Profit-maximizing firms in perfectly competitive markets

• Profit: total revenue a firm receives from the sale of its product minus all costs - explicit and implicit - incurred in producing it.

• Profit-maximizing firm: firm whose primary goal is to maximize the difference between its total revenues and total costs.

• Perfectly competitive market: market in which no individual supplier has significant influence on the market price of the product.

• Price taker: firm that has no influence over the price at which it sells its product.

• Characteristics of markets that are perfectly competitive:

  • All firms sell the same standardized product.

  • The market has many buyers and sellers, each of which buys or sells only a small a fraction of the total quantity exchanged.

  • Productive resources are mobile.

  • Buyers and sellers are well informed.

    • That means they are aware of the relevant opportunities available to them.

• Imperfectly competitive firm: firm that has at least some control over the market price of its product.

• Factor of production: input used in the production of a good/service.

• Short run: period of time sufficiently short that at least some of the firm's factors of production are fixed.

• Long run: period of time of sufficient length that all the firm's factors of production are variable.

• Law of diminishing returns: property of the relationship between the amount of a good/service produced and the amount of a variable factor required to produce it; the law says that when some factors of production are fixed, increased production of the good eventually requires ever-larger in creases in the variable factor.

• Fixed factor of production: input whose quantity cannot be altered in the short run.

• Variable factor of production: input whose quantity can be altered in the short run.

• Fixed cost: sum of all payments made to the firm's fixed factors of production.

• Variable cost: sum of all payments made to the firm's variable factors of production.

• Total cost: sum of all payments made to the firm's fixed and variable factors of production.

• Marginal cost: as output changes from one level to another, the change in total cost divided by the corresponding change in output.

• Profit = Total revenue - Total cost

• Profit = Total revenue - Variable cost - Fixed cost

• Average variable cost (AVC): variable cost divided by total output.

• Average total cost (ATC): total cost divided by total output.

• Profitable firm: firm whose total revenue exceeds its total cost.

Determinants of supply revisited

• Among the relevant factors causing supply curves to shift are:

  • New technologies

  • Changes in input prices

  • Changes in the number of sellers

  • Expectations of future price changes

  • Changes in the prices of other products that firms might produce

Supply and producer surplus

• Producer surplus: amount by which price exceeds the seller's reservation price.