Perfect Competition CHAPTER 8 © 2003 South-Western/Thomson Learning.

Terminology An industry consists of all firms that supply output to a particular market, interchangeable with market Many of the firm’s decisions depend on the structure of the market in which it operates Market structure describes the important features of a market

Market Structure Aspects of market structure Number of suppliers
Many or few Product’s degree of uniformity Do firms in the market supply identical products or are there differences across firms? The ease of entry into the market Can new firms enter easily or are they blocked by natural or artificial barriers? Forms of competition among firms Do firms compete only through prices or are advertising and product differences common as well?

Perfectly Competitive Market Structure
Characteristics of perfect competition Many buyers and sellers  so many that each buys and sells only a tiny fraction of the total amount exchanged in the market Firms sell a standardized or homogeneous product Buyers and sellers are fully informed about the price and availability of all resources and products Firms and resources are freely mobile  over time they can easily enter or leave the industry

Perfect Competition If these conditions are present in a market, individual participants have no control over the price Price is determined by market supply and demand  the perfectly competitive firm is a price taker  it must “take” or accept, the market price Once the market establishes the price, each firm is free to produce whatever quantity maximizes profit

Perfect Competition The model of perfect competition allows us to make a number of predictions that hold up when compared with the real world It provides us with an important benchmark for evaluating the efficiency of other types of markets

Demand Under Perfect Competition
Suppose the market in question is the world market for wheat and the firm in question is a wheat firm Exhibit 1 provides the relationship between the industry and the firm in the case of a perfectly competitive industry

Exhibit 1: Market Equilibrium and the Firm’s Demand Curve in Perfect Competition
The market price of wheat of $5 per bushel is determined in the left panel by the intersection of the market demand curve and the market supply curve. Once the market price is established, any farmer can sell all he or she wants at that market price. (a) Market Equilibrium (b) Firm’s Demand S l l e e h h s s u u b b r r e e p p $5 $5 d e e c c i i r r P P D Bushels of wheat per day Bushels of wheat per day ,200,000 5 10 15

Demand Each firm is so small relative to the market that each has no impact on the market price  each farmer is a price taker Because all farmers produce an identical product, anyone who charges more than the market price will sell no wheat No farmer would sell at a lower price because they can sell all they want at the higher price

Demand The demand curve facing an individual farmer is therefore a horizontal line drawn at the market price Ironically, two neighboring wheat farmers in perfect competition are not really rivals  they both can sell as much wheat as they want to at the market price because the amount one sells has no effect on the market price or the amount the other can sell

Short-Run Profit Maximization
How does the perfectly competitive firm maximize profit? The perfectly competitive firm has no control over price, however, what the firm does control is the amount produced – the rate of output  the question facing the wheat farmer is How much should I produce to earn the most profit?

Total Revenue Minus Total Cost
The firm maximizes economic profit by finding the rate of output at which total revenue exceeds total cost by the greatest amount Total revenue is simply output times the price per unit Exhibits 2 and 3 provide us with the needed information

Exhibit 2: Short-Run Costs and Revenues
The individual farmer’s output possibilities measured in bushels of wheat per day are shown in column (1) Column (2) has the market price. Total revenue is in column (3) = column (1)  column (2)  P  q Total cost is shown in column (4) Total revenue in column (3) minus. Total cost in column (4) yields the farmer’s economic profit. (1) (2) (3) = (1)  (2) (4) (5) (6) = (4) + (1) (7) = (3) - (4) Bushels of Marginal Wheat Revenue Total Total Marginal Average Economic per day (Price) Revenue Cost Cost Total Cost Profit or (q) (p) (TR = q  p) (TC) MC=TC/  Q ATC = TC / q Loss = TR - TC $ $ $15.00 $ $4.75 $

Exhibit 3a: Short-Run Profit Maximization
(a) Total Revenue Minus Total Cost The total cost curve shows first increasing then diminishing marginal returns from the variable resource. Total cost Total revenue (= $5 × q ) $60 At output less than 7 bushels and greater than 14 bushels, total cost exceeds total revenue  economic loss measured by the vertical distance between the two curves. Maximum economic profit = $12 48 Total dollars 15 Total revenue exceeds total cost between 7 and 14 bushels per day  economic profit is maximized at the rate of output of 12 bushels of wheat per day. 5 7 10 12 15 Bushels of wheat per day

Marginal Revenue Equals Marginal Cost Approach
Another way to find the profit-maximizing rate of output is to focus on marginal revenue and marginal cost Marginal revenue, MR, is the change in total revenue from selling another unit of output Since the firm in perfect competition is a price taker, marginal revenue from selling one more unit is the market price  MR = P

Marginal cost is the change in total cost resulting from producing another unit of output Exhibit 2 provides the information needed to make this comparison

Exhibit 2: Short-Run Costs and Revenues
(1) (2) (3) = (1)  (2) (4) (5) (6) = (4) + (1) (7) = (3) - (4) Bushels of Marginal Wheat Revenue Total Total Marginal Average Economic per day (Price) Revenue Cost Cost Total Cost Profit or (q) (p) (TR = q  p) (TC) MC=TC/ Q ATC = TC / q Loss = TR - TC $ $ $15.00 $ $4.75 $ Marginal revenue is presented in column (2) while marginal cost is in column (5). The firm will increase quantity supplied as long as each additional unit adds more to total revenue that to total cost  as long as marginal revenue exceeds marginal cost. Marginal revenue exceeds marginal cost for the first 12 bushels of wheat. The farmer, as a profit-maximizer will limit output to 12 bushels per day.

Exhibit 3b: Short-Run Profit Maximization
The marginal cost curve intersects the marginal revenue curve at point e where output is 12 bushels per day. (b) Marginal Cost Equals Marginal Revenue At rates of output less than 12 bushels, marginal revenue exceeds marginal cost  firm can increase profit by expanding output. At higher rates of output, marginal cost exceeds marginal revenue  the firm could increase profit by reducing output. Marginal cost Average total cost e $5 d = Marginal revenue Profit = average revenue 4 a Profit appears in the blue shaded rectangle. The height of the rectangle, ae, equals the price of $5 minus the average cost of $4  per unit profit of $1 per bushel. Dollars per unit Bushels of wheat per day 5 10 12 15

Golden rule of profit maximization: Generally, a firm will expand output as long as marginal revenue exceeds marginal cost and will stop expanding output before marginal cost exceeds marginal revenue

Economic Profit in the Short Run
Because the perfectly competitive firm can sell any quantity for the same price per unit, marginal revenue is also average revenue Average revenue, AR, equals total revenue divided by quantity  AR = TR / q Regardless of the rate of output, the following equality holds along the firm’s demand curve Market price = marginal revenue = average revenue

Minimizing Short-Run Losses
Sometimes the price that the firm is required to “take” will be so low that no rate of output will yield an economic profit Faced with losses at all rates of output, the firm has two options It can continue to produce at a loss, or Temporarily shut down It cannot shut down in the short run because by definition the short run is a period too short to allow existing firms to leave or new firms to enter

Fixed Cost and Minimizing Losses
The firm has two types of costs in the short run Fixed cost Variable cost A firm that shuts down in the short run must still pay its fixed costs But, by producing, a firm’s revenue may more than cover variable cost  a firm will produce if the revenue thus generated exceeds the variable cost of production  can cover a least a portion of its fixed cost

Exhibit 4: Minimizing Losses
(1) (2) (3) = (1)  (2) (4) (5) (6) = (4) + (1) (7) (8) = (3) - (4) Bushels of Marginal Average Wheat Revenue Total Total Marginal Average Variable Economic per day (Price) Revenue Cost Cost Total Cost Cost Profit or (q) (p) (TR = q  p) (TC) MC=TC/Q ATC = TC /q AVC = TVC / q Loss = TR - TC $ $ $15.00 $ $4.75 $ $ Marginal revenue exceeds marginal cost for the first 12 bushels of wheat. Because of the lower price, total revenue is lower at all rates of output and economic profit has disappeared  column (8) Column (8) indicates that the firm’s loss is minimized at $10 per day when 10 bushels are produced  the net gain of $5 total cost. Exhibit 5 illustrates this same conclusion graphically.

Exhibit 5: Minimizing Short-Run Losses
(a) Total Cost and Total Revenue In panel (a), the total cost curve remains the same but the total revenue curve rotates downward because of the lower price. Notice that the total revenue now lies below the total cost curve at all output rates. The vertical distance between the two curves measures the loss at each rate of output. Total cost Total revenue (= $3 × q ) Total dollars $40 30 Minimum economic loss = $10 15 Bushels of wheat per day b) Marginal Cost Equals Marginal Revenue Marginal cost The vertical distance is minimized at an output rate of 10 bushels where the loss is $10 per day. Average total cost Dollars per bushel Average variable cost $4.00 Loss e 3.00 d = Marginal revenue 2.50 = average revenue Bushels of wheat per day

Exhibit 5: Minimizing Short-Run Losses
(a) Total Cost and Total Revenue We get the same result using marginal analysis as seen in panel (b). Total cost Total revenue (= $3 × q ) Total dollars The firm will produce rather than shut down if marginal revenue equals marginal cost at a rate of output where the price equals or exceeds average variable cost. $40 30 Minimum economic loss = $10 15 Bushels of wheat per day b) Marginal Cost Equals Marginal Revenue MR intersects MC at point e, where the output rate is 10 bushels per day and the price of $3 exceeds the average variable cost per bushel of $ The total economic loss is shown by the shaded area. Marginal cost Average total cost Dollars per bushel Average variable cost $4.00 Loss e 3.00 d = Marginal revenue 2.50 = average revenue Bushels of wheat per day

Shutting Down in the Short Run
As long as the loss that results from producing is less than the shutdown loss, the firm will remain open for business in the short run However, if the average variable cost of production exceeds the price of all rates of output, the firm will shut down A re-examination of Exhibit 4 indicates that if the price of wheat were to fall to $2 per bushel, average variable cost exceeds $2 at all rates of output

Shutting Down in the Short Run
Note that shutting down is not the same as going out of business In the short run, even a firm that shuts down keeps its productive capacity intact  that when demand increases enough, the firm will resume operation If market conditions look grim and are not expected to increase, the firm may decide to leave the market  a long run decision

Firm and Industry Short-Run Supply Curves
If the price exceeds average variable cost, the firm will produce the quantity where marginal revenue equals marginal cost Further, the firm will vary output as the market price changes Exhibit 6 illustrates the effects of various prices on the firm’s output decision

Exhibit 6: Summary of Short-Run Output Decisions
At a price as low as p1, the firm will shut down rather than produce at point 1, because the price is below average variable cost at all output rates  the loss-minimizing output rate at a price of p1 is zero as shown by q1 Marginal cost Average total cost At a price of p2, the firm will be indifferent between producing q2 and shutting down because either way the loss will equal fixed cost since the price just equals average variable cost. Point 2 is called the shutdown point. 2 p2 d2 1 p1 d1 Shutdown point Dollars per unit Quantity per period q 2 q 5 q 1

Marginal cost If the price is p3, the firm will produce q3 to minimize its loss while at p4, the firm will produce q4 to earn just a normal profit  the break-even point. Break-even point p5 5 d5 Average total cost 4 p4 d4 Average variable cost q 3 3 p3 d3 2 p2 d2 1 p1 d1 If the price rises to p5, the firm will earn a short-run economic profit by producing q5 Shutdown point Dollars per unit Quantity per period q 1 q 2 q 4 q 5

Short-Run Firm Supply Curve
As long as the price covers average variable cost, the firm will supply the quantity resulting from the intersection of its upward-sloping marginal cost curve and its marginal revenue, or demand curve Thus, that portion of the firm’s marginal cost curve that intersects and rises above the lowest point on its average variable cost curve becomes the short-run firm supply curve

The quantity supplied when the price is p2 or higher is determined by the intersection of the firm’s marginal cost curve and its demand or marginal revenue curve. Marginal cost p5 5 d5 Average total cost The solid portion of the short-run supply curve indicates the quantity the firm is willing and able to supply in the short run at each alternative price. 4 p4 d4 Average variable cost q 3 3 p3 d3 2 p2 d2 1 p1 d1 The short-run supply curve is the upward-sloping portion of the marginal cost curve, beginning at point 2. Dollars per unit Quantity per period q 2 q 4 q 5 q 1

Exhibit 7: Aggregating Individual Supply to Form Market Supply
(a) Firm A (b) Firm B (c) Firm C (d) Industry, or market, supply SA+ SB+ SC = S S S S i t A B C n u r e p p' p' p' p' e c i p p p p r P Quantity Quantity Quantity Quantity per period per period per period per period The short-run industry supply curve is the horizontal sum of all firms’ short-run supply curves  horizontal summation of the firm level marginal cost curves At a price below p, no output is supplied. At a price of p, each of the three firms supplies 10 units, for a market supply of 30 units, and at a price of p', each firm supplies 20 units  the market supply is 60 units.

Exhibit 8: Relationship Between Short-Run Profit Maximization and Market Equilibriuim
(a) Firm (b) Industry, or market t t i i n n u u r r SMC = S e MC = s e p p s e r c a i l l r o P ATC D AVC $5 d $5 Profit 4 D Bushels of wheat ,200,000 Bushels of wheat per day per day If we suppose there are 100,000 identical wheat farmers, their individual supply curves are summed horizontally to yield the market supply curve which is shown in the right panel where the market price of $5 is determined. At this price, each farmer produces 12 bushels per day, as shown in the left panel, for a total quantity supplied of 1,200,000 bushels per day  each farmer earns an economic profit of $12 per day as shown by the blue shaded rectangle.

Summary A perfectly competitive firm selects the short-run output rate that maximizes profit or minimizes loss When confronting a loss, a firm either produces an output that minimizes that loss or shuts down temporarily Given the conditions for perfect competition, the market will converge toward the equilibrium price and quantity

Perfect Competition in Long Run
In the short run, the quantity of variable resources can change, but other resources, which generally determine firm size, are fixed However, in the long run, firms have time to enter and exit and to adjust their size  adjust the scale of their operations  there is no distinction between fixed and variable cost because all resources under the firm’s control are variable

Short-run economic profit will in the long run encourage new firms to enter the market and may prompt existing firms to expand the scale of their operations Economic profit will attract resources from industries where firms earn only normal profit or suffer losses

The expansion in the number and size of firms will shift the industry supply curve rightward in the long run, driving down the price New firms will continue to enter a profitable industry and existing firms will continue to increase in size as long as economic profit is greater than zero

Conversely, a short-run loss will, in the long run, force some firms to leave the industry or to reduce the scale of operation In the long run, departures and reductions in scale shift market supply to the left  market price increases until the remaining firms just earn a normal profit Exhibit 9 shows these results

Exhibit 9: Long Run Equilibrium for the Firm and the Industry
(a) Firm (b) Industry, or market MC S ATC LRAC Dollars per unit Price per unit e p d p D Q q Quantity per period Quantity per period In the long run, market supply adjusts as firms enter or leave, or change their size. This process continues until the market supply intersects the market demand at a price that equals the lowest point on each firm’s long-run average cost curve  at point e with each firm producing q units. At point e, marginal cost, short-run average total cost and long-run average cost are all equal.

Long-Run Adjustment to a Change in Demand
To explore the long-run adjustment process, let’s consider how a firm and an industry respond to an change in market demand Further, suppose that the costs facing each individual firm do not depend on the number of firms in the industry Exhibits 10 and 11 illustrate the impact of an increase and a decrease in demand respectively

Exhibit 10: Long-Run Adjustment to an Increase in Demand
(a) Firm (b) Industry, or Market S MC p' d' p' b ATC Profit Dollars per unit Price per unit LRAC a p d p D' D q q' Quantity per period Qa Qb Quantity per period Suppose the initial point of equilibrium is given as point a in the right hand panel where the market clearing price is p and the market quantity is Qa  the individual firm supplies q units and earns a normal profit. Now suppose market demand increases as shown by the shift from D to D'  the market price increases in the short run to p'. Each firm responds to the higher price by expanding output along its short-run supply, or marginal cost curve  the quantity supplied increases to q'

Exhibit 10: Long-Run Adjustment to an Increase in Demand
(a) Firm (b) Industry, or Market S S' c Qc MC p' d' p' b ATC Dollars per unit Price per unit LRAC a p d p S* D' D Quantity per period q q' Qa Qb Quantity per period In the long run, economic profit attracts new firms  additional supply to the market shifting out the market supply curve  market price to fall. Firms continue to enter as long as they earn economic profit  the market supply eventually shifts out to S', where it intersects D' at point c, returning price to its initial equilibrium level, p  the demand curve facing the individual firm shifts back down from d' to d  firms again earning a normal profit. Even though industry output increases from Qa to Qb, each firm’s output returns to q  new firms provide the additional output

Exhibit 11: Long-Run Adjustment to a Decrease in Demand
(a) Firm (b) Industry, or Market S MC ATC LRAC Price per unit a e Dollars per unit p d p Loss f p" p" D d" D" q" q Quantity per period Qg Qf Qa Quantity per period Again, suppose that the initial long-run equilibrium is shown by point a in the market and point e for the firm. Now suppose that market demand for this product declines from D to D"  the market price falls to p"  the demand curve facing each firm drops to d" Each firm responds in the short run by cutting its output to q", where marginal cost equals the now-lower marginal revenue. Market output falls to Qf  each firm operates at a loss as shown by the red shaded area.

Exhibit 11: Long-Run Adjustment to a Decrease in Demand
(a) Firm (b) Industry, or Market S" S MC ATC LRAC Price per unit g a e Dollars per unit p d p S* Loss f p" p" D d" D" q" q Quantity per period Qg Qf Qa Quantity per period The short-run loss, if it continues, will in the long run force some firms out of this business  market supply will decrease from S to S"  price increases back to p and the new market equilibrium is shown by point g. Market output has fallen to Qg and the remaining firms are just earning a normal profit as demand shifts back to d.

Long-Run Industry Supply Curve
In Exhibits 10 and 11, we began with an initial long-run equilibrium point; then, in response to a shift in demand, we found two more long-run equilibrium points In each case, the price remained the same in the long run, but industry output increased in Exhibit 10 and decreased in Exhibit 11.

Long-Run Industry Supply Curve
Connecting these long-run equilibrium points yields the long-run industry supply curve, labeled S* in both of these Exhibits The long-run industry supply curve shows the relationship between price and quantity supplied once firms fully adjust to any short-term economic profit or loss resulting from a shift in demand

Constant-Cost Industry
The industry we have studied thus far is called a constant cost industry because each firm’s long-run average cost curve does not shift as industry output expands Resource prices and other production costs remain constant in the long run as industry output increases or decreases

Constant-Cost Industry
In a constant-cost industry, each firm’s per-unit production costs are independent of the number of firms in the industry  the firm’s long-run average cost curve remains constant in the long run as firms enter or leave the industry The industry uses such a small portion of the resources available that increasing industry output does not bid up resource prices The long-run supply curve for a constant-cost industry is horizontal

Increasing-Cost Industry
Firms in some industries encounter higher average costs as industry output expands in the long run Firms in these increasing-cost industries find that expanding output bids up the prices of some resources or otherwise increases per-unit production costs  each firm’s cost curves shift upward Exhibit 12 illustrates the adjustment process for an increasing cost industry

Exhibit 12: An Increasing-Cost Industry
(a) Firm (b) Industry, or Market S MC ATC Price per unit Dollars per unit d p a p a a a a D q Quantity per period Qa Quantity per period The initial position of equilibrium is shown at point a, where the initial market demand and supply curves are D and S  the market price is pa and the market quantity Qa  the demand and marginal revenue curve facing each firm is da  the firm produces q, average total cost is at a minimum  firm earns no economic profit in this long-run equilibrium

(a) Firm (b) Industry, or Market S b p d qb D' Qb MC ATC Price per unit Dollars per unit d p a p a a a a D q Quantity per period Qa Quantity per period The increase in market demand is shown by the shift from D to D' which intersects the short-run market supply curve S at point b  short-run equilibrium price pb and market quantity Qb  each firm’s demand curve shifts from da up to db  b in the left panel where the marginal cost curve intersects the new demand curve  each firm produces qb  economic profit equal to qb times the difference between the pb and the average total cost at that rate of output

(a) Firm (b) Industry, or Market c p d ATC' MC' S' Qc S b p d qb D' Qb MC ATC c Price per unit Dollars per unit c d p a p a a a a D Quantity per period q Quantity per period Qa The existence of economic profit attracts new entrants but because this is an increasing-cost industry, new entrants’ increased demand for resources drives up the costs of production and raises each firm’s marginal and average cost curves. In the left panel, MC and ATC shift up to MC' and ATC'. The entry of the new firms also shifts the short-run industry supply curve outward from S to S'  decline in the market price from b to c.

(a) Firm (b) Industry, or Market MC' S b p d qb D' Qb MC S' ATC' ATC S* c Price per unit Dollars per unit p d p c c c c d p a p a a a a D q Quantity per period Qa Qc Quantity per period New firms continue to enter the industry until the combination of a higher production cost and a lower price squeeze economic profit to zero  S'. The market price does not fall back to the initial equilibrium level because each firm’s average total cost has shifted up with the expansion of industry output. The new long-run market equilibrium occurs at point c and when points a and c are connected, we get the upward sloping long-run market supply curve shown as S*

Summary In constant-cost industries, each firm’s costs depend simply on the scale of its plant and its rate of output For firms in increasing-cost industries, costs depend also on the number of firms in the market By bidding up the price of resources, long-run expansion in an increasing-cost industry increases each firm’s marginal and average costs

Perfect Competition and Efficiency
How does perfect competition stack up as an efficient allocator of resources? There are two concepts of efficiency used to judge market performance Productive efficiency refers to producing output at the least possible cost Allocative efficiency refers to producing the output that consumers value the most Perfect competition guarantees both allocative and productive efficiency in the long run

Productive Efficiency
Productive efficiency occurs when the firm produces at the minimum point on its long-run average-cost curve  the market price equals the minimum average total cost The entry and exit of firms and any adjustment in the scale of each firm ensure that each firm produces at the minimum point on its long