INTRODUCTION

• The price of a product under perfect competition is determined by the intersection of the demand and supply curvesin the industry.
• To determine the long-run price of a product under perfect competition, the long-run supply curve of the competitive industry must be derived.
• The concept of supply curve is only relevant under perfect competition as a large number of firms produce identical products with no control over the price.
• An industry is in equilibrium when there is no tendency for expansion or contraction of its output, i.e., when the demand for the product and the supply of the product are balanced.
• If at a given price, quantity demanded exceeds quantity supplied, the price will tend to rise, and the industry’s output will tend to increase.
• If at a given price, quantity demanded is less than quantity supplied, the price and output will tend to fall.
• The industry is in equilibrium at the level of output where the quantity demanded equals the quantity supplied, i.e., where the demand curve and the supply curve intersect.
• Output in the industry can vary in two ways:
  1. Existing firms may vary their output levels.
  2. The number of firms in the industry may change (firms enter or exit).
• In the short run, the number of firms in the industry is fixed, and firms cannot exit immediately.
• For short-run equilibrium:
  1. The demand for the product and short-run supply must be balanced.
  2. Each firm must be in equilibrium by equating price with marginal cost to maximize profits.
• For the industry to be in equilibrium in the long run, there should be no tendency for firms to enter or exit, which occurs when all firms are earning zero economic profits or normal profits.
• Normal profits are essential for the long-run equilibrium of the industry:
  1. Normal profits are sufficient to keep entrepreneurs in the industry and to prevent them from seeking alternative opportunities.
  2. Normal profits include wages of management (entrepreneur’s transfer earnings) and the normal return on capitalinvested.
• If firms in the industry earn profits above normal, firms outside the industry will be incentivized to enter, increasing the number of firms.
• If firms earn below normal profits (incurring losses), some will exit the industry in search of profits elsewhere, reducing the number of firms.
• Long-run equilibrium in the industry occurs when there is no tendency for firms to enter or leave, and all individual firms are in equilibrium, i.e., they are equating marginal cost (MC) with marginal revenue (MR).
• The MC curve cuts the MR curve from below in the long-run equilibrium.

Short-Run Equilibrium of the Industry

• In the short run, only existing firms can adjust their output; no new firms can enter, nor can any firms leave the industry.
• The industry is in short-run equilibrium when:
  1. The short-run demand and supply of the industry’s product are equal.
  2. All firms in the industry are in equilibrium.
• In short-run equilibrium, firms may make supernormal profits or may incur losses, depending on the demand conditions of the industry’s product.
• Short-run equilibrium of the industry is shown in Fig. 24.1:
  • The industry’s demand curve (DD) and short-run supply curve (SRS) intersect at point E, determining the equilibrium price (OP) and the equilibrium output (OO) of the industry.
  • Firms adjust their output at the profit-maximizing level at price OP.
• In the right-hand panel of Fig. 24.1, the firm is in equilibrium at OM output and makes supernormal profits equal to the area PRST.

• If all firms have the same cost conditions, then all firms will make supernormal profits in the short run.
• If the demand conditions for the product are unfavorable (e.g., the demand curve is lower), the equilibrium price may lead to losses for firms.
• Fig. 24.2 shows this scenario:
  • The short-run supply curve (SRS) intersects the given demand curve DD at point E, determining the price OP2.
  • At price OP2, firms face horizontal AR and MR curves at the level of price OP2.
  • The firm will produce ON output to equate price (OP2) with marginal cost (MC).
  • At equilibrium output ON, the price is less than average cost (SAC), and the firm is making losses but is in equilibrium by minimizing its losses.

• The two conditions for short-run equilibrium of the industry under perfect competition:
  1. Short-run demand and supply must be in balance.
  2. All firms should be in equilibrium by equating price with MC, whether they are making profits or having losses.