What are the characteristics of perfect competition? Explain the equilibrium condition of a firm under perfect competition in the short run and in long run.
Perfect competition is a market situation in which there area large number of buyers and sellers, firms sell a homogeneous product and there is free entry and exit. Although, these are several features as stated below but the first three are key features of perfect competition:
- Very large number of buyers and sellers.
- Homogeneous product.
- Free entry and exit of firms.
- Perfect knowledge about market and technology.
- Perfect mobility.
- Absence of transport cost.
- Demand curve.
Short-Run Equilibrium: Under perfect competition all firms don’t earn profits. In terms of short-term profitability operating firms can be classified into three broad categories:
- Firms earning profit : Firms earn profits when its average cost is lower than its price/average revenue.
- Firms first break-even : In then SR, there are some firms which earn only normal profits. There are some firms which just break-even.
- Firms making profits: Firms suffer loses when their SRAC is higher then price. For such firms price exceeds their average variable cost.
Long -Run Equilibrium: Firms in perfect competition in long run only break-even or earn zero profits. No firms has an incentive to exist in this situation. As firms are earning zero profits in breaking even situation, there’s no incentive to enter the industry either.