Demand in economics is defined as how many goods and services are bought at various prices during a certain period of time. In other words, we can say that demand is the consumer’s need or desire to own the product. Consumers standard market function is downward sloping because a rational consumer will demand more of a commodity when its price falls.The factors responsible for the downward sloping of the demand curve are:Law of Diminishing Marginal Utility: The law of diminishing marginal utility states that the satisfaction derived from a commodity will diminish with consumption of every successive unit. As a person increases consumption of a product whilst keeping consumption of other products constant the Marginal Utility a person derives from consuming each additional unit of that product declines. Accordingly, the consumer would be willing to pay less and less for each successive unit of that commodity.The Income Effect: It is one that reflects the change in the individual’s or economy’s income and shows how that change impacts the quantity demanded of a good or service.
There is a direct relationship between income and demand. As income falls demand falls too as the purchasing power of the income (real income) has fallen. This is called the income effect of a price rise or price drop.
The Substitution Effect: When prices rise or income decrease consumers will replace more expensive items with less costly alternative.Profit Maximization condition in a perfect competition:Perfect competition occurs in a structure when there are many firms producing homogenous products with none being large enough to influence the industry. There are no barriers to entry and the firms would be price takers as there is perfect information on prices and no firm can influence the price. In an existing market a price taker can sell as much as it can produce. Therefore, the total revenue (TR) will be p*q where p=price and q=quantity. The average revenue (AR) would be the total revenue divided by quantity. The Marginal Revenue (MR) is the change in total quantity divided by the change in revenue. In this scenario market price of the good is $ 35 and the firm in question produces 5 units of goods per day then its total revenue for the day will be $35*5= $175.
The marginal revenue(MR) related with producing the sixth unit per day would be the market price $35 and the total revenue(TR) per day would increase from $175 to $210($35*6).Marginal costs will change, depending upon the quantity produced. The firm would expect the firm to increase input up to the point where marginal cost(MC) is equal to the market price. In the short run, a firm will produce as long as its average variable costs do not exceed the market price. If the market price is less than the firm’s total average cost(TVC), but greater than its average variable cost(AVC), then the firm will still operate in the short run. Its losses will be lowered by producing, since nothing can be done about fixed costs in the short run.
Over the long run, the firm will need to cover all of it costs if it is to keep on producing. If the market price at least covers the firm’s variable costs, it may make sense to keep on operating. Any price in excess of the average variable cost will at least help to cover the fixed cost. Unless the firm decides to completely leave the business, it will come out ahead by continuing to operate.If the market price is below the firm’s average variable cost, it will not make sense for the firm to operate as it will lose even more money. If the firm believes that business conditions will improve, it will temporarily shut down. Seasonal businesses might shut down temporarily during vacation period such as ski resorts or restaurants located at a certain time. Manufacturers temporarily might shut down a factory and plan to reopen the factory when business conditions improve.
A firm is said to be in equilibrium when it has maximized its profit. It is also called as the difference between total revenue (TR) and total cost (TC). The firm gives different outputs, at times it gives low and at times it gives high output which provides lower amount of profit to the firm. When the situation is nor high nor low i.e. equilibrium is obtained and it gives more profit.Once the firm has attained equilibrium, the firm doesn’t have any incentive to change its price and output because profit is already maximized.
The firm equilibrium is explained with the help of two approaches:1) Marginal Revenue and Marginal Cost approach (MR-MC approach).2) Total Revenue and Total Cost approach (TR-TC approach).The MR-MC approach will be used to explain short equilibrium. According to this approach, the firm is said to be in equilibrium if the following conditions are fulfilled:1. Marginal Cost is equal to Marginal Revenue i.e. (MC=MR).2.
Marginal cost cuts Marginal Revenue from below.3. Marginal cost cuts Average Cost from the minimum point. If these conditions are fulfilled then the firm is said to be in equilibrium i.e. Maximized profit.Market equilibrium is when the equilibrium price is the price of a good or service and when the supply of it is equal to the demand for it in the market.
(Source: www.economicshelp.org)The theory of perfect competition illustrates an extreme form of capitalism. In it firms are entirely subject to market forces. They have no power whatsoever to affect the price of the product. The price they face is determined by the interaction of demand and supply in the whole market. (Solman et al, P163)There are four assumptions on which the model of perfect competition is based, and these are: -1. Firms act as price takers.
Under perfect competition firms act as a price taker as there are many sellers selling the same type of commodity. Each firm produces a small portion of the entire supply of the industry and hence no firm can alone change the price of a product. 2.
There is free entry for the new firms and free exit for the existing sellers under perfect competition. Existing firms cannot restrict new firms from entering the market. For any new firm setting up takes time therefore competition to existing any new firms is applicable only in the long run. 3. Identical products are produced by all firms. Homogeneous products are identical in nature and they can be substituted easily for another product of the same nature. Therefore, there is no branding and advertising.
4. A situation of perfect knowledge prevails amongst the consumers and the producers. The producer of the commodity has perfect knowledge regarding the changes occurring with respect to prices, technology, costs and market opportunities. Whereas the consumer has perfect knowledge regarding the availability of the product, its quality and the price that prevails in the market.In a short run equilibrium under perfect competition there is too little time for new firms to enter the industry. (Sloman et al P 163) (Source: www.economicsonline.co.
uk) The determents of short run equilibrium are:Price: The price is determined in the industry by the intersection of market demand and supply. The firm faces a horizontal demand (or average revenue) curve at this price. It can sell all it can produce at market price (Pe). It would sell nothing at price above Pe however, since competitors would be selling identical products at a lower price.
Output: The firm will maximize profit where marginal cost equals marginal revenue(MR=MC) at an output Qe. Since the price is not affected by the firm’s output, marginal revenue will equal price. Thus, the firm’s MR curve and AR curve (=demand curve) are the same horizontal straight line. Profit: If the average cost(AC) curve (which includes normal profit) dips below the average revenue(AR) curve the firm will earn supernormal profit. Supernormal profit per unit at Qe is the vertical difference between AR and AC at Qe.