Which of the following statements are true regarding price and output determination under perfect competition? A. A firm is a price taker B. In the long run, a firm is in equilibrium when its AR = MR = LAC = LMC C. A firm is in equilibrium in the short run only when its AC = AR = MR = MC D. A firm reaches its shut-down point when price goes below its AC E. A firm fixes the price of its products when AR = MR Choose thecorrectanswer from the options given below:
A and B only
Understanding Price and Output Determination in Perfect Competition
Perfect competition is a market structure characterized by a large number of buyers and sellers, homogeneous products, perfect information, and free entry and exit. In such a market, individual firms have no control over the market price and must accept it as given. This behavior influences how price and output are determined for a firm in both the short run and the long run.
Analysis of Statements on Perfect Competition
Statement A: A firm is a price taker
In a perfectly competitive market, there are numerous small firms, none of which is large enough to influence the market price. The market price is determined by the overall market demand and supply. Individual firms simply have to accept this market price to sell their products. They are so small relative to the market that their individual output decisions do not affect the price. Therefore, a firm in perfect competition is indeed a price taker.
This statement is true.
Statement B: In the long run, a firm is in equilibrium when its AR = MR = LAC = LMC
In the long run under perfect competition, firms can freely enter or exit the market. This free entry and exit ensures that in long-run equilibrium, firms earn only normal profits. Normal profits occur when the price (which is equal to Average Revenue, AR, and Marginal Revenue, MR, for a price taker) is equal to the minimum point of the Long-run Average Cost (LAC) curve. At this minimum point, the Long-run Marginal Cost (LMC) curve intersects the LAC curve. Thus, the long-run equilibrium condition for a perfectly competitive firm is where Price $= \text{AR} = \text{MR} = \text{LAC} = \text{LMC}$. The equality with LAC represents the normal profit condition, and the equality with LMC represents the profit-maximizing (or loss-minimizing) output level.
This statement is true.
Statement C: A firm is in equilibrium in the short run only when its AC = AR = MR = MC
A firm's short-run equilibrium position is determined by the condition where Marginal Cost (MC) equals Marginal Revenue (MR), provided that MC is rising. Since the firm is a price taker, Price $(\text{P}) = \text{AR} = \text{MR}$. So, the short-run equilibrium condition is $\text{P} = \text{MR} = \text{MC}$ (with MC rising). At this equilibrium output level, the firm could be making supernormal profits (if $\text{AR} > \text{AC}$), normal profits (if $\text{AR} = \text{AC}$), or suffering losses (if $\text{AR} < \text{AC}$). The condition $\text{AC} = \text{AR} = \text{MR} = \text{MC}$ describes a specific scenario within short-run equilibrium where the firm earns normal profits. It is not the only condition for short-run equilibrium. A firm is in equilibrium as long as $\text{MR} = \text{MC}$ and price is above the shut-down point.
This statement is false because equilibrium does not require $\text{AC} = \text{AR}$ in the short run.
Statement D: A firm reaches its shut-down point when price goes below its AC
The shut-down point in the short run is the level of output where the firm is just covering its Average Variable Costs (AVC). If the market price falls below the minimum AVC, the firm will not even be able to cover its variable costs, and it would be better to shut down temporarily to minimize losses (losses would equal fixed costs). If the price is below Average Total Cost (AC) but above AVC, the firm is incurring a loss but should continue to produce because it is covering all variable costs and contributing towards fixed costs. The shut-down decision is based on AVC, not AC.
This statement is false.
Statement E: A firm fixes the price of its products when AR = MR
As established in Statement A, a perfectly competitive firm is a price taker. It does not fix the price. The condition $\text{AR} = \text{MR}$ is always true for a price-taking firm because the price per unit is constant, meaning each additional unit sold adds the same amount (the price) to total revenue. This equality describes the revenue relationship for a price taker, not the process by which the firm sets a price.
This statement is false.
Summary of Statement Analysis
Based on the analysis:
- Statement A is true.
- Statement B is true.
- Statement C is false.
- Statement D is false.
- Statement E is false.
Therefore, the statements that are true regarding price and output determination under perfect competition are A and B.
Revision Table: Key Conditions in Perfect Competition
| Condition | Short Run Equilibrium | Long Run Equilibrium | Shut-down Point (Short Run) |
|---|---|---|---|
| General Rule | MR = MC (and MC is rising) | MR = LMC = Minimum LAC | Price < Minimum AVC |
| Profit Position | Supernormal Profit ($\text{P} > \text{AC}$), Normal Profit ($\text{P} = \text{AC}$), or Loss ($\text{P} < \text{AC}$) | Normal Profit ($\text{P} = \text{LAC}$) | Loss (equal to or greater than total fixed cost) |
| Price Taker | Yes ($\text{P} = \text{AR} = \text{MR}$) | Yes ($\text{P} = \text{AR} = \text{MR}$) | Yes ($\text{P} = \text{AR} = \text{MR}$) |
Additional Information on Perfect Competition Output Decisions
To understand output determination under perfect competition, it's crucial to remember the firm's objective: profit maximization. In the short run, the firm will produce the output level where MR = MC. If MR > MC, the firm can increase profit by producing more. If MR < MC, the firm should reduce output. Since $\text{P} = \text{MR}$ for a price taker, the firm produces where $\text{P} = \text{MC}$.
The short-run supply curve of a firm under perfect competition is its marginal cost curve above the minimum point of the average variable cost curve. Below this point, the firm shuts down, and its output is zero.
In the long run, the entry and exit of firms ensure that the market price adjusts until it equals the minimum point of the LAC curve for all firms. This ensures that all firms earn zero economic profit (i.e., normal profit). The long-run market supply curve is typically horizontal at this minimum LAC price if all firms have identical costs.
Important Questions from Price determination under different market forms
‘Oligopoly’ refers to:
Which of the following statements regarding price and output determination under monopoly are correct?
A. A monopoly firm can fix its price anywhere along its demand curve
B. Even during short run when a monopoly firm earns normal profit, it produces less than its optimum capacity
C. The slope of monopoly's MR curve is twice the slope of its AR curve
D. Price discrimination is possible only when demand curves are identical in two markets
E. Equilibrium price of a monopolist is always higher than that of a perfectly competitive firm.
Choose thecorrectanswer from the options given below:
A price ceiling below the equilibrium price of a commodity leads to
A. Commodity glut in market
B. Shortage of commodity
C. Demand erosion
D. Black marketing
Choose the correct answer from the options given below:
Given below are two statements, one is labelled as Assertion A and the other is labelled as Reason R
Assertion A: An oligopolist firm cannot decide the price it wishes to charge as well as the quantity it wishes to sell, both at the same time.
Reason R: An oligopolist firm takes into consideration the competitor's actions and counter actions because of a strong interdependence among the competitive firms
In light of the above statements, choose the most appropriate answer form the options given below
Firm A acquirers firm B. Market price of shares of B is Rs. 20 per share and EPS is Rs. 5. For an exchange ratio of 1.5 ∶ 1, what was the P/E ratio used in acquiring firm B ?
