Equilibrium under Perfect Competition of Market

There is a demand curve under perfect competition:

Equilibrium under perfect competition

This is a horizontal demand of curve. So, the price is given and the firm has to decide the output to be produced according to their cost condition at that price.

Equilibrium Condition or the optimal output level:

The firm which wants to maximize its profit and minimize the loss should produce a output where MR=MC. This condition is applied to all the firms regardless of whether it has the control to set the price or not. But where the firm has no power to decide, the price MR is the going market price (P=MR).

Revenue and cost concept tells that TR-TC is total profit. Similarly, MR-MC is the marginal profit. When both reach at this point that is MR=MC. This formula shows that the firm can make no more profit and therefore should stop there. This is called output level.

We can show the equilibrium condition under perfect competition as:

Equilibrium Condition under Perfect Competition

After this condition there are short run equilibrium with loss and long run equilibrium. The short run equilibrium with loss brings a condition of shut down point. In short run, the firm may continue its production to recover losses in long run.

We assume that all the firms have identical cost condition in the industry. In the short run, the firm will keep on producing even when it is incurring loss. But in the long run, the firm, which is not even getting normal profit, will shut down.

The existing firms will return to normal profits from super profits. So, in long run, under perfect competition the firm incurs normal profit. There are no super normal profit and no huge loss.

This concept brings an understanding about market and competition of market. This curve is applied in all competition of market.

Cost and Importance of Cost Analysis in Market

Cost is important aspect in business decision. There are different types of cost:

Opportunity cost: It is the most important and useful concept of economic analysis. Opportunity cost is known as the amount that is foregone in choosing an activity over the next best alternative.

Explicit and Implicit cost: Explicit costs are involved in actual payment to the other parties. Implicit costs are known as the value of foregone opportunities. It is not involve in an actual payment. Implicit costs are also important as the explicit costs. Sometimes implicit costs are neglected.

Sunk, incremental cost and marginal cost – Sunk costs are known as fixed costs. It is known as irrelevant costs also in daily decision making. Incremental cost is known as total additional cost of implementing managerial decision. Managerial costs are known as total cost which is associated with one unit change in output.

Incremental cost is the most important cost in real world’s business. It is applicable in real business world.

Direct and Indirect cost: Direct costs are known as the direct attribute to production of a particular product. On the other hands, indirect costs are those costs which are incurred on stationary, electricity bills, administrative expenses etc. These can’t be separated accurately or easily into individual units of production.

Fixed and Variable cost: Fixed costs incurred when output is zero. It doesn’t vary with changes in output. Variable costs change with change in output. It increases when out is increased. It decreases when out put is decreased.

Short Run Period:

It is a time of period when a fixed cost and some variable costs are fixed. In this period fixed cost can not be changed but variable cost can be increased or decreased.

Long Run Period:

It is a long period to change all the factors of production which means there are no fixed factors. All the factors are known as variable factors. In this time, business decisions are made, except on the level of technology.

Cost Output and Relationship:

Short run cost curve is divided into total fixed cost and total variable cost. So, we can indicate it as:

TC = TFC+TVC
TC = Total Cost
TFC = Total Fixed Cost
TVC = Total Variable Cost

TVC is known as the total variable cost which changes directly with the change in output. It refers cost of labour, raw material, power etc.

We can show it in a figure:

Total Fixed Cost Curve

There is another diagram which will show the curve of Total Variable Cost:

Total Variable Cost Curve

We can show the diagram to put all the curves also:

The TC, TVC and TFC Curves

At last, we can say that costs are very important in decision making because though all the units are sold in the same price but the cost of production of these units are not same. Marginal cost and incremental cost are relevant in decision making whereas sunk cost are irrelevant.