Perfect Competition Test - 5

When a price ceiling is set below the equilibrium price, it creates a situation where the quantity demanded exceeds the quantity supplied, leading to excess demand in the market as consumers are willing to purchase more goods at the lower price.

In a perfectly competitive market, a firm can earn a normal profit, super-normal profit, or it can bear a loss. At the equilibrium quantity, if the average cost is equal to the average revenue, then the firm is earning a normal profit.

If the demand for a good is inelastic, an increase in its price will cause the total expenditure of the consumers of the good to increase. Raising prices will always cause total revenue to increase.

Law of demands and law of supply operates under market equilibrium. 

Law of Demand: This law states that, all else being equal, as the price of a good or service decreases, the quantity demanded for it increases, and vice versa. This means that there is an inverse relationship between price and quantity demanded. When the price of a product decreases, consumers tend to buy more of it, and when the price increases, they tend to buy less.

Law of Supply: This law states that, all else being equal, as the price of a good or service increases, the quantity supplied for it increases, and vice versa. This means that there is a direct relationship between price and quantity supplied. When the price of a product increases, producers are motivated to supply more of it to the market, and when the price decreases, they are inclined to supply less.

When these two laws are combined, they interact to determine the market equilibrium.

In a perfect competition market, transportation costs are typically assumed to be zero. This is because products are homogeneous, and firms compete solely on price, leading to efficient market conditions where transportation costs are minimized or absorbed by the sellers. As a result, buyers can access goods from various sellers without incurring significant additional transportation expenses.

A price floor above the equilibrium price creates a situation where the quantity supplied exceeds the quantity demanded, leading to excess supply or a surplus in the market as producers are willing to sell more goods at the higher price.

When the market price is above the equilibrium price, it indicates that the quantity supplied exceeds the quantity demanded, resulting in a surplus of the product in the market.

A firm under perfect competition is a price taker. It cannot influence/change the market price, implying a constant AR for a firm corresponding to all levels of output.

When the price of a substitute good decreases, consumers are more likely to choose the cheaper substitute over the original good. This leads to an increase in the demand for the original good as consumers switch away from the substitute. Additionally, producers of the substitute good may reduce their production due to lower demand, leading to an increase in the supply of the original good as resources are reallocated. Therefore, both demand and supply increase, resulting in a higher equilibrium price and quantity.

Supernormal profit is defined as extra profit above that level of normal profit. Here the firm earns a profit of Rs. 2 over the cost incurred.