Price Determination under Perfect Competition

In a perfect market, prices are determined and fixed by the forces of demand and supply. This implies that under perfect market, not one firm or producer can influence the price of a commodity. Therefore, a perfectly competitive firm has horizontal price line which makes the demand curve perfectly elastic. Quantity Determination under Perfect Competition The perfect competitive firm produces the most profitable output where its MARGINAL COST equals MARGINAL REVENUE (i.e., MC = MR) If the firm produces beyond this point, the Marginal Cost will be higher than the Marginal Revenue bringing about decrease in profits.

Short-run Situation of a Perfect Competitor
It is possible for a perfect competitive firm to make abnormal profit in the
short-run because its MARGINAL AND AVERAGE COSTs fall as output
increases. So, it can sell at a price higher than the average cost in the short-
run thereby earning abnormal profit or super profit.
The shaded portion in the diagram below represents the abnormal or super
profit of a perfect competitive firm in the short-run. Here, Price or Average
Revenue is higher than the average cost of production i.e., P or AR > AC.

Long-run Situation of a Perfect Competitor
The abnormal profit of a perfect competitor is wiped-off in the long run due
to much competition encouraged by free entry into the market. As more
firms join the market to partake in the short-run abnormal profit, output
expands and price falls till price or average revenue equals average cost (i.e.,
AR=AC), where normal profit is made. So, a perfect competitor can only
make normal profit in the long-run where AR = AC.
Therefore, firm is at equilibrium where: