Perfect Competition — Price and Output Determination

Under perfect competition, an individual firm faces a perfectly elastic (horizontal) demand curve at the price fixed by the interaction of total market demand and total market supply — the firm can sell any amount at this given price but cannot influence it by its own action. This means $AR = MR = \text{Price}$ for a perfectly competitive firm, shown as a single horizontal line.

A profit-maximising firm chooses the output at which its Marginal Cost (MC) equals its Marginal Revenue (MR) — the general profit-maximisation rule that applies to a firm under ANY market structure. Since $MR=\text{Price}$ under perfect competition specifically, the equilibrium condition simplifies to:

with the additional requirement that MC must be RISING at that point — this is exactly why a perfectly competitive firm's short-run supply curve is its own rising-MC curve, from the point where MC cuts AVC upward.

Short-run possibilities. In the short run, price is given by the market and may not cover the firm's full average cost; four cases can arise depending on where the given price cuts the firm's cost curves:

• If $P > ATC$ at the equilibrium output, the firm earns super-normal (abnormal) profit.
• If $P = ATC$, the firm earns exactly normal profit — it just covers all its costs, including the entrepreneur's implicit reward.
• If $AVC < P < ATC$, the firm makes a loss but continues producing in the short run, because production still covers all variable cost and part of fixed cost — stopping would mean losing the ENTIRE fixed cost instead of only part of it.
• If $P < AVC$, the firm minimises its loss by shutting down immediately (the shutdown point), since continuing would not even cover variable cost, adding to the loss beyond the unavoidable fixed cost. …