Question

Show how under perfect competition the price of a commodity is equal to its average and marginal costs of production in the long-run. Does the perfectly competitive firm always operate at the minimum point of the average cost curve?

“In a perfectly competitive equilibrium, the price of a commodity is equal to the marginal and average cost of production.” Explain.

Answer 1

• In the long run, a firm under perfect competition earns only normal profit.
• Free entry and exit of firms ensure that abnormal profits or losses do not last.
• If firms earn supernormal profits, new firms enter the market.
• This increases industry supply, causing the market price to fall.
• As the price falls, supernormal profits reduce and become normal profits.
• If firms face losses, some firms exit the market.
• This decreases supply, raising the price until remaining firms earn normal profit.
• In the long run, firms earn just enough to cover all costs, i.e., normal profit.
• There is no incentive for new firms to enter or existing firms to exit.
• The firm is in equilibrium when LMC = MR and LMC cuts MR from below.
• Also, AR = LAC at equilibrium, ensuring normal profit.
• Since AR = MR in perfect competition, the equilibrium condition is:
  LMC = MR = AR = LAC
• This occurs at the minimum point of the LAC curve, where the firm produces optimum output.
• At this point, price = AR = MR = AC = MC, and the firm is fully efficient.
• Therefore, in the long run, the firm is in stable equilibrium with only normal profits.