1. The Meaning of Competition
A perfectly competitive market has the following characteristics:
ä There are many buyers and sellers in the market.
ä The goods offered by the various sellers are
largely the same.
ä Firms can freely enter or exit the market. 2

2. The Meaning of Competition
A perfectly competitive market has the following outcomes:
ä The individual firm produces a small portion of total market output.
ä The firm cannot have any influence over the price
it charges. 3

3. The Meaning of Competition
The individual firm in a perfectly competitive market is a price taker.
ä It takes the price determined by the market as the price that it will receive for its output. 3

4. Revenue of a Competitive Firm
Total revenue for a firm is the selling price times the quantity sold.
TR = (P X Q) 5

5. Revenue of a Competitive Firm
Total revenue is proportional to the amount of output. 5

6. Revenue of a Competitive Firm
Average revenue tells us how much revenue a firm receives for the typical unit sold. 8

7. Revenue of a Competitive Firm
In perfect competition, average revenue equals the price of the good. 8

8. Revenue of a Competitive Firm
In perfect competition, average revenue equals the price of the good. 8

9. Revenue of a Competitive Firm
Marginal revenue is the change in total revenue from an additional unit sold.
MR = TR / Q 9

10. Revenue of a Competitive Firm
For competitive firms, marginal revenue equals the price of the good. 9

11. Quick Quiz!
When a competitive firm doubles the amount it sells, what happens to the price of its output and its total revenue? 11

12. Profit Maximization for the Competitive Firm
The goal of a competitive firm is to maximize profit.
ä This means that the firm will want to produce the quantity that maximizes the difference between total revenue and total cost. 12

13. Profit Maximization for the Competitive Firm
Profit maximization occurs at the quantity where marginal revenue equals marginal cost.
If MR > MC, increase Q to increase profit.
If MR < MC, decrease Q to increase profit.
If MR = MC, profit is maximized. 12

14. Profit Maximization for the Competitive Firm
Costs
and
Revenue
Quantity 20

15. Profit Maximization for the Competitive Firm
Costs
and
Revenue
ATC
AVC
Quantity 20

16. Profit Maximization for the Competitive Firm
Costs
and
Revenue MC
ATC
AVC
Quantity 20

17. Profit Maximization for the Competitive Firm
Costs
and
Revenue MC
ATC P
P = AR = MR
AVC
Quantity 20

18. Profit Maximization for the Competitive Firm
Costs
and
Revenue
The firm maximizes
profit by producing
the quantity at which
marginal cost equals
marginal revenue. MC
ATC P
P = AR = MR
AVC
QMAX
Quantity 20

19. Profit Maximization for the Competitive Firm
A competitive firm will adjust its production level until quantity reaches QMAX where profit is maximized. 27

20. Profit Maximization for the Competitive Firm
Costs
and
Revenue MC
ATC P
P = AR = MR
AVC
QMAX
Quantity 20

21. Profit Maximization for the Competitive Firm
Costs
and
Revenue MC
ATC
P = MR1
P = AR = MR
AVC
MC1 Q1
QMAX
Quantity 20

22. Profit Maximization for the Competitive Firm
Costs
and
Revenue MC
ATC
P = MR1
P = AR = MR
AVC
MC1
MR > MC,
increase Q Q1
QMAX
Quantity 20

23. Profit Maximization for the Competitive Firm
Costs
and
Revenue MC
MC2
ATC
P = MR2
P = AR = MR
AVC
QMAX Q2
Quantity 20

24. Profit Maximization for the Competitive Firm
Costs
and
Revenue MC
MC2
ATC
P = MR2
P = AR = MR
AVC
MR < MC,
decrease Q
QMAX Q2
Quantity 20

25. The Firm’s Decision to Shut Down
A shutdown refers to a short-run decision not to produce anything during a specific period of time.
Exit refers to a long-run decision to leave the market. 28

26. The Firm’s Decision to Shut Down
The firm considers its sunk costs when deciding to exit, but ignores them when deciding whether to shut down.
ä Sunk costs are costs that have already been committed and cannot be recovered. 10

27. The Firm’s Decision to Shut Down
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 28

28. The Firm’s Decision to Shut Down
Costs
Quantity 28

29. The Firm’s Decision to Shut Down
Costs MC
ATC
AVC
Quantity 28

30. The Firm’s Decision to Shut Down
Costs
If P > ATC,
keep producing
at a profit. MC
ATC
AVC
Quantity 28

31. The Firm’s Decision to Shut Down
Costs
If P > ATC,
keep producing
at a profit. MC
ATC
If P > AVC,
keep producing
in the short run.
AVC
Quantity 28

