Chapter 8: Concise

Perfect Competition: Key Concepts

• Law of Production: Seeks to maximize economic profit (π)
• Economic Profit Formula: π = TR - TC
• Production Decision Rule: Produce where MR = MC if price ≥ Min[SRAVC]

Characteristics of Perfect Competition

• Market Structure:
  • Many small sellers
  • Homogeneous products
  • Easy entry and exit
• Firm Behavior:
  • Firms are price takers; they cannot influence the market price.

Demand and Revenue

• Individual Firm Demand:
  • Demand curve is perfectly elastic.
  • Marginal Revenue MR = P at any output level.

Profit Maximization and Economic Loss

• Profit Levels:
  • Economic Profit:
  • If P > ATC, then π > 0
  • If P = ATC, then π = 0
  • If AVC < P < ATC, then π < 0 but stay open.
  • If P < Min[SRAVC], firm should shut down.
• Shutting Down vs. Exiting:
  • Shut down: Maintain fixed costs temporarily.
  • Exit: Leave the market to avoid losses.

Short-Run Supply Curve

• Firm's Supply Curve:
  • Corresponds to the short-run marginal cost (MC) above Min[SRAVC].

Long-Run Equilibrium

• In Long Run: π = 0
  • P = MR = SRMC = SRATC = LRAC = LRMC
• Market Adjustments:
  • Entry of new firms drives prices down in cases of excess profits.
  • Exit increases prices in cases of losses.

Types of Long-Run Industry Supply Curves

• Increasing Cost Industry:
  • Entry raises resource prices.
• Constant Cost Industry:
  • Entry does not change resource prices.
• Decreasing Cost Industry:
  • Entry lowers resource prices.

Graphical Illustrations

• Equilibrium Points:
  • Changes in demand lead to shifts in curve and changes in firm outputs.
  • Example: Market equilibrium shift leads to new long-run equilibrium and normal profits later on.