Question

Show with the help of a diagram, how a perfectly competitive firm earns a normal profit in short-run equilibrium.

Explain with the help of a well-labelled diagram how a perfectly competitive firm earns normal profit in the short run.

Explain how short-run equilibrium is attained by a perfectly competitive firm earning normal profits.

Answer 1

Under perfect competition, a firm’s average revenue curve is equal to the marginal revenue curve due to uniform prices for homogeneous goods. In the short run, a competitive firm can earn supernormal profits and normal profits can also suffer losses. The adjacent diagram shows a perfectly competitive firm earning normal profits. Since the firm is a price taker, it has to decide the amount of output it should produce at the given price so as to maximise profits following the equilibrium conditions.

SMC = MR and AR = AC

In the given diagram, OQ is equilibrium output, where SMC is equal to MR Since SAC is tangent to the P = AR = MR line, the firm covers only its SAC, which includes normal profits.