Q.2 Explain how a firm gets profit maximisation under perfect competition.

ANS:

Profit is the main objective of any firm into business. Each and every firm tries to makes maximum possible profit into the business. Firm earns profit when Total revenue which has earned subtracted from the Total cost which he has bare for the production.

Therefore, we say that the price under perfect competition is equal to the average revenue which a firm earns in a market. A firm in a perfectly competitive market tries to maximize his profits. In the short-run, it is possible for a firm to earn profits which can be positive, negative, or zero. Economic profits which the firm earns will be zero in the long-run.

In the short-run, if a firm earns negative economic profit, it is said that he should continue to operate his business if its price exceeds its average variable cost and he should shut down if its price is below its average variable cost.

The marginal revenue (MR) is the change in total revenue from an additional unit of output sold in the market for which the firm bares Marginal cost.

In order to maximize the profits in a perfectly competitive market, the firms set the price where the marginal revenue equal to marginal cost (MR=MC). The MR curve is the slope of the revenue curve, which is also equal to the demand curve (DD), price (P) and the Marginal and Average Revenue curve. Therefore, In the shortterm, it is possible for a firm to earn economic profits to be positive, zero, or negative. When price is greater than average total cost, the firm is making a profit. When price is less than average total cost, the firm is making a loss in the market.

Perfect Competition in the Short Run: In the short run, it is possible for an individual firm to make an economic profit. This state is shown in the above Diagram 9.1, as the price or average revenue, denoted by P, is above the average cost denoted by AR. In the long-run, if firms try to earning positive economic profits, more and firms will enter into perfectly competitive market are, which will shift the supply curve to the right of the original place. As the supply curve shifts to the right, the equilibrium price of the firm will go down. As the price goes down, the economic profits will decrease until they become zero.

When the price is less than the average total cost of the production, at that time the firms are making a loss. In the long-run, if firms in a perfectly competitive market are earning negative economic profits, then more firms will leave the market and which in turn will shift the supply curve left of the diagram. As the supply curve shifts to the left, the price will rise. As the price rises, the economic profits will increase until they become zero.

In the long-run, companies that are engaged in a perfectly competitive market will earn zero economic profits. The long-run equilibrium point for a perfectly competitive market occurs where the demand curve (price)(P) intersects the marginal cost (MC) curve at the minimum point of the average cost (AC) curve.

Perfect Competition in the Long Run: In the long-run, economic profit cannot be constant. The entry of new firms in the market will cause the demand curve of each individual firm to shift the demand curve downward, bringing down the price, the average revenue (AR) and marginal revenue curve (MR). In the long-run, the firm will make zero economic profit. Its horizontal demand curve will touch its average total cost curve at its lowest point (E). The firm is at equilibrium at the point (E) where Marginal revenue (MR) is tangent to Marginal cost (MC).