition in related markets such as the market for essential raw materials, labour and capital goods.
We can come fairly close to a world of perfect competition but in practice there are nearly always barriers to pure competition.
Establishing price and output in the short run under perfect competition:
A perfectly competitive industry is made up of a large number of small independent firms, each selling homogeneous (identical) products to a large number of buyers. The firms demand curve is perfectly elastic because any firm that raises the price sees a demand fall to zero as consumers, with perfect knowledge switch to other producers offering an identical product.
The first diagram shows the short run equilibrium for perfect competition. In the short run, the twin forces of market demand and market supply determine the equilibrium “market-clearing” price for the industry. In the second diagram, a market price P1 is established and output Q1 is produced. This price is taken by each of the firms. The average revenue curve (AR) is their individual demand curve. Since the market price is constant for each unit sold, the AR curve also becomes the Marginal Revenue curve (MR).
For the firm, the profit maximising output is at Q2 where MC=MR. This output generates a total revenue (P1 x Q2). The total cost of producing this output can be calculated by multiplying the average cost of a unit of output (AC1) and the output produced. Since total revenue exceeds total cost, the firm in this example is making abnormal (economic) profits. This is not necessarily the case for all firms. It depends on their short run cost curves. Some firms may be experiencing sub-normal profits if average costs exceed the market price. For these firms, total costs will be greater than total revenue.
Short run losses:
In the situation below, a firm is making losses in the short run, perhaps because of a fall in industry demand which has caused a fall in the market clearing equilibrium price.
The adjustment to the long-run equilibrium: