Chapter 15: Perfect Competition & Supply Curve

Goal of a firm is to

maximize profit

Perfect competition

There are many buyers and sellers, each with a small market share. The product is standardized across sellers. Free entry and exit

Market share

the fraction of the total industry output accounted for by the producers output

Buyers and sellers are

price-takers

Price taker

their actions have no effect on price

Standardized product (Commodity)

consumers regard different sellers’ products as equivalent

Free entry and Exit

New producers can easily enter into an industry and existing producers can easily leave that industry

Total revenue =

Price x Quantity

Profit =

total revenue - total cost

Marginal revenue =

ΔTR / ΔQ

Optimal output rule

Profit is maximized by producing the quantity of output at which the marginal revenue of the last unit produced is equal to its marginal cost

If MR > MC

Quantity Increases

If MR < MC

Quantity decreases

What if marginal revenue and marginal cost aren’t exactly equal?

Produce the largest quantity for which the difference between marginal revenue and marginal cost is positive

If TR > TC

the firm is profitable

If TR = TC

the firm breaks even

If TR < TC

the firm incurs a loss

If P > AC

Positive Profit

If P = AC

break even

If P < AC

loss

What should a firm do in the short-run if it is making a loss?

Fixed costs must be paid whether or not the firm produces in the short-run

Firms will choose to produce (even at a loss)

if they can cover their variable and some of their fixed cost

Shut down price

minimum average variable cost

A firm will produce at every price above minimum ATC where

price intersects the MC curve

In the short-run, a firm will produce if P _ shutdown price

>

A firm will NOT produce if P _ min AVC

<

If P > break-even, firms are

profitable

Industry

collection of all firms in a market

In long-run equilibrium in a perfectly competitive industry, which is NOT true for all firms

Firms will earn economic profits

A firm in a perfectly competitive industry can earn economic profits in the:

short run but not the long run

The curve showing the relationship between the price of a good and the total output of the industry as a whole is known as the:

industry supply curve

If the price is consistently below the average variable cost, then in the short run, a perfectly competitive firm should:

shut down