Perfect competition:

Perfect competition is a market structure characterized by several key features:

1. Many Buyers and Sellers: In a perfectly competitive market, there are numerous buyers and sellers, which means that no single entity can influence the market price or quantity significantly.
2. Sellers Are Price Takers: Each individual firm in a perfectly competitive market is so small relative to the entire market that it can only sell its products at the prevailing market price. Firms have no pricing power; they take the market price as given.
3. Free Entry and Exit: Firms can freely enter or exit the market without significant barriers. There are no legal or economic barriers that prevent new firms from participating in the market.
4. Perfect Knowledge: Both buyers and sellers have perfect knowledge about the market. This means that they are fully aware of the prices, products, and terms of trade in the market.
5. Homogeneous Goods: Products offered by different firms are identical or perfect substitutes for one another. This is often referred to as product homogeneity.
6. Firms Are Short-Run Profit Maximizers: In the short run, firms aim to maximize their profits. This means they may continue operating even if they are making economic losses in the short term.
7. Factors of Production Are Perfectly Mobile: Factors of production, such as labor and capital, can easily move between industries or firms in response to changes in market conditions.

In a perfectly competitive market, the price of the product is determined by the interaction of market demand and market supply. Due to the presence of many sellers, each with a negligible market share, no single firm can significantly influence the market price. As a result, profits in perfectly competitive markets tend to be minimal, and prices are driven down to a level where they are in line with the average cost of production. If any firm in a perfectly competitive market earns economic profits, new firms are likely to enter the market, increasing supply and driving down prices until profits are reduced to a normal level. This process ensures that firms in perfect competition earn only normal profits in the long run.

Short-Run Profit Maximization:

• Firms in a perfectly competitive market aim to maximize profits in the short run. To achieve this, they will produce the quantity of output where marginal cost (MC) equals marginal revenue (MR).
• If the market price (determined by the intersection of market supply and demand) exceeds the firm's average total cost (ATC) at this level of output, the firm earns supernormal profits.
• If the market price equals the firm's ATC, the firm earns normal profits.
• If the market price is below the firm's ATC but above its average variable cost (AVC), the firm operates at a loss but may continue to produce in the short run.
• If the market price falls below AVC, the firm may choose to temporarily shut down its production because it cannot cover its variable costs. In this case, it incurs short-run losses.

Long-Run Equilibrium:

• In the long run, if firms in a perfectly competitive market are earning supernormal profits, new firms are likely to enter the market because there are no significant barriers to entry.