Saturday, September 25, 2010

Pricing under perfect competition.

Pricing under perfect competition.
Equilibrium of firm and industry :The following three conditions should be fulfilled for an industry to be equilibrium :
  1. The quantity demanded and supplied of the commodity produced by the industry should be equal.Because,if demand and supply are not equal,three cannot be equilibrium price.For example, if supply is higher than supply,the price tends to rise and if supply is higher than demand,price tends to fail.
  2. All firms must be in equilibrium.The firm will be in equilibrium when marginal revenue equals marginal cost and the MC curve cuts the MR curve from below.
  3. There should be no tendency on firms to enter or leave the industry.The tendency does not exit when all the firms are earning only normal profit.The firm earn normal profit when average revenue equals average cots.The normal profit is just sufficient to retain the firms in industry.If the firms are earning abnormal profit ,there is tendency on new firms to enter the industry.On the other hand,if the firms are increasing losses,there is tendency on firms to leave the industry.The situation of earning normal profit is called full equilibrium.
Short-run equilibrium :
The three conditions necessary for industry equilibrium mentioned above are fulfilled in the long run.The third condition need not be fulfilled in the short run.Because,in the short run there in no possibility of new firm entering the industry and exiting firm leaving the industry.
There are two approaches to show equilibrium of a firm : total revenue - total cost approach and marginal revenue - marginal cost approach.

Total revenue - Total cost approach :
The aim of the firm is to maximise profit.So the firm will be in equilibrium when it maximises profit.Profit is the difference between TR from sales and total cost of operation.Profit is maximum for the rate of output that maximises the excess of revenue over cost.

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