1. 14
Perfect Competition

2. Perfectly Competitive Market
Many buyers and sellers
Identical goods
Free entry/exit
No market power
Price takers

3. Revenue of a Competitive Firm
TR = (P  Q)
TR is proportional to the amount of output.
Quick Quiz #1: When a competitive firm doubles the amount it sells, what happens to the price of its output and total revenue?

4. Revenue of a Competitive Firm
Average revenue = how much rev. firm receives for typical unit sold

5. The Revenue of a Competitive Firm
Marginal revenue = change in TR from an additional unit sold
MR =TR/ Q
For competitive firms, MR = P

6. Table 1 Total, Average, and Marginal Revenue for a Competitive Firm
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7. Profit Maximization Firm’s goal is to maximize profit
Firm will want to produce at the level that maximizes the difference between TR and TC

8. PROFIT MAXIMIZATION AND THE COMPETITIVE FIRM’S SUPPLY CURVE
Profit maximization occurs at the quantity where marginal revenue equals marginal cost.
When MR > MC, increase Q
When MR < MC, decrease Q
When MR = MC, profit is maximized
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9. Figure 1 Profit Maximization for a Competitive Firm
Costs
The firm maximizes
profit by producing
the quantity at which
marginal cost equals
marginal revenue.
and
Revenue MC MC 2 Q
ATC P = MR 1 2 AR Q
MAX
AVC MC 1 Q
Quantity
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10. Firm’s Short-Run Decision to Shut Down or Exit
Shutdown = short-run decision not to produce anything during specific period of time b/c of current market conditions
Exit = long-run decision to leave market

11. Firm’s Short-Run Decision to Shut Down
The firm considers its sunk costs when deciding to exit, but ignores them when deciding whether to shut down.
Sunk costs are costs that have already been committed and cannot be recovered.
The firm shuts down if the revenue it gets from producing is less than the variable cost of production.
Shut down if TR < VC
Shut down if TR/Q < VC/Q
Shut down if P < AVC
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12. Figure 3 The Competitive Firm’s Short Run Supply Curve
Costs
Firm ’
s short-run
supply curve
If P > ATC, the firm will continue to produce at a profit. MC
ATC
If P > AVC, firm will continue to produce in the short run.
AVC
Firm
shuts
down if P
<
AVC
Quantity
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13. Firm’s Long-Run Decision to Exit
In the long run, the firm exits if the revenue it would get from producing is less than its total cost.
Exit if TR < TC
Exit if TR/Q < TC/Q
Exit if P < ATC
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Entrepreneur will enter market if P > ATC

14. Figure 4 The Competitive Firm’s Long-Run Supply Curve
Costs
Firm ’
s long-run
supply curve
MC = long-run S
Firm
enters if
P > ATC
ATC
Firm
exits if
P < ATC
Quantity
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15. Figure 4 The Competitive Firm’s Long-Run Supply Curve
Costs MC
Firm ’
s long-run
supply curve
ATC
Quantity
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16. THE SUPPLY CURVE IN A COMPETITIVE MARKET
Short-Run Supply Curve
The portion of its marginal cost curve that lies above average variable cost.
Long-Run Supply Curve
The marginal cost curve above the minimum point of its average total cost curve.

17. Quick Quiz #2
How does a competitive firm determine its profit-maximizing level of output? Explain.
When does a profit-maximizing competitive firm decide to shut down?
When does it decide to exit a market?
Provide a graph that visually summarizes your responses.

