Markets again.In a perfectly competitive market, a firm may only generate excess profit or take a loss in the short period.
A company which is taking a loss in the short period may continue to produce goods, so long as their fixed costs are greater than their losses. Since fixed costs cannot be dispensed with in the short period, by continuing production, the firm still loses less than they would by producing nothing. In general, a firm will continue production so long as its revenue is greater than or equal to its variable costs. Only if variable costs are greater than revenue will a firm stop production in the short term.
In the long period, all factors can be changed. In the long period, neither excess profit nor loss is possible. If the industry shows excess profit, more firms will be inclined to enter the market, increasing supply, and therefore lowering the price until the excess profit is eliminated. Likewise, if the industry shows loss, firms will be inclined to leave the market, lowering supply, and therefore increasing the price until the loss is eliminated.
Therefore, in the long period of a perfectly competitive market, Marginal Revenue will always be equal to Marginal Cost, Average Revenue, and Average Cost at the point of production.
The opposite of a perfectly competitive market is a Monopoly. A monopoly situation means only one producer exists in a market, and therefore no competition exists. It also implies that no substitute exists for the product in question. In a monopoly situation, the monopolist has the power to fix the price.
Monopolies can be created by multiple methods
- Extreme capital requirements, that only one producer is willing to undertake
- Control over vital resources
- Exclusive licensing or government restriction of production
- Exclusive and desirable trademarks can create monopolies, but are highly subject to substitution
A monopolist’s demand curve is a downward slope, as usual for demand curves. For the monopolist, however, the average revenue and price line are equal to the demand at any given point. Marginal revenue for a monopolist is also downward sloping, but falls more quickly than demand.