Solution:

Price and Output Determination under short period:

• A firm is said to be in equilibrium in a short period where marginal cost (MC) is equal to marginal revenue (MR) and the curve MC cuts MR from below.

• This also determines the level of output. A short period is a period in which all factors of production cannot be changed, only variable factors like labor, raw material, etc. can be changed for the change in the level of output.

• Hence, a short period is such a period in which no firm enters or leaves an industry.

Under equilibrium position, a firm in a short period can have the following situations:

• (1) Super Normal profit or Profit situation.

• (2) Normal profit situation.

• (3) Loss situation.

• (4) A case of shut down point.

(1) Supernormal profit or a profit situation:

• As depicted in diagram 8.1 average revenue (AR) is equal to marginal revenue (MR) which is shown by a horizontal line parallel to the x-axis and short-run average cost (SAC) and short-run marginal cost (SMC) have also been shown in the diagram.

• According to the condition of equilibrium of a firm the equilibrium will be at E where SMC equals MR from below and also cuts SAC at its minimum.

• Hence the price and output are determined at point E. The price is OP and the level of output is OQ.

• Average cost = OL or MQ

• Then profit per unit = EQ-MQ = EM or PL

(2) Normal profit situation:

• The next possible situation in a short period can be a normal profit. When there is no profit i.e. average cost equals the average revenue or price per unit. In diagram OP is the price given by the industry and SMC also cuts MR from below and at its point E, SMC and SAC, AR, and MR are all equal.

• Hence, the level of output is determined as equal to OQ and the price charged by the firm is OP or EQ.

• Average Cost = EQ

• Profit per unit = EQ-EQ = Zero.

• Hence, at this point of equilibrium E, the firm has normal profit i.e. no profit i.e. no-profit situation. A normal profit situation is a situation in which a firm neither makes a profit nor makes a loss. Normal profit is the minimum revenue a firm must get to continue in the industry.

• The normal profit situation not only covers explicit cost but also covers the implicit cost of production i.e. cost of the owner's resources engaged in production.

(3) Loss situation:

• The third possibility in a short period under perfect competition may be a loss situation where the prevailing market price may be less than the average cost of the firm that is to say that AR is less than its MC.

• In such a situation, the firm will be incurring losses which are well depicted in Diagram Here in equilibrium at a point, E and output are determined to equal to OQ and OP is the price charged by the firm.

• At point E, SMC cuts MR from below and SAC at its minimum.

• Per unit price = OP or EQ

• Per unit cost = OL or MQ

• Per unit Loss = ME (=MQ-EQ)

• Hence, total loss = LP ME is shown by the shaded area. Under a loss situation, all the firms will incur losses and many firms will try to exit the industry but due to short periods, they will be unable to do so.

• But at the equilibrium position E, the firms will be incurring minimum losses.

(4) A case of shut down point:

• The position is very much clear that in a short period situation the firm can neither enter an exit.

• Now the question arises whether the firms will continue production or breakaway, the answer is that the firm will continue production up to a particular level if it is able to meet its variable cost of production but if AR is less than its average variable cost (AVC) then it will close its doors and stop production this is well depicted in the diagram It is also further elaborated that when the price falls so much that the firm is not able to meet even its the variable cost then it is advisable to stop the production in a short period.

• The shutdown point arises at that point where the price is below the variable cost. Thus, in a short, period when the price is less than the variable cost then it will stop production.

• When the price is OP then the level of output is OQ and the firm is incurring losses equal to LP ME at equilibrium point E. When the price is OP then the output will be less than before equal to OQ1 and the equilibrium is at E1.

• Here the firm is meeting its average variable cost and if the price reduces beyond this to OP2 then it will close its doors. Thus, E is the shutdown point of the firm where the price is equal to the average variable cost (P=AVC).

• At point E1 the firm is not meeting any fixed cost but meeting its variable cost. Here the firm is indifferent, if it stops products on, then it will incur losses equal to fixed costs.

• Hence, it can be said that if the firm is indifferent, it can either stop the production or continue its production. In both situations, the firm is having the same losses. Thus E1 is the shutdown point of the firm.