18. Figure 5 Profit as the Area between Price and Average Total Cost
(a) A Firm with Profits
Price
ATC MC
Profit
ATC Q P P = AR MR
Quantity
(profit-maximizing quantity)
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19. Figure 5 Profit as the Area between Price and Average Total Cost
(b) A Firm with Losses
Price MC
ATC
ATC Q
Loss P = AR MR
Quantity
(loss-minimizing quantity)
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20. The Short Run: Market Supply with a Fixed Number of Firms
Market supply equals the sum of the quantities supplied by the individual firms in the market.
For any given price, each firm supplies a quantity of output so that its marginal cost equals price.
The market supply curve reflects the individual firms’ marginal cost curves.
Add graphs to your notes

21. Figure 6 Market Supply with a Fixed Number of Firms
(a) Individual Firm Supply
(b) Market Supply
Price
Price MC
Supply
$2.00
200
$2.00
200,000
1.00
100
1.00
100,000
Quantity (firm)
Quantity (market)
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22. The Long Run: Market Supply with Entry and Exit
Firms will enter or exit the market until profit is driven to zero.
In the long-run, P = minimum ATC (efficient scale)
Long-run market supply curve is horizontal at this price.
After process of entry and exit ends, remaining firms must be making zero economic profit.
Recall that total cost includes opportunity costs. In zero-profit equilibrium, firm’s revenue compensates owners for time and money they expend running business.
Add graphs to your notes

23. Figure 7 Market Supply with Entry and Exit
(a) Firm ’
s Zero-Profit Condition
(b) Market Supply
Price
Price MC
ATC P
= minimum
ATC
Supply
Quantity (firm)
Quantity (market)
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24. A Shift in Demand in the Short Run and Long Run
An increase in demand raises price and quantity in the short run.
Firms earn profits because price now exceeds average total cost.
Entry and exit occurs until firms are operating back at efficient scale.
Add graphs to your notes

25. Figure 8 An Increase in Demand in the Short Run and Long Run
(a) Initial Condition
Firm
Market
Price
Price
ATC MC S
Short-run supply, 1 D
Demand, 1 1 Q A P 1
Long-run
supply P 1
Quantity (firm)
Quantity (market)

26. Figure 8 An Increase in Demand in the Short Run and Long Run
(b) Short-Run Response
Firm
Market
Price
Price D 2
ATC MC
Profit S 1 Q 2 P B P 2 D 1 Q 1 A P 1 P
Long-run 1
supply
Quantity (firm)
Quantity (market)
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27. Figure 8 An Increase in Demand in the Short Run and Long Run
(c) Long-Run Response
Firm
Market
Price
Price D 2 S MC
ATC 1 S 2 B P 2 A Q 3 C P 1 P
Long-run 1
supply D 1
Quantity (firm) Q Q
Quantity (market) 1 2
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28. Constant, Increasing, and Decreasing Costs
Perfectly elastic long-run supply is good assumption for many industries; implies constant costs across the industry
Each firm faces the same cost structure; perfectly elastic supply of inputs (i.e. agriculture, bakeries, etc.)
ATC curve does not shift when firms enter or exit the industry
Some industries have increasing costs; as the industry expands, the price of productive inputs increases due to increased demand for those inputs.
ATC curve shifts upwards as more firms enter the industry
i.e. beach front resort hotels that must compete for limited quantity of prime beachfront property.
Some industries have decreasing costs: as the industry expands, the price of productive inputs decreases due to economies of scale
ATC curve shifts downwards as more firms entire the industry
i.e. electric car industry; economies of scale in the production of lithium batteries lowers input prices
Revisit part (d) and (e) on the 2011 Form B FRQ. How would your responses compare for a firm with constant costs, a firm with increasing costs, and a firm with decreasing costs.

29. Practice AP FRQ: 2011 Form B

31. Quick Quiz!
Martin Tomatoes is a perfectly competitive firm in the constant cost industry for tomatoes. Currently, the company is operating at an economic loss, but at a point where the price is greater than average variable costs.
Draw correctly labeled side-by-side graphs for the industry and for Martin Tomatoes that show the current situation.
Label the area of economic loss.
Identify and explain why Martin Tomatoes should or should not shut down.
Explain what will occur in this market and to Martin Tomatoes after all long-run adjustments are made.
Graph the firm and Martin Tomatoes after all long-run adjustments have taken place in the industry.