Perfect Competition Graph in Short Run and Long Run
What is the perfect competition?
A perfectly competitive market is a hypothetical market structure where a large number of buyers and sellers buy and sell the goods, and all of these buyers and sellers have the opportunity to get perfect information, all of these buyers and sellers work as price takers, buyers of the market take decisions rationally, there are no any entry and exit barriers in the market structure, no externalities, non-increasing returns to scale and homogenous products are sold in the market structure. Perfect competition graph of a firm is a horizontal line (perfectly elastic). Because a perfect competitive firm is a price taker.
You may be interested in to read more,
Perfectly Competitive Market Meaning, Characteristics, & Examples
Perfect competition demand curve
Demand curve in perfectly competitive market
The demand curve in a perfectly competitive market is negatively sloped. Because it is the total of all individual and household demand curves. It is represented by the curve “D” of the following perfect competition market graph.
The equilibrium market price of the perfect competition graph is decided by the total market supply and total market demand forces. It is represented by the curve “P1” of the following perfect competition market graph.
Market equilibrium means the market condition where market supply and demand equals to each other. In this situation, there is no tendency to increase or decrease market price per unit and number of goods. So, when the market is in equilibrium, there is no surplus or shortage.
Demand curve for perfectly competitive firm
The demand curve facing a perfectly competitive firm is a horizontal line. In other words, the demand curve of a perfectly competitive firm is perfectly elastic.
The reason for that is, a firm that operates in a perfectly competitive market is a price taker. Because a perfectly competitive market has to accept the equilibrium market price and produce the quantity of supply that the firm needs. This equilibrium market price is decided by the total market supply and total market demand forces. An individual firm has no power to influence the market price. If a perfectly competitive firm increases its price more than the market price, this firm will lose a significant portion of its sales. Because any rational buyer does not need to pay a high price for identical products. Although a firm in perfect competition sells its products lower than the market equilibrium price, it will not get any more incentives.
So, the demand curve in a perfectly competitive market and the demand curve for perfectly competitive firm can be presented as follows.
According to the above graph, the market price of the perfect competition is decided by the perfect competition market supply and market demand forces. In other words, the market price is decided by the total market supply and total market demand. The market price is P1.
An individual perfect competitive firm has no power to influence the market price. It has to accept the P1 price. The demand curve of a perfectly competitive firm is perfectly elastic (a horizontal line). So, the firm can sell the quantity that it wishes at the given price level (P1).
Perfect competition graph
Let’s consider how to graph perfect competition firm in short run and long run
Perfect competition short run graph
In the short run, firms in perfect competition can earn an economic profit, normal profit for economic loss.
Perfect competition graph profit in short run
If firms earn economic profits, new firms see economic profits and come to the market (because there are no entry barriers).
Economic profit is the total revenue minus explicit and implicit costs. Supernormal or economic profit, in the views of some experts, is the difference between accounting profit and the opportunity cost the company has incurred by investing in its current initiative.
You may be interested in to read more,
What is Supernormal Profit? – With Diagrams
Accounting Profit and Economic profit
Following is the perfect competition graph in short run that earns a profit.
This individual perfect competitive firm has no power to influence the market price. It has to accept the P1 price. The demand curve of a perfectly competitive firm is perfectly elastic (P/ AR). So, the firm can sell the quantity that it wishes at the given price level (P1). In a perfect competitive firm, marginal revenue (MR) curve is also lay on demand curve of the firm. Marginal cost (MC) curve is labelled as MC and average cost curve is labelled as AC.
The point where MR =MC can be considered as the profit maximization point or loss minimization point. According to the following perfect competition graph, Q2 is the profit maximization point of the firm in short run (output level where MR=MC). At this output level, AR is higher than AC. So, the firm earns an economic profit. Amount of economic profit is presented in ABP1P2 area of this perfect competition graph.
Perfect competition graph loss in short run
If perfectly competitive firms earn economic losses in the short run, some of the existing firms exit from the marketplace (because there are no exit barriers).
Following is the perfect competition graph in the short run with economic loss.
The point where MR =MC can be considered as the profit maximization point or loss minimization point. According to the following perfect competition graph, Q2 is the loss minimization point of the firm in short run (output level where MR=MC). At this output level, AC is higher than AR. So, the firm earns an economic loss. Amount of economic loss is presented in ABP1P3 area of this perfect competition graph.
Long run perfect competition graph
In the long run, only normal profits can be earned for firms in perfect competition. Because in the short run new firms eliminate the economic profits earned by the existing firms and some of the existing firms who earn economic losses exit from the marketplace. So, in the long run, only normal profits can be earned for firms in perfect competition.
The normal profit is the zero economic profit. When a firm earns the normal profit, it earns the minimum amount of revenue that needs to prevail in the industry or market. In other words, when a firm produces normal profit, its total revenue will be equalized to total cost (TR = TC). At this point, the firm produces an efficient level of output.
To read more about normal profit, kindly click here
Long run equilibrium graph perfect competition
The point where MR =MC can be considered as the profit maximization point or loss minimization point. According to the above perfect competition graph, the P1 price level is determined by the perfectly competitive industry and the firm can sell whatever amount at the P1 price level. So, the firm produces at the Q2 quantity which is profit maximization output level of the organization. At this output level, the average cost (AC) of the firm equals to average revenue (AR). So, the firm only earns normal profits.
