Firm and Market in Short Run in Perfect Competition

In this article, we will briefly explain the Firm and Market in Short Run in Perfect Competition.

We will examine the three important cases – Super normal profits, normal profits and losses.

Case 1: Super normal profits or positive economic profits:

Here equilibrium price is P*, equilibrium quantity is Q*, where MC=MR. This is the output the company will produce.

But here at output OQ*, if the average total cost (ATC) is below the price per unit, then profits per unit is AB.

Since profits per unit = Price per unit – ATC

AQ* – BQ* = AB

Thus total profits is Profit per unit × Quantity

AB × OQ*

These are positive economic profits or super normal profits.

Case 2: Normal profits or zero economic profits:

Here equilibrium price is P*, equilibrium quantity is Q*, where MC=MR. This is the output the company will produce.

But here at output OQ*, if the average total cost (ATC) is at the price per unit, and so profits per unit is zero.

Since profits per unit = Price per unit – ATC

AQ* – AQ* = 0

Thus total profits is Profit per unit × Quantity

0 × OQ* = 0

These are zero economic profits or (as they are also called) normal profits.

Thus here you are making accounting profits, meaning you are taking money home, but that is exactly equal to your opportunity cost.

Thus this is an equilibrium situation, since you do not have any tendency to make a change.

Case 3: Losses:

Here equilibrium price is P*, equilibrium quantity is Q*, where MC=MR. This is the output the company will produce.

But here at output OQ*, if the average total cost (ATC) is OP1 or Q*B while price per unit is AQ*.

Thus we have losses per unit of AB.

Since profits per unit = Price per unit – ATC

BQ* – AQ* = -AB = Losses.

Thus total losses = Losses per unit × Quantity

AB × OQ* = P1BAP

This is a situation where the firm is incurring losses.