Equilibrium Under Perfect Competition In The Factor Market
When there is perfect competition. an individual firm cannot influence the price of a factor, by buying more or less of it, because its own demand for the factor constitutes a small fraction of the total demand. Consequently, a finn has to accept the price of a factor. say. labor. prevailing in the market (i.e., wage) as given. Similarly, n.o individual supplier of a factor supplies an appreciable quantity thereof so as to be able to affect its price ill the market. In this case. therefore. marginal factor cost (MFC) and average factor cost (AFC) will tend to be equal and their curves will be the same or they will coincide. and will be a horizontal straight line as in the case uf product prices. In the commodity market also. under perfect competition. marginal revenue (MR) and average revenue (AR) arc equal aim they arc represented by horizontal straight line.
MRP is the marginal revenue productivity curve and the same curve represents the value of marginal pro conductivity (YMP). because we assume perfect competition in the product market. PW horizontal straight line represents bush marginal factor cost MFC and average factor cost AFC. This firm will obtain maxi- mum profit where marginal revenue productivity (MRP = YMP) is equal to the marginal factor cost (MFC). They are equal at the po nt E where the two curves intersect. At the point f equilibrium. Ihe firm will employ ON quantity of the f tor and pay 01′ (= EN) as the price or wage the position of maximum profit.
In the diagram, it I be seen that these curves intersect also at an e r int. T. But this cannot be the position of ma i profit. since at this point
marginal revenue ( 1RP) is still rising, whereas the factor the same. Hence the producer will not top at conduct to employ more labour till he falling. It is thus clear that E int of equilibrium. We can. therefor Ie that a purely competitive producer m h rt run profits (or minimizes 10 only he employee each productive resource or t: tor of production up to the point where the al It. marginal product equals the market price of the factor,
Thus. under perfect competition. since marginal factor cost ( IFC) is equal to average factor cost (AFC), at equilibrium marginal revenue productivity (MRP) is equal to marginal factor cost. it is also equal tu average factor cost. This means that for a firm to be in equilibrium in a competitive factor market. two condition. must be satisfied, (I 1RP = MFC f 21 1RP curve must cut the MFC curve from above. From the above diagram . we cannot say whether the firm makes a profit or incurs a loss and if there is profit how much’! This we shall be able to know from the following diagram In this diagram ARP is the average revenue productivity curve and MRP is the marginal revenue productivity curve, MRP curve cuts the ARP curve at its highest point E. At the OW’ wage level. the equilibrium will be at E’. Here there is extra profit per unit E’ L’. This is however, a short-run situation. III the long-run new firms will enter the Indus try because super-normal profit is being made. when the new firms enter, the demand for labor will n crease : hence the wage level will go up to OW, w here E is the point of equilibrium. Here super-normal pr fit ha disappeared, because wage is equal to avers e revenue productivity. If on the other hand, the vague level is OW”. the equilibrium will be at E”. In case, the wage is higher than the average revenue productivity. Hence, there is loss instead of profit. In the long-run, therefore, some firms will leave the ind try; the demand for labor will decrease till the age level comes down to OW and the loss will disappear The equilibrium at E will be restored and the wage will be OW. Here, the wage is equal both to ARP and RP. Thus. we conclude that, under competitive conditions wall’s tend in the lolTUn to equal marRillal revenue P’ maturity average revenue