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2. KRUGMAN’S
Economics
for AP®
S E C O N D E D I T I O N

3. Section 11
Module 59

4. What You Will Learn in this Module
Evaluate a perfectly competitive firm’s situation using a graph
Determine a perfect competitor’s profit or loss
Explain how a firm decides whether to produce or shut down in the short run
What You Will Learn in this Module
Section 11 | Module 59

5. Interpreting Perfect Competition Graphs
Total profit can be expressed in terms of profit per unit. TR Q TC
Section 11 | Module 59

6. Profitability and the Market PriceTR Q TC
Section 11 | Module 59

7. Profitability and the Market PriceTR Q TC
Section 11 | Module 59

8. Interpreting Perfect Competition Graphs
The break-even price of a price-taking firm is the market price at which it earns zero profits.
Whenever market price exceeds minimum average total cost, the producer is profitable.
Whenever the market price equals minimum average total cost, the producer breaks even.
Whenever market price is less than minimum average total cost, the producer is unprofitable.
Section 11 | Module 59

9. The Short-Run Individual Supply Curve
Section 11 | Module 59

10. The Shut-Down Price There are two cases to consider:
When the market price is below the minimum average variable cost.
When the market price is greater than or equal to the minimum average variable cost.
The minimum average variable cost determines the shut-down price.
When price is greater than minimum average variable cost, the firm should produce in the short run.
Section 11 | Module 59

11. The Shut-Down Price
The short-run individual supply curve shows how an individual firm’s profit maximizing level of output depends on the market price, taking fixed cost as given.
Section 11 | Module 59

12. In the long run, firms can acquire or get rid of fixed inputs.
Changing Fixed Cost
In the long run, firms can acquire or get rid of fixed inputs.
In most perfectly competitive industries the set of firms changes in the long run as firms enter or exit the industry.
Exit and entry lead to an important distinction between the short-run supply curve and the long-run supply curve.
Section 11 | Module 59

13. Summary of the Competitive Firm’s Profitability and Production Conditions
Section 11 | Module 59

14. F Y I Prices Are Up…But So Are Costs
In 2005, Congress passed the Energy Policy Act, that by the year 2012, 7.5 billion gallons of alternative oil—mostly corn-based ethanol—be added to the American fuel supply.
One farmer increased his corn acreage by 40% after demand for corn increased which drove corn prices up. Even though the price of corn increased, so did the raw materials needed to grow the corn.
Farmers will increase their corn acreage until the marginal cost of producing corn is approximately equal to the market price of corn—which shouldn’t come as a surprise because corn production satisfies all the requirements of a perfectly competitive industry
Section 11 | Module 59

15. Summary
A firm is profitable if total revenue exceeds total cost or, equivalently, if the market price exceeds its break-even price—minimum average total cost. If market price exceeds the break-even price, the firm is profitable; if it is less, the firm is unprofitable; if it is equal, the firm breaks even. When profitable, the firm’s per-unit profit is P − ATC; when unprofitable, its per-unit loss is ATC − P.
Fixed cost is irrelevant to the firm’s optimal short-run production decision, which depends on its shut-down price—its minimum average variable cost—and the market price.
When the market price is equal to or exceeds the shut-down price, the firm produces the output quantity where marginal cost equals the market price.
Section 11 | Module 59

16. Summary
When the market price falls below the shut-down price, the firm ceases production in the short run. This generates the firm’s short-run individual supply curve.
Fixed cost matters over time. If the market price is below minimum average total cost for an extended period of time, firms will exit the industry in the long run. If above, existing firms are profitable and new firms will enter the industry in the long run.
Section 11 | Module 59