Principle of Microeconomics (BCOG-171)

Opportunity cost is the value of the next best alternative foregone. For example, if a student uses 3 hours to study economics instead of working part-time, the wages he could have earned are the opportunity cost of studying. Similarly, using land for wheat means sacrificing production of some other crop.

Movement along a demand curve occurs due to change in price of the commodity, causing expansion or contraction of demand. Shift of demand curve occurs due to changes in other factors like income, tastes, prices of related goods, expectations etc., causing increase in demand (right shift) or decrease in demand (left shift).

Perfect competition is a market structure with a large number of buyers and sellers, homogeneous product, free entry and exit and perfect knowledge. Because each firm is very small relative to the market, it cannot influence price and hence is a price taker.

Price determination: Industry price is determined by market demand and market supply. A single firm accepts this market price. Therefore, for a competitive firm, AR = MR = Price and the firm’s demand curve is horizontal.

Short run equilibrium: The firm maximises profit where MR = MC. Since MR = P, equilibrium output occurs where P = MC. If at this output P > AC, the firm earns supernormal profit; if P = AC, it earns normal profit; if P < AC but P ≥ AVC, it continues in short run to minimise loss. If P < AVC, the firm shuts down.

Long run equilibrium: In the long run, entry and exit of firms occur. Supernormal profits attract new firms, increasing supply and reducing price. Losses cause firms to exit, reducing supply and raising price. Long run equilibrium is reached when firms earn only normal profit and there is no incentive to enter or exit. The condition is P = MR = MC = AC, and the firm produces at minimum AC.

Thus, perfect competition leads to normal profit in the long run and efficient allocation of resources.