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Posted on April 11th, 2014, by

In perfect competition, a company maximizes its profits by choosing a manufacturing output with which MR = MC = P. If the product price in the short time interval exceeds the average cost, the company receives an economic benefit. If the price is equal to the average cost, the company gets a normal (zero) profit. If the market price is lower than the average cost, the company bears a loss. Production temporarily stops if the commodity price falls below the minimum average variable costs (closing point) (Cukrowski & Aksen, 2003; Russell & Cohn, 2012).

For a long period, it is not possible, because under the conditions of free entering and leaving the industry, high profits in the industry attract other companies while unprofitable firms are leaving the industry. Under conditions of perfect competition in the long term, the following equality is observed (Cukrowski & Aksen, 2003):

MR = MC = AC = P.

Perfect competition helps to allocate the limited resources in such a way as to achieve maximum satisfaction of needs. This is provided under the condition that P = MC. This point means that the companies will produce the maximum possible quantity of products until the marginal costs of the resource are equal to its price. Perfect competition forces the companies to produce products with a minimum average cost and sell it at a price that matches the cost. If the market price (P) is set above the average long-term cost of a typical company, i.e. P>LATC, the company starts getting a positive economic profit. Other companies enter the industry, the market supply shifts to the right, and with the same market demand the price falls to the equilibrium level (Cukrowski & Aksen, 2003; Russell & Cohn, 2012).

Thus, the process of companies entering and leaving the industry will continue until the long-term equilibrium is established. It should be noted that in practice, the regulating market forces work better for the extension than for the compression. Economic profit and free entry to the market actively stimulate the increase of industrial production. On the contrary, the process of pushing the companies away from over-expanded and loss-making industry takes time and is extremely painful for the participating companies (Dietsch, 2010).

While observing the phenomena of economic crisis, a conclusion was made that this form of competition is usually fails and can recover only with the outside interference (Machovec, 1995; Russell & Cohn, 2012). However, the model of perfect competition:

  • allows exploring the markets with a large number of small companies selling homogeneous products, i.e. the markets close in the terms to this model;
  • clarifies the conditions of profit maximization;
  • is the standard for evaluating the effectiveness of the real economy.

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