Plus Two Economics-Chapter-4-Questions and Answers in English

Chapter 4 Theory of Firm Under Perfect Competition

1. A firm cannot make super normal profit in the long run under perfect competition . Do you agree ? Substantiate your answer .
Answer:

Yes , I do agree to the statement that a firm cannot make super normal profit in the long run under perfect competition . This is because , freedom of entry will prevent super normal profit in the long run .

2. Define ‘ Break even point ‘ .
Answer:

The point on the supply curve at which a firm eams normal profit is called the break even point . The point of minimum average cost at which the supply curve cuts the LRAC curve is therefore the break even point of a firm .

3. Examine the difference between the short run price and the long run price of a firm under perfect competition .
Answer:

There is a major difference between the short run and long run price under perfect competition . In the short run , price should be equal to or greater than the minimum AVC . If the price falls below this level , the firm will shut down production . On the other hand , the long run price should be equal to or greater than the minimum AC . Below this level , the firm will shut down production .

4. What is the supply curve of the firm in the long run ?
Answer:

In the long run a firm will produce output only when its price is at least equal to the average cost of production . Therefore , average cost curve represents the supply curve of the firm .

5. How does technological progress affect the supply curve of the firm ?
Answer:

The supply curve of the firm slopes upward from left to right indicating a direct relationship between price and quantity supplied . When there is a technological progress , it will affect the supply . Now the firm will be in a position to produce and supply more output at the same price . Therefore the supply curve will shift towards the right side .

6. How does an increase in the number of firms in a market affect the market supply curve ?
Answer:

As the number of firms changes the market supply curve shifts . When the number of firms increases . the market supply curve shifts to the right . On the other hand , if the number of firms decreases , the market supply curve shifts to the left .

7. Define ‘ shut down point ‘
Answer:

Shut down point refers to a situation where average revenue is equal to average variable cost . If the price fails to cover even average variable cost , firm will stop its production .

8. Make pairs

   Perfect competition , price marker , oligopoly , Cournot model , price taker , monopoly .

Answer:

Table 4.1
Perfect Competition	Price Taker
Monopoly	Price Maker
Oligopoly	Cournot model

9. The diagram below shows two curves faced by a firm under perfect competition . Name them .

   

Answer:

A. Total revenue curve

B. Average / Marginal revenue curve

10. Match the following .

    Table 4.2
    A	B
    Perfect Competition	TR – TC
    TR	Minimum point of AVC
    Profit	Price Taker
    Shut down point	Price × Quantity
    Supply curve of the firm	Rise in unit tax
    Shift of supply curve	Rising portion of SMC

Answer:

Table 4.3
A	B
Perfect Competition	Price Taker
TR	Price × Quantity
Profit	TR – TC
Shut down point	Minimum point of AVC
Supply curve of the firm	Rising portion of SMC
Shift of supply curve	Rise in unit tax

11. A firm maximizes profit when the difference between total revenue and total cost is the maximum . Profit is maximized when certain conditions are satisfied . Do you agree ?
Answer:

A firm maximizes profit when the following three conditions are satisfied .

• a ) The market price , p , is equal to the marginal cost .
• b ) The marginal cost is nondecreasing .
• c ) In the short run , the market price must be greater than or equal to the average variable cost . In the long run , the market price must be grater than or equal to the average cost .
12. Write the economic terms
    • a ) Cost vary with output
    • b ) Total Cost divided by quantity
    • c ) TR_n – TR_n-1
    • d ) TR = TC point
    • e ) A case where an increase in all the inputs lead to a just proportionate increase in output .
Answer:
• a ) Variable Cost
• b ) Average Cost
• c ) Marginal Revenue
• d ) Break Even Point
• e ) Constant Returns
13. Perfect competition does not exist in the real world . Do you agree ? Substantiate your view .
Answer:

competition does not exist . This is because , it is rare to find the features of perfect competition especially the features like perfect knowledge , perfect mobility of factors and product , etc. What we really find in the world is monopolistic competition which is a mix of perfect competition and monopoly .