32. The Firm’s Decision to Shut Down
Costs
If P > ATC,
keep producing
at a profit. MC
ATC
If P > AVC,
keep producing
in the short run.
AVC
If P < AVC,
shut down.
Quantity 28

33. The Firm’s Decision to Shut Down
The portion of the marginal-cost curve that lies above average variable cost is the competitive firm’s short-run supply curve. 28

34. The Firm’s Decision to Shut Down
Costs
If P > ATC,
keep producing
at a profit. MC
ATC
If P > AVC,
keep producing
in the short run.
AVC
If P < AVC,
shut down.
Quantity 28

35. The Firm’s Decision to Shut Down
Costs MC
Firm’s short-run
supply curve
ATC
AVC
Quantity 28

36. The Long-Run Decision to Exit an Industry
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 41

37. The Long-Run Decision to Enter an Industry
A firm will enter the industry if such an action would be profitable.
Enter if TR > TC
Enter if TR/Q > TC/Q
Enter if P > ATC 41

38. The Competitive Firm’s Long-Run Supply Curve35

39. The Competitive Firm’s Long-Run Supply Curve
Costs
Quantity 35

40. The Competitive Firm’s Long-Run Supply Curve
Costs MC
ATC
AVC
Quantity 35

41. The Competitive Firm’s Long-Run Supply Curve
Costs MC
Firm enters
if P > ATC
ATC
AVC
Quantity 35

42. The Competitive Firm’s Long-Run Supply Curve
Firm enters
if P > ATC
Firm exits
if P < ATC
Quantity MC
ATC
AVC
Costs 35

43. The Competitive Firm’s Long-Run Supply Curve
The competitive firm’s long-run supply curve is the portion of its marginal-cost curve that lies above average total cost. 35

44. The Competitive Firm’s Long-Run Supply Curve
Firm enters
if P > ATC
Firm exits
if P < ATC
Quantity MC
ATC
AVC
Costs 35

45. The Competitive Firm’s Long-Run Supply Curve
Costs MC
Firm’s long-run
supply curve
ATC
AVC
Quantity 35

46. The Firm’s Short-Run and Long-Run Supply Curves
Short-Run Supply Curve
ä The portion of its marginal cost curve that lies
above average variable cost.
Long-Run Supply Curve
ä The marginal cost curve above the minimum point
of its average total cost curve. 35

47. Profit as the Area Between Price and Average Total Cost

48. Profit as the Area Between Price and Average Total Cost
Quantity

49. Profit as the Area Between Price and Average Total CostMC
ATC
Quantity

50. Profit as the Area Between Price and Average Total CostMC
ATC P
P = AR = MR
Quantity

51. Profit as the Area Between Price and Average Total CostMC
ATC P
P = AR = MR
ATC
Profit-maximizing
quantity Q
Quantity

52. Profit as the Area Between Price and Average Total CostMC
ATC
Profit P
P = AR = MR
ATC
Profit-maximizing
quantity Q
Quantity

53. Loss as the Area Between Price and Average Total Cost

54. Loss as the Area Between Price and Average Total CostMC
ATC
Quantity

55. Loss as the Area Between Price and Average Total CostMC
ATC P
P = AR = MR
Quantity

56. Loss as the Area Between Price and Average Total CostMC
ATC
ATC P
P = AR = MR
Loss-minimizing quantity Q
Quantity

57. Loss as the Area Between Price and Average Total CostMC
ATC
ATC P
P = AR = MR
Loss
Loss-minimizing quantity Q
Quantity

58. Quick Quiz!
How does the price faced by a profit-maximizing competitive firm compare to its marginal cost? 42

59. Quick Quiz! When will a profit-maximizing firm decide to shut down?
Oil in the news 42

60. Supply in a Competitive Market
Market supply equals the sum of the quantities supplied by the individual firms in the market.

61. Supply in a Competitive Market
Market Supply with a Fixed Number of Firms
ä For any given price, each firm supplies a quantity of output so that price equals its marginal cost.
ä The market supply curve reflects the individual firms’ marginal cost curves. 43

62. Supply in a Competitive Market
Market Supply with Entry and Exit
ä Firms will enter or exit the market until profit is driven to zero.
ä In the long-run, price equals the minimum of average total cost.
ä The long-run market supply curve is horizontal at this price. 44

63. The Supply Curve in a Competitive Market
(a) Firm’s Zero-Profit Condition
(b) Market Supply
Price
Price MC
ATC
P =
minimum
ATC
Supply
Quantity
(firm)
Quantity
(market) 44

64. Increase in Demand in the Short Run
An increase in demand raises price and quantity in the short run.
Firms earn profits because price now exceeds average total cost. 44

65. Initial Condition Firm Market Price Price Quantity (firm) Quantity
Quantity
(firm)
Quantity
(market) 44

66. Initial Condition Firm Market Price Price MC ATC S 1 P1 P1 Long-run
supply D1
Quantity
(firm) Q1
Quantity
(market) 44

67. Short-Run Response Firm Market Price Price MC ATC S 1 P1 P1 P1B S 1 A P1 P1 P1
Long-run
supply D 2 D 1
Quantity
(firm) Q1
Quantity
(market) 44

68. Short-Run Response Firm Market Price Price MC ATC S 1 P2 P2 P1 P1B S 1 P2 P2 A P1 P1
Long-run
supply D 2 D 1
Quantity
(firm) Q1 Q2
Quantity
(market) 44

69. Short-Run Response Firm Market Price Price Profit MC ATC S 1 P2 P2 P1B S 1 P2 P2 A P1 P1
Long-run
supply D 2 D 1
Quantity
(firm) Q1 Q2
Quantity
(market) 44

70. Increase in Demand in the Long Run
Over time, the short-run supply curve shifts as profits encourage new firms to enter the market. 44

71. Increase in Demand in the Long Run
Price falls as new firms enter the market. 44

72. Increase in Demand in the Long Run
In the new long-run equilibrium profits return to zero and price returns to minimum average total cost. 44

73. Increase in Demand in the Long Run
The market has more firms to satisfy the greater demand. 44

74. Long-Run Response Firm Market Price Price Profit MC ATC S 1 P2 P2 P1B S 1 P2 P2 A P1 P1
Long-run
supply D 2 D 1
Quantity
(firm) Q1 Q2
Quantity
(market) 44

75. Long-Run Response Firm Market Price Price Profit MC ATC S1 P2 P2 P1 P1B S1 P2 P2 S2 A P1 P1
Long-run
supply D2 D1
Quantity
(firm) Q1 Q2
Quantity
(market) 44

76. Long-Run Response Firm Market Price Price MC ATC S1 P2 P1 P1 Long-runB S1 P2 S2 A P1 P1
Long-run
supply D2 D1
Quantity
(firm) Q1 Q2
Quantity
(market) 44

77. Increase in Demand in the Short and Long Run
Firm
Market
Price
Price MC
ATC B S1 S2 A C P1 P1
Long-run
supply D2 D1
Quantity
(firm) Q1 Q2 Q3
Quantity
(market) 44

78. Why the Long-Run Supply Curve Might Slope Upward
Some resources used in production may be available only in limited quantities.
Firms may have different costs. 45

79. Shifts in Cost Curves Change in resource price
Change in technology or productivity
Is it a change in a fixed cost or variable cost?
Fixed = change ATC, but leave MC and AVC
Variable = change AVC, ATC, and MC
Lump sum vs per unit 45

80. Shifts in Cost Curves
Suppose the book-printing industry is competitive and begins in LR equilibrium.
Draw a diagram describing the typical firm in the industry.
Hi-Tech Printing Co. invents a new process that sharply reduces the cost of printing books.
What happens to Hi-Tech’s profits and the price of books in the short run when Hi-Tech’s patent prevents other firms from using the new technology?
What happens in the long-run when the patent expires? 45

81. Conclusion
Because a competitive firm is a price taker, its revenue is proportional to the amount of output it produces.
The price of the good equals both the firm’s average revenue and its marginal revenue 45

82. Conclusion
To maximize profit a firm chooses the quantity of output where marginal revenue equals marginal cost.
This is also the quantity at which price equals marginal cost.
Allocative Efficiency

83. Conclusion
In the short run, the firm will choose to shut down temporarily if the price of the good is less than average variable cost.
In the long run, it will choose to exit if the price is less than average total cost.

84. Conclusion
If firms can freely enter and exit the market, the price also equals the lowest possible average total cost of production in the long run.
Productive Efficiency
The number of firms adjusts to drive the market back to the zero-profit equilibrium.
Invisible Hand 45

85. Conclusion
Because firms can enter and exit more easily in the long run than the short run, the long-run supply curve is typically more elastic than the short-run supply curve.
Constant-cost
Increasing-cost
Decreasing costs 45