Perfect competition is that state of the market in which the price of a commodity is determined on the basis of total demand and supply of the industry. In this condition, each firm has to sell its commodity at that very price. Firm is not a price determiner but a price accepter. Hence, the marginal revenue curve of the firm in this situation is a straight line parallel to the X axis.
The marginal cost curve is a perfect U-shaped curve in perfect competition market as it is in any other market, since it is affected by laws of production.
In a perfect competition market, the firm’s equilibrium lies at a point,
where the following two conditions are met –
- Where marginal revenue (MR) is equal to marginal cost (MC).
- Where the marginal cost curve cuts the marginal revenue curve from below.
This can be shown by the following figure :
Explanation of the figure :
At point E, the marginal revenue (MR) is equal to the marginal cost (MC). Also at this point, the MC curve cuts the MR curve from below. Hence, both conditions of equilibrium are being fulfilled at this point. This is the firm’s equilibrium point and OQ is the equilibrium quantity.
In contrast, if the firm produces equal to ON, the first condition of equilibrium, since marginal revenue is equal to marginal cost, but the second condition is not fulfilled, because at this point the marginal cost curve is not cutting the marginal revenue curve from below. Hence, the firm cannot earn maximum profit at this point. Thus, this is not a state of equilibrium.