14. A firm’s supply curve in the short run is the rising part of the SMC curve . Why ?
Answer:

A firm under perfect competition in the short run will start supplying only if the price is equal to or greater than the short run average variable cost . Therefore , the rising part of the short run marginal cost which begins with the minimum SAVC is the supply curve of the firm in the short run .

15. Imagine that Sº is the original supply curve of the firm . If a unit tax is imposed , what happens to the supply curve ? Show the change in a diagram .
Answer:

If a unit tax is imposed , firm’s long run supply curve shifts to the left . It is shown in the following diagram .



16. List the factors affecting elasticity of supply .
Answer:

The factors affecting elasticity of supply are,

• a ) nature of the commodity
• b ) cost of production
• c ) time period
• d ) technique of production
17. Observe the following figures and answer the questions .

    

    • i ) Point out the elasticities on the above supply curves .
    • ii ) Which method is applied here .
Answer:
• i ) S₁ Elastic supply
  S₂ Unitary elastic supply
  S₃ Inelastic supply
• ii ) Geometric method is applied here .
18. • a ) Identify the market structure that is represented by the AR curve in the diagram .
    • b ) Explain why the AR curve is horizontal
    

Answer:
• a ) Perfect competition
• b ) It is assumed that under perfect competition compared to the industry the share of each firm is meagre . No firm can influence the market supply . So even if a firm doubles the quantity supplied the market supply will not change . The price remains the same . So the AR or the demand curve is horizontal .
19. Information about a firm is given in the following table .

    Table 4.4
    Output	Total Revenue	Total Cost
    1	6	7
    2	12	13
    3	18	17
    4	24	23
    5	30	31

    Find out the equilibrium level of output in terms of MC & MR . Give reasons for your answer .
Answer:

Table 4.5
Output	TR	TC	MR	MC
1	6	7	6	7
2	12	13	6	5
3	18	17	6	5
4	24	23	6	6
5	30	31	6	18

Equilibrium quantity is 4. At this level of output MC = MR & MC cuts MR from below .
20. A firm can sell any quantity of the output it produces at a given price . If so , what is the behaviour of mar ginal revenue and average revenue . Draw the two curves in a single diagram .
Answer:

The demand curve facing the firm is perfectly elastic . At this condition AR = MR = Price .



21. Consider the following table .

    Table 4.5
    Output	TFC	TVC	TC	Price	TR
    0	500	—	500	15	—
    50	500	500	1000	15	750
    100	500	1000	1500	15	1500
    200	500	2000	2500	15	3000

    • a ) At which production level there will be no profit or loss to the producer ?
    • b ) Comment on the profit and loss conditions as TC 1000 and TR 750 .
Answer:
• a ) At the production level of 100 units of output the producer incurs 1500 TC and 1500 TR . So there will be no profit or loss to the producer
• b ) When TC = 1000

  TR = 750

  Loss TC – TR

  = 1000 – 750 = 250 .

22. How would each of the following affect the market supply curve for wheat ?
    • a ) A new and improved technique is discovered .
    • b ) The price of fertilizers falls .
    • c ) The government offers new tax concessions to farmers .
    • d ) A bad weather affects the crops .
Answer:

Table 4.6
a ) A new and improved technique is discovered .	increase market supply
b ) The price of fertilizers falls	increase market supply
c ) The government offers new tax concessions to farmers .	increase market supply
d ) A bad weather affects the crops .	decrease market supply

23. The following table shows the total cost schedule of a competitive firm . It is given that the price of the good is ₹ 10. Calculate the profit at each output level . Find the profit maximizing level of output .

    Table 4.7
    Output	TC (₹)
    0	5
    1	15
    2	22
    3	27
    4	31
    5	38
    6	49
    7	63
    8	81
    9	101
    10	123

Answer:

Table 4.8
Output (q)	TC (₹)	TR = Unit (q) × Price (P)	Profit (𝝅) = TR – TC
0	5	0 × 10 = 0	0 – 5 = -5
1	15	1 × 10 = 10	10 – 15 = -5
2	22	2 × 10 = 20	20 – 22 = -2
3	27	3 × 10 = 30	30 – 27 = 3
4	31	4 × 10 = 40	40 – 31 = 9
5	38	5 × 10 = 50	50 – 38 = 12
6	48	6 × 10 = 60	60 – 49 = 11
7	63	7 × 10 = 70	70 – 63 = 7
8	81	8 × 10 = 80	80 – 81 = -1
9	101	9 × 10 = 90	90 – 101 = -11
10	123	10 × 10 = 100	100 – 123 = -23

Profit maximising level of output is five , there the diffrence between Tr and TC is maximum.
24. Differentiate between the shut – down point and break even point .
Answer:

Shut down point refers to a situation where average revenue is equal to average variable cost . In other words it is the minimum pint of AVC . On the other hand , break – evenpoint is the no – profit , no loss point . It is the point where TR = TC or AR = AC .

25. Explain briefly break even point with the help of an example .
Answer:

Break even point refers to a situation when total revenue is equal to total cost assuming a given selling price per unit of output .

TR = TC

This can be explained with the help of an example

Table 4.9
Output	TC	TR	Profit / Loss
0	100	0	Loss
100	150	100	Loss
200	200	200	Break even point
300	250	300	Profit
400	300	400	Profit

If the firm produces less than 200 units , its TR < TC . So it bears loss .
If the firm produces more than 200 units , its TR > TC . So it earns profit .
If the firm produces 200 units , its TR = TC . This is the break even point .
Break even point is a normal profit point as beyond it the firm ears super normal profits and below it , the firm incur losses .
26. Observe the following diagram .

    

    Plot the break even point and shut down point .
Answer:



Point ‘ A ‘ represents shut down point Point ‘ B ‘ represents the break even point .
27. Complete the following tables and identify the market structure .
    • a )

      Table 4.10
      Output (q)	P	TR	AR	MR
      1	20
      2	20
      3	20
      4	20
      5	20

    • b )

      Table 4.11
      Output (q)	P	TR	AR	MR
      1	10
      2	9.5
      3	9
      4	8.5
      8	20

Answer:
• a )

  Table 4.12
  Output (q)	P	TR	AR	MR
  1	20	20	20	20
  2	20	40	20	20
  3	20	60	20	20
  4	20	80	20	20
  5	20	100	20	20

  This market represents a perfectly competitive market because in this market , P = AR = MR .
• b )

  Table 4.13
  Output (q)	P	TR	AR	MR
  1	10	10	10	10
  2	9.5	19	9.5	9
  3	9	27	9	8
  4	8.5	34	8.5	7
  5	8	40	8	6

  This market represents a monopoly market . In this market AR and MR are different and AR > MR .
28. At the market price of ₹ 10 , a firm supplies 4 units of orange . The market price rises to ₹ 30. The price elasticity of the firm’s supply is 1.25 . What quantity will the firm supply at the new price ?
Answer:

In the given example ,

P =10
Q = 4
P₁ =30
es = 1.25
ΔP = 30 – 10 = 20
Applying these values in the formula , e_s = \( \mathbf{{{\frac{ΔQ}{ΔP}} }} \) × \( \mathbf{{{\frac{P}{Q}} }} \)
we get,
e_s = \( \mathbf{{{\frac{ΔQ}{ΔP}} }} \) × \( \mathbf{{{\frac{P}{Q}} }} \)
1.25 = \( \mathbf{{{\frac{ΔQ}{20}} }} \) × \( \mathbf{{{\frac{10}{4}} }} \)
= \( \mathbf{{{\frac{ΔQ}{8}} }} \)
ΔQ = 1.25 × 8 = 10
Therefore the new quantity , the firm will supply at the new price is ₹ 10 .
29. Suppose that the market demand in a perfectly competitve industry is given by ,

    Qd = 7000-500 P

    and the market supply function is given by

    Qs = 4000 + 250 P

    Find the market equilibrium price .

Answer:

Equilibrium is determined by the condition ,

Qd = Qs .

In this example ,

7000 – 500 P = 4000 + 250 P

7000 – 4000 = 250 P + 500 P

3000 = 750 P

P = \( \mathbf{{{\frac{3000}{750}} }} \) = 4

30. Point out the features of perfect competition .
Answer:

Features of perfect competion are pointed out below .

• i ) Large number of buyers and sellers
• ii ) Homogneous product
• iii ) Freedom of entry and exit
• iv ) Free movement of product and factors of production
• v ) Profit motive
• vi ) Perfect knowledge of market conditions
• vii ) Absense of transport cost
31. Identify from the diagram below .
    • a ) Shut down point and break even point
    • b ) Distinguish between these two
    

Answer:
• a ) Point ‘b’ is the break even point and point ‘a’ is the shut down point
• b ) Break down point shows a situation where a firm earns no profit or no loss . It is the point where AR = AC . Shut down point shows a situation where a firm is compelled to stop the production since it is not able to cover its variable cost . This is the situation where the firm’s P ≥ AVC .
32. Identify the profit maximizing level of output from the diagram below . List out the condition for profit maximization .

    

Answer:

B is the profit maximizing level of output .

Conditions for profit maximisation are,

• i ) MR = MC
• ii ) At the profit maximizing level of output MC is non decreasing , that is the slope of MC is positive
• iii ) P > AVC
33. Match the commodities given below with the diagram . Justify your answer .
    • a ) Coconut
    • b ) Mobile phone

    

Answer:
• a ) Diagram ‘A’ stands for mobile phones
• b ) Diagram ‘B’ stands for coconut
The supply of mobile phones are relatively price elastic . This is because the purchase of mobile phones can easily react to a change in price . It is a manufactured good . All the raw materials needed to produce a mobile phone can easily be available . The producers can pile up stock and when price increases they can increase the supply .

The supply of coconut can be price inelastic . This is because the producers cannot easily react to a change in the price of coconut . Years needed for a coconut tree to get mature and start to produce coconuts . It is an agricultural product . The producers cannot hold the stock of coconut for a longer duration .

34. The following table gives you certain information about a firm .

    Table 4.14
    Output	Price	TR	MR
    1		8	12
    2		16	9
    3		24	8
    4		32	9
    5		40	10

    • i ) Find the price at which output is sold and identify the form market .
    • ii ) Is this firm a price – taker or price – maker ? Give reasons .
    • iii ) Find the firm’s equilibrium level of output in terms of MC & MR . Give reasons .
    • iv ) Also find profit of the firm at this level of output .
Answer:
• i ) Price – 8
• ii ) Price – taker , a firm has no influence on price de termination under perfect competition .
• iii ) Equilibrium quantity is 3. At this level of output MC = MR .
• iv ) Firm is at no profit – no loss condition . i.e. , he is at break even point .
35. Prepare a seminar report on ‘ perfect competitive markets ‘ .
Answer:

Respected teachers and dear friends ,

The topic of my seminar paper is perfect competitive markets . The term market refers to all the places in which buyers and sellers are in contact with each other for the purchase and sale of any commodity or service . There are different kinds of markets based on their characteristics – say perfect competitive mar kets and noncompetitive markets .

Introduction :

Perfect competition is a market situation character ized by the existence of large number of buyers and sellers , homogeneous products , free mobility of fac tors of production , freedom of entry and exit , perfect knowledge of market conditions and absence of transportation costs .

Contents :

• a ) Profit Maximisation
• b ) Profit Maximisation in short run : Diagrammatic representation
• c ) Long run profit maximisation

Conclusion :

Thus it can be concluded that perfect competition is a market structure characterized by complete absence rivalry among individual sellers . Sellers in the market do not hold any freedom of influencing market price . Therefore , they are known as price takers . However , it should be admitted that it is a rare form of market .

36. The diagram shows one of the short run equilibrium situations of a firm under perfect competition .
    • a ) List out any four features of such market condition .
    • b ) Identify the equilibrium situation of the firm profit , normal profit , loss diagrammatically . Show a situation in which the firm makes a profit .
    • c ) With the help of a diagram explain the long run situation of a firm under perfect competition .

    

Answer:
• a )
• i ) Large number of sellers
• ii ) Homegeneous product
• iii ) Firm is a price taker
• iv ) Free entry and exit
• b ) The firm is making a normal profit .

  The firm produces ‘ oq ‘ level of output and charges a price ‘ op ‘ . The shaded area in the diagram shows profit .

  

• c ) Firm under perfect competition in the long run makes only normal profit . This is because if firms are making profit , new entrants will be attracted into the industry . The price falls due to increase in supply and the extra profit will be taken away . If the firms are making loss some of them will leave the industry , price rises and the loss will be turned into profit . This is shown in the diagram below .

  

  The firm under perfect competition in the long run will produce ‘ OQ ‘ level of output and charges a price ‘ OP ‘ .

37. How are price and output determined under perfect competition in the short run ? Compare the profit of a firm in the short run and long run and bring out the difference . Give suitable diagram .
Answer:

Under perfect competition , market determines the price – price taker and not price maker firms produce the output that maximises its profit – a firm may get ab normal profit or normal profit or loss in the short run only normal profit will prevail in the long run – due to free entry and exit – Draws separate diagram for short run and long run – explains price and output determina tion as well as profit in short run and long run .

PROFIT MAXIMIZATION IN SHORT – RUN : DIAGRAMMATIC REPRESENTATION

The profit maximizing condition of a firm in short – rn can be understood from the figure . All the three profit maximizing conditions of a firm in short run are sat isfied at point of output level q ₀.

• i ) The price must be equal to MC ( P = MC )
• ii ) MC must be non – decreasing
• iii ) P ≥ AVC

Short – run profit maximization



All the profit maximizing conditions are satisfied in the figure given above .

• i ) The prices become equal to MC . At point E , the firm reaches equilibrium at the output level q₀ ( MC = MR ) .
• ii ) At q₀ MC is non – decreasing at point E.
• iii ) At point E , prices have become more than AVC ( P ≥ AVC at point E ) .
Therefore , three conditions for the equilibrium level of output are depicted in a single figure .

LONG RUN PROFIT MAXIMISATION

The profit maximization level of the firm is reached when the long run supply curve of the firm is that portion of LRMC curve which lies over and above the minimum point of LRAC curve ( P ≥ minimum of LRAC ) . The supply curve of a firm in the long run is the rising portion of minimum point of LRMC . It can be explained with the help of the following figure .

Long – run profit maximization



38. Correct the following statements , if necessary :
    • Statement I : Liquidity trap is the situation in which speculative demand for money is infinitely elastic .
    • Statement II : The imposition of a unit tax shift the supply curve of a firm to the left .
    • Stetement III : The profit level that is just cover the explicit cost and opportunity cost is super normal profit .
    Answer:
    • Statement I : No correction
    • Statement II : No correction
    • Statement III : The profit level that is just cover the explicit cost and opportunity cost is normal profit .
39. There are three identical firms in a market . The following table shows the supply schedule of a firm :

    Table 4.15
    Price (₹)	Supply (Units)
    0	0
    1	1
    2	2
    3	4
    4	6
    5	8
    6	10

    • i ) Define market supply .
    • ii ) Compute market supply schedule .
    • iii ) Draw market supply curve .
Answer:
• i ) The output level that firms in the market produce in aggregate , corresponding to different values of market prices .
• ii )

  Table 4.16
  Price	Supply (1)	Supply (2)	Supply (3)	Market Supply
  0	0	0	0	0
  1	1	1	1	3
  2	2	2	2	6
  3	4	4	4	12
  4	6	6	6	18
  5	8	8	8	24
  6	10	10	10	30

• iii ) Draw a market supply curve that slopes upwards corresponding to the above values .
40. At the market price of * 10 , a firm supplies 4 units of output . The market price increases to 30. The price elasticity of the firm’s supply is 1.25 . What quantity will the firm supply at the new price ?
Answer:

Price elasticity of supply ( ES ) = \( \mathbf{{{\frac{P}{q}} }} \) × \( \mathbf{{{\frac{Δq}{ΔP}} }} \) in the given situation ,

ES = 1.25

Δq = ?

Δp = 20

p =10

Q = 4

Applying these values in formula , we get ,

1.25 = \( \mathbf{{{\frac{10Δq}{4}} }} \) × \( \mathbf{{{\frac{20}{ΔP}} }} \)

1.25 = \( \mathbf{{{\frac{10\,Δq}{80}} }} \)

100 = 10Δq

∴Δq = \( \mathbf{{{\frac{100}{10}} }} \) = 10

Since Δq = 10, firm’s new output = 4 + 10 = 14 .

41. ” Any factor that affects a firm’s marginal cost curve is of course a determinant of its supply curve ” , there are three factors – determining the supply curve of a firm . Identify them .
Answer:

determining the supply curve of a firm are :

• → Technical progress
• → Input prices
• → Unit tax
42. Mr. Potti is a textile mill owner . He is facing challenges in production and marketing screnario . The situations he faced are given in column A and corresponding outcomes in marginal cost and supply of output are given in column B and C. Match A with B and C.

    Table 4.17
    A Situations	B MC Curve	C Supply Curve
    a . Technical Progress	Shifts right	Shifts right
    b . Increase tax per unit	Shifts left	Shifts left
    c . Increase input price Shifts left	Shifts left	Shifts left

Answer:

Table 4.18
A Situations	B MC Curve	C Supply Curve
a . Technical Progress	Shifts right	Shifts left
b . Increase tax per unit	Shifts left	Shifts right
c . Increase input price Shifts left	Shifts right	Shifts left

43. Under perfect competition a firm’s profit inthe short run is maximized when 3 conditions are satisfied .
    • a ) Discuss the 3 conditions .
    • b ) From the following schedule , suggest profit maximizing level of output inthe short run if price .

    Table 4.19
    Output (q)	TC
    0	5
    1	15
    2	22
    3	27
    4	31
    5	38
    6	49
    7	63
    8	81
    9	101
    10	123

Answer:
• a )
  • i ). MC must be equal to MR
  • ii ). MC must cut MR from below
  • iii ). Slope of MC must be greater than slope of MR
• b )

  Table 4.20
  Output (q)	TC	MC	P	TR	MR
  0	5	–	–	–	–
  1	15	10	10	10	10
  2	22	7	10	20	10
  3	27	5	10	30	10
  4	31	4	10	40	10
  5	38	7	10	50	10
  6	48	10	10	60	10
  7	63	15	10	70	10
  8	81	15	10	80	10
  9	101	20	10	90	10
  10	123	22	10	100	10

• c ) Since MC = MR = 10 at 6^th unit of output , the profit maximising level of output is 6 units .
44. In the following diagram , at points E and E₁ , MC and MR are equal . Among these , which point do you consider as producer’s equilibrium ? Justify your answer .
    

Answer:

In this diagram , producer’s equilibrium is at point E₁ . This is because this point satisfies all the conditions of equilibrium . The conditions for attaining equilibrium are ,

• i) MC = MR
• ii ) MC must cut MR from below
These two conditions are satisfied at point E₁ .
45. Firm ‘ A ‘ is operating under the condition of perfectly competitive market . Whether firm ‘ A ‘ is capable of maintaining abnormal profit in the long run ? Why ?

    Hint : Long run equilibrium of a firm under perfect competition .

Answer:

Yes , I do agree to the statement that a firm cannot make super nomal profit in the long run under perfect competition . This is because ; freedom of entry will prevent super normal profit in the long run . We first determine the firm’s profit – maximizing out put level when the market price is greater than or equal to the minimum ( long run ) AC . This done , we determine the firm’s profit – maximizing output level when the market price is less than the minimum ( long run ) AC .

Case 1 : Price greater than or equal to the minimum LRAC

Case 2 : Price less than the minimum LRAC

Combining cases 1 and 2 , we reach an important conclusion . A firm’s long run supply curve is the rising part of the LRMC curve from and above the minimum LRAC together with zero output for all prices less than the minimum LRAC .

46. Under perfect competition , a firm will not produce output level in cases under ( a ) P > MC and ( b ) P < MC . If so , what is the condition of profit maximising output in the shortrun . Give diagramatic illustration . ( Hint : Short run equilibrium of a firm under perfect competition ) .
Answer:

Perfect Competition – Short Run Equilibrium

In the model of price and output determination under perfectly competitive market conditions , price is determined by the impersonal market forces of supply and demand , and not by individual actions of buyers and sellers . The individual firm in such a market may be said to be a price – taker . Perfect competition is used by economists not so much as an attainable goal , but as a pure state against which all other markets can be measured .

For a market to be perfectly competitive , the following necessary conditions must , in general , prevail .

• i ) There must be many firms acting independently . Each firm is small enough relative to the size of the market , so that a single firm’s decision to either stop production entirely or to produce to full capacity will not have any perceptible effect on market supply to cause a change in market price .
• ii ) Entry and exit from the market are free and frictionless for both the firms and consumers .
• iii ) The products offered for sale are homogeneous and divisible into small units .
• iv ) Buyers and sellers have perfect knowledge about the market conditions .
• v ) Price is determined by the impersonal market forces of supply and demand , and not by individual actions of buyers and sellers . The individual firm in such a market may be said to be a price – taker .
• vi ) There is perfect knowledge among consumers about the price at which goods are being sold in the market . Sellers thus cannot manipulate the commodity price and thereby exploit the consumer .
• vii ) There is perfect mobility of goods and factors of production among firms . Uniformity in factor prices is prevalent in the market .
If these necessary conditions prevail , the firm can lose its entire market if it sets its price above the market price . It can also expect no gain by lowering price , since it can sell all it wishes to produce at the market price . The competitive firm has no price discretion . Market price will not be affected by the independent action of a single firm . No firm is able to influence market price .
The objective of each firm is to maximize profit . Profit is the difference between revenue and cost of production . Marginal cost ( MC ) is the cost incurred to produce an additional unit of the product . If the per unit price of a commodity is greater than the marginal cost , the firm will be interested in producing more of the commodity . On the other hand if price falls below marginal cost , the firm will curtail its production . Equilibrium condition will prevail at a point where profit is maximized . This happens where price is equal to marginal cost ( P = MC ) . Also at the point of equilibrium , the marginal cost curve must be upward sloping .



In the diagram the given price is P. Again the firm will produce the level of output for which MC = MR . This occurs at point E , giving a level of output of Q. Notice that at this point , AR = AC , so the firm is making normal profit .

So , in the short run , a perfectly competitive firm could be making super normal profit , or a loss , or just normal profit , depending on the given market price . Note that if the firm’s losses get too big in the short run ( i.e. AR < AVC ) then it will have to shut down .

47. What are the conditions that are to be fulfilled for a firm to be in short run equillibrium under perfectly competitive market conditions ?
Answer:

A firm is in equilibrium when it has no tendency to change its level of output . It needs neither expansion nor contraction . It wants to earn maximum profits . In the words of A.W. Stonier and D.C. Hague , ” A firm will be in equilibrium when it is earning maximum money profits . ”

Equilibrium of the firm can be analysed in both short run and long – run periods . A firm can earn the maximum profits in the short run or may incur the minimum loss . But in the long run , it can earn only normal profit .

Short – run Equilibrium of the Firm :

The short run is a period of time in which the firm can vary its output by changing the variable factors of production in order to earn maximum profits or to , incur minimum losses . The number of firms in the industry is fixed because neither the existing firms can leave nor new firms can enter it .

It’s Conditions :

The firm is in equilibrium when it is eaming maximum profits as the difference between its total revenue and total cost .

For this , it essential that it must satisfy two conditions :

• ( i ) MC = MR , and
• ( ii ) the MC curve must cut the MR curve from below at the point of equality and then rise upwards .
The price at which each firm sells its output is set by the market forces of demand and supply . Each firm will be able to sell as much as it chooses at that price . But due to competition , it will not be able to sell at all at a higher price than the market price . Thus the firm’s demand curve will be horizontal at that price so that P = AR = MR for the firm .

Marginal Revenue and Marginal Cost Approach :

The short – run equilibrium of the firm can be explained with the help of the marginal analysis as well as with total cost – total revenue analysis . We first take the marginal analysis under identical cost conditions .

This analysis is based on the following assumptions :

• i ) All firms in an industry use homogeneous factors of production .
• ii ) Their costs are equal . Therefore , all cost curves are uniform .
• iii ) They use homogeneous plants so that their SAC curves are equal .
• iv ) All firms are of equal efficiency .
• v ) All firms sell their products at the same price determined by demand and supply of the industry so that the price of each firm is equal to AR = MR .

Determination of Equilibrium :

Given these assumptions , suppose that price OP in the competitive market for the product of all the firms in the industry is determined by the equality of demand curve D and the supply curve S at point E in Figure 1 ( A ) so that their average revenue curve ( AR ) coincides with the marginal revenue curve ( MR ) .
48. A fruits seller sells 600 Kg . of grapes at market price of 40 per kg . When price increases to 50 per kg . he is ready to sell 750kg of grapes . Find out the price elasticity of supply .
Answer:

As Elasticity of supply ,

= \( \mathbf{{{\frac{Percentage\,change\,in\,quantity\,supplied}{Percentage\,change\,in\,price}} }} \)

\( \mathbf{{{\frac{P}{q}} }} \) × \( \mathbf{{{\frac{Δq}{ΔP}} }} \)

= \( \mathbf{{{\frac{40}{600}} }} \) × \( \mathbf{{{\frac{150}{10}} }} \)

= \( \mathbf{{{\frac{6000}{6000}} }} \) = 1

Here price elasticty of supply is one .

49. Will a profit – maximizing firm in a competitive market ever produce a positive level of output in the range where the marginal cost is falling ? Give an explanation with the help of a diagram .
Answer:

No , a profit maximising firm will not produce in the range where the marginal cost is falling . This is because , at this range , his profit is not maximised . So he fixes his level of out output at the point where marginal cost equals marginal revenue .

This can be explained with the help of a diagram .



As per the diagram , if the firm fixes output at the range where MC is falling his profit will not be maximised . Being profit maximising firm , he goes on producing OQ level of output corresponding to the point where MC = MR . This is at the rising part of MC . So his profit is maximised as shown in shaded area .

50. At the market price of ₹ 10 , a firm supplies 4 units of output . The market price increases to ₹ 30. The price elasticity of the firm’s supply is 1.25 . What quantity will the firm supply at the new price ?
Answer:

Price elasticity of supply ( ES ) = \( \mathbf{{{\frac{Δq}{ΔP}} }} \) × \( \mathbf{{{\frac{P}{q}} }} \) in the given situatuon,

ES = 1.25

Δq = ?

Δp = 20

P = 10

q = 4

Applying these values in formula , we get ,

1.25 = \( \mathbf{{{\frac{Δq}{20}} }} \) × \( \mathbf{{{\frac{10}{4}} }} \)

1.25 = \( \mathbf{{{\frac{10Δq}{80}} }} \)

100 = 10Δq

∴Δq = \( \mathbf{{{\frac{100}{10}} }} \) = 10

Since Δq = 10 , Firm’s new output = 4 + 10 = 14

51. Distinguish :
    • a ) Break even point
    • b ) Shutdown point
    Answer:
    • a ) The point on the supply curve at which a firm earns normal profit is called the break even point . The point of minimum average cost at which the supply curve cuts the LRAC curve is therefore the break even point of a firm .
    • b ) In the short run the firm continues to produce as long as the price remains greater than or equal to the minimum of AVC . Therefore , along the supply curve as we move down , the last price – output combination at which the firm produces positive output is the point of minimum AVC where the SMC curve cuts the AVC curve . Below this , there will be no production . This point is called the short run shutdown point of the firm . In the long run , the shut down point is the minimum of LRAC curve .
52. Graphically explain the short run equilibrium of the firm under Perfect Competition . Draw separate diagram depicting the following conditions :
    • i ) The firm is earning super normal profit .
    • ii ) The firm is earning only normal profit .
    • iii ) The firm is incurring a loss .
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