The Theory Of The Firm Under Perfect Competition - Class 11 Commerce Economics - Extra Questions

Price elasticity of supply is a measure of the degree of responsiveness of quantity supplied to  change in the product's own price. Price and supply move in the same direction hence price elasticity of supply is positive.

price of pen	supply of pen
5	10
10	20
15	30
20	40
25	50

Supply schedule is a table showing different quantities of  commodity that an individual firm is ready to sell at different prices.

Individual supply schedule for apples.

Price (Rs/kg)	Qty Supplied (Kgs)
10 20 30 40 50	2 4 6 8 10

As seen in the figure, a perfectly elastic supply curve is the one in which the supply curve is perfectly horizontal. It is a theoretical curve and such a curve does not actually exist in practice. What the curve actually explains is that a supplier can sell at a particular price an infinite quantity of goods and a small decrease in the price of a quantity can reduce the quantity which is supplied by a supplier to zero because it becomes unprofitable for a supplier to sell at a even a slightly reduced price.

2) Geomtric method: Geometrically, elasticity os supply depends on the origin of the supply curve.

Price elasticity of supply = % change in quantity supplied / % change in price

Opportunity cost of production of a commodity refers to the cost which the producer has to sacrifice in terms of the next best alternative which could be produced out of that cost in order to produce every unit of the given commodity in the economy. 

The total opportunity cost of production of a commodity refers to the total cost which the producer has to sacrifice in terms of the next best alternative which could be produced out of given resources and technology in order to produce the total units of the given commodity.

When percentage change in quantity supplied is greater than the percentage change in own price of commodity, supply is said to be elastic.

Supply schedule is a table showing various quantities of a commodity offered for sale corresponding to different possible prices at a point of time. It is the tabular depiction of the relationship between price and quantity supplied, represented graphically as a supply curve.

Yes, in long period, all factors are variable factors, while in the short period, some factors are fixed and some are variable. Accordingly, while in the long period supply can be increased by employing more of all the factors, in the short period supply can be increased by employing more of the variable factors only.
Thus, supply can be increased to a much larger extent in the long period compared to short period. Therefore, it is more responsive to price in the long period compared to the short period.

Supply curve is a graphic presentation of supply schedule, indicating positive relationship between price of a commodity and its quantity supplied. 

Profits are said to be normal when TR=TC or AR=AC. Normal profits are defined as the minimum return that the producer expects from his capital invested in the business. Normal profits are a part of total cost.

The rising segment of the firm's MC curve (Starting from the break-even point, when price$$=$$ average cost) represents the firm's supply curve in the long run.
The long-run is a period in which supply can be changed by changing all the factors of production.
There is no distinction between fixed and variable factors. In the long run, the firm produces only at minimum average cost.

Sub-normal profits or losses occur when: TR<TC OR AR<AC. When the total revenue obtained by the firm is lesser than the total costs, then the firm incurs, sub-normal profits or losses.

The equilibrium of a firm occurs when $$MR = MC$$ and $$MC$$ is rising. In state of losses, $$TR < TC$$ or $$AR < AC$$, however, the firm may still be able to attain equilibrium at $$MR=MC$$. Production, in this case, continues in the short run as long as variable costs are being covered. Total losses in this case would be limited to the total fixed costs of the firm, which it will still have to bear in the short run even if the it stops production.

Normal profit is defined as the minimum return that the producer expects from the capital invested in the business. If this minimum return is not available, he will withdraw his capital from the existing use and shift it to the next best alternative use. Therefore, normal profit is a part of total cost.

At break-even point, a firm makes normal profits. At this point, total revenue and total cost are equal.Profits are said to be normal when TR=TC or AR=AC. Normal profits are defined as the minimum return that the producer expects from his capital invested in the business. Normal profits are a part of total cost.A firm reaches shut-down point when: AR=AVC.When a firm is able to cover its variable costs only, it will be at shut-down point.  At shut-down point, the firm no longer gets benefits from its operations.

Perfect competition is a form of the market in which there is a large number of buyers and sellers and where homogeneous product is sold at a uniform priceA price taker firm means that it has to accept the price as determined by the forces of market demand and market supply.Firm's demand curve under perfect competition is a horizontal straight line parallel to X-axis.Under perfect competition, AR is constant for a firm. Hence, AR = MR.

When $$AR = AVC$$, the firm is is just able to cover its variable cost in the short-run. The loss that the firm is incurring in this case is of the total fixed cost, which it would still have to bear if it decides to stop operating in the short run. Thus, a firm is expected to operate in the short-run until it is able to cover its variable costs, though it may also decide to suspend production of the commodity for the time being.

Shut-down point occurs when a firm is just able to cover its variable cost, which means $$TR=TVC$$ in the short-run. The loss that the firm is incurring in this case is the total fixed cost, which it would still have to bear if it decides to stop operating in the short run. Thus, a firm is expected to operate in the short-run until it is able to cover its variable costs, though it may also decide to suspend production of the commodity for the time being.
The firm would exit the industry when it is not able to cover all its costs, i.e. when $$TR<TC$$ or $$AR<AC$$ in the long run.

No, in the long run a firm will not operate if it is incurring losses.
Yes in the short run. In the short run, a firm continues to cope with losses so long as $$AR \geq AVC$$, because, by covering variable costs, the firm is incurring the loss of fixed cost only which it has to incur even when production is discontinued.

Perfectly competitive market structure refers to that form of the market in which there is a large number of small producers. An individual producer exercises no control over the market. His production is only a small fragment of the total market supply. He exercises no control over price. He can sell any quantity at the given price. The producers earn only normal profits in the long run.
Competitive market structure under oligopoly refers to that form of the market in which there are a few big firms producing a commodity. Each firm has a significant share of the market. Accordingly price and output policy of one firm significantly impacts the price and output policy of the rival firms There is a high degree of interdependence among firms which leads to cut-throat competition. Each firm tries to increase its share of the market through innovative technology and by introducing innovative products in the market.Both these market structures are suitable for the growth and development of the Indian economy. But in different areas of production activity.Perfectly competitive market structure is most suited in the area of retail trade. In fact, already our retail trade is like a perfectly competitive market. Being dominated by a large number of small producers, retail trade in India is generating lots of employment opportunities. We understand how important it is in a country like India which is highly overpopulated and has a huge reserve of employable population.On the other hand, there are certain areas of production which need huge investment and innovative technology. These include automobile industry, civil aviation, software engineering, defence goods industry, and the like. India lacks funds for investment as well as the innovative technology. Accordingly, we have to depend on 'multinational corporations'. These are global enterprises but a few in number. FDI (Foreign Direct Investment) by these enterprises would definitely lead to the emergence of oligopoly market structure. But this is the only way we can achieve growth in such areas of production activity which need high investment and innovative technology.

Yes, it is true. Equilibrium price will remain unchanged when supply is perfectly elastic whether demand increases or decreases. See fig. Here, price remains constant at OP when demand increases to $$ { D }_{ 1 } $$ and also remains constant at OP when demand decreases to $$ { D }_{ 2 } $$.

Opportunity cost of production of a commodity refers to the cost which the producer has to sacrifice in terms of the next best alternative which could be produced out of that cost in order to produce every unit of the given commodity. So when Rahul select the job offering 30,000 rupees, he will sacrifice 25,000 of another job and when he selects job offering 25,000 rupees, he will sacrifice 20,000 rupees which becomes the opportunity cost of the following selections. 

Opportunity cost of production of a commodity refers to the cost which the producer has to sacrifice in terms of the next best alternative which could be produced out of that cost in order to produce every unit of the given commodity. Therefore, the opportunity cost for celebrating birthday will be the total amount spent on the birthday occasion which is 400+20= 420 rupees. 

Given, percentage change in quantity supplied $$= (-) 75\%$$
$$P = Rs. 12; P_{1} = Rs. 9; \triangle P = P_{1} - P = Rs. 9 - Rs. 12 = (-) Rs. 3$$
Percentage change in price $$= \dfrac {\triangle P}{P}\times 100$$
$$= \dfrac {-3}{12}\times 100 = (-) 25\%$$
Price elasticity of supply $$(E_{S}) = \dfrac {\text {Percentage change in quantity supplied}}{\text {Percentage change in price}}$$
$$= \dfrac {(-) 75\%}{(-)25\%} = 3$$
Price elasticity of supply $$= 3$$.

Inversely.

The quantity that all the producers are willing to produce and offer for sale at a particular price during a specified period is known as market supply.

Market supply curve is a graphical representation that lists the quantity supplied for a good or service that suppliers throughout the whole economy are willing and able to supply at all possible prices.

The percentage change in quantity supplied due to a percentage change in the market price of the goods is called price elasticity of supply.

Natural factors are particularly important for the supply of agricultural products. Natural factors like drought, flood, unfavourable climatic conditions, etc. affect the supply.

The percentage method of elasticity of supply is the ratio of percentage change in quantity supplied to a percentage change in its price.
Es = % Change in Quantity supplied  / % Change in price. 

Unitary elasticity of supply refers to a situation when the percentage change in quantity supplied of a commodity is exactly equal to the percentage change in its price.

Perfectly inelastic supply is the supply where, there is no supply response, no matter how large a price.

A perfectly elastic supply represents a case in which the quantity supplied of a commodity responds by an infinite amount to a very small change in price.

The point method of elasticity of demand is used to measure the elasticity of supply at a given point on the supply curve. That is why it is also known as geometric method measuring elasticity of supply.

Supply is said to be inelastic when the percentage change in quantity supplied of a commodity is less than the percentage change in its price.

Supply is said to be elastic when the percentage change in the quantity supplied of a commodity is greater than the percentage change in its price.

If resources can be shifted easily from production of other production to production of the other product whose supply has increased then the price elasticity will be more hence higher the factor of mobility greater the elasticity.

Determinants of elasticity of supply are: 
1. Cost of production;
2. Time factor;
3. Nature of commodity;
4. Techniques of production;
5. Factor mobility;
6. Risk taking;
7. Expectation about future prices.

The elasticity of supply is determined by the willingness of the entrepreneurs to take risks, hence the higher the risk greater the elasticity. This is called risk-taking in the elasticity of supply.

Break-even for a firm occurs when it is able to cover its all costs of production that is neither profit nor loss. This situation prevails at the point where total cost is equal to total revenue. i.e. TR = TC.

Shut Down Point is defined as a situation when TR=TVC or AR=AVC. It occurs when firm is just able to cover its variable costs, incurring the loss of fixed cost of production.

Following are the two reasons for the supply of a product to be price inelastic:

1. Running out of raw materials: There will come a time when we run out of raw materials – oil, natural gas. When this occurs, the supply will be inelastic because it is physically impossible to increase supply.
2. Short term: Supply will be more inelastic in the short term. In the short term, capital is fixed. It takes time to invest and increase the size of a factory.

Following are the types of elasticity of supply:

1. Perfectly Elastic Supply: When there is an infinite supply at a particular price and the supply becomes zero with a slight fall in price, then the supply of such a commodity is said to be perfectly elastic. In such a case Es = and the supply curve is a horizontal straight line parallel to the X-axis, as shown in Fig.
2. Perfectly Inelastic Supply: When the supply does not change with change in price, then supply for such a commodity is said to be perfectly inelastic. In such a case, Es = 0 and the supply curve (SS) is a vertical straight line parallel to the Y-axis as shown as in Fig.
3. Highly Elastic Supply: When percentage change in quantity supplied is more than the percentage change in price, then supply for such a commodity is said to be highly elastic. In such a case, Es > 1 and the supply curve has an intercept on the Y-axis as shown in Fig.
4. Less Elastic Supply: When percentage change in quantity supplied is less than the percentage change in price, then supply for such a commodity is said to be less elastic. In such a case, Es < 1 and the supply curve has an intercept on the X-axis as shown in Fig.
5. Unitary Elastic Supply: When percentage change in quantity supplied is equal to percentage change in price, then supply for such a commodity is said to the unitary elastic. In such a case, Es = 1 and supply curve is a straight line passing through the origin as shown in Fig.

Perfect competition is a type of market structure where all producers and consumers have perfect information, no transaction costs, where there are a large number of producers and consumers competing with one another.

Perfect competition market refers to a market situation where there are very large number of buyers and sellers dealing in a homogeneous product at a price fixed by the market.

Opportunity cost is the cost of next best alternative foregone. The Government of your State is planning to construct a by-pass around a very busy market town, the new road will run through wetlands bordering a local river, where a wide range of different creatures live. So the environmentalists are against the project. The educationists and the other, wanted the money to be used to built an Engineering College and to improve the existing poor health facilities. The Government decide to go ahead with road construction. Here, construction of engineering college which is foregone by the government is the opportunity cost.

a. (i) Nature of cost of production: 
Elasticity of supply depends upon change in the cost of producing additional quantity of output. If an increase in output by the firms in an industry causes only a slight increase in their cost per unit or leads to decrease in cost per unit, we would expect supply to be fairly elastic. If, on the other hand, increase in supply leads to a large increase in "cost of production, the supply would be relatively inelastic.' 
ii. (1)$$\varepsilon p = \infty $$ Perfectly Elastic Supply : In this figure, PS is perfectly elastic supply curve. It is parallel to X-axis. At price OP supply may $$OQ_1$$ or $$OQ_2$$. Symbolically, it can be said that $$\varepsilon p = \infty $$ or elasticity of supply is infinity. It is purely an imaginary concept. When a minute change or- without any change in price, supply may change to any extent, then the supply is perfectly elastic. 
2. $$\varepsilon p = 0$$ ie. Perfectly Inelastic supply: The supply of a commodity is said to be perfectly inelastic when quantity supplied does not change at all in response to change in its price. In such a case, supply curve becomes vertical or parallel to Y-axis. The fig. clearly indicates that supply remains fixed at OS, even when price rises to $$OP_1$$ or fall to $$OP_2$$. The numerical values of elasticity of supply in this case will be zero.
3. $$\varepsilon p > 1$$ i.e. More elastic supply.  In this figure, supply curve SS is more elastic as in this case $$\delta P < \delta Q$$. Mathematically, more elastic supply can be represented as $$\varepsilon>1$$. Supply is said to be more elastic when a small change in the price brings about a large change in quantity supplied.
(b) Commercial bank is a financial institution which deals in money i.e. borrowing and lending of money. It performs the functions of accepting 
deposits from the general public and giving loans for investing to them with the aim of earning profit. The three methods adopted by commercial banks to mobilise funds from the public are as under:
1.Cash Credit: In cash credit, the bank advances a cash loan upto a specified limit to the customer against a bond or other security. A borrower is required to open a current account and bank allows the borrowers to withdraw upto the full amount of the loan. The interest is charged only on the amount actually utilized by the borrower and not on the loan sanctioned.
2. Loans: A loan is granted against some kind of security of assets or personal security of the borrower and the interest is charged on the full amount sanctioned as loan, irrespective of the fact whether full amount or part of it has been used. In case of loans, the borrower is provided with the facility to repay the loan in installment or as a lumpsum.
3. Overdraft: The overdraft facility is allowed to the depositor maintaining a current account with the bank. According to this facility, a borrower is allowed to withdraw more amount than what he has deposited. The excess amount so withdrawn has to be repaid to the bank in a short period and that too with interest. The rate of interest is usually charged more than that charged in case of loans. However, the overdraft facility is given only against security of some assets or on personal security of the customer. 

In the diagram $$\overline{C}+bY$$ is the consumption curve. 

market supply schedule(units)

46

59

72

84

In the above graph we can understand that the supply is parallel to X-axis.

Degree of elasticity is infinitive in such supply curves.

At P_e the market supply equals the quantity demanded.

A perfectly elastic supply can be best illustrated by a drug company selling a cancer drug that cures cancer. The drug company will sell it at the highest price that the market will bear, but it will supply any amount at that price. Higher prices would make the drug unaffordable.

Opportunity cost of production of a commodity refers to the cost which the producer has to sacrifice in terms of the next best alternative which could be produced out of that cost in order to produce every unit of the given commodity. If an economy can produce rice 2000 quintals of rice or 4000 quintals of wheat with the given resources and the economy chose to produce wheat then the opportunity cost will be 2000 quintals of rice which the economy has sacrificed.