Q4Managerial Economics & Financial Accounting
Question
"A competitive firm is not a price maker, but adjustor." Explain this statement with reference to price determination in long and short term under perfect competition. (4+6=10)
Answer
A competitive firm takes the market price and adjusts its output to maximize profit where MR=MC in both short and long terms.
Under perfect competition, a single firm is too small to influence the market price. The market demand and supply determine the price. The firm must simply "take" this price, making it an adjustor (it can only adjust its output, not its price).
Short Term: The firm adjusts output to the point where . It may earn supernormal profits, normal profits, or incur losses, depending on its Average Cost. Long Term: Due to free entry and exit, supply adjusts. If there are profits, new firms enter, supply rises, and price falls until all firms earn only normal profits (). Thus, the firm continually adjusts to market forces.