Short-run Equilibrium of firm and industry:-
Short-run refers to that time period in which a firm can not change the fixed factors of production. Therefore, a firm cannot change its production process and there may be abnormal profit, normal profit or even loss depending on the firm’s revenue and cost. The profit and loss also depends upon the nature of AC and AR, which can be presented as follows:-
- If AR=AC, the firm receives a normal profit.
- If AR> AC, the firm receives abnormal profit.
- If AR< AC, the firm bears the loss.
The profit and loss depend also on the nature of MR and MC and the following conditions must be fulfilled in order to obtain equilibrium in the perfect competition market:
- Market supply must be equal to market demand.
- MC must be equal to MR.
- MC must cut MR from below.
The short-run equilibrium of the firm and industry under perfect competition can be explained by the help of the following diagrams:-
In the above figures, we can see the equilibrium price determination in the industry in the first figure. In the second, third, and fourth figures, the conditions of equilibrium in three different firms are shown under perfect competition, in the short run. There are three possibilities which are as follows:-
1. Abnormal profit (supernormal or excess profit):-
The second figure shows the abnormal profit earned by the firm. The firm earns an abnormal profit when AR is greater than AC. In this figure, E is the equilibrium point because here MR and MC are equal and MC is intersecting MR from below. So, OQ is the equilibrium quantity. The firm is earning abnormal profit equal to the shaded rectangular area. The firm’s average cost of production is ‘OC’.
2. Normal profit:-
In the third figure, the firm is in equilibrium at point E. Because at this point MC is intersecting MR from below. The equilibrium output is OQ. The firm is earning just a normal profit because AR and AC are equal at this level of output. It is that profit which is just sufficient to run the business.
In the fourth figure, the firm is in equilibrium at point E because, at this point, both necessary and sufficient conditions are fulfilled. The equilibrium output determined by the firm is OQ. At this output, AC is greater than AR. So, the firm is bearing loss equal to the shaded area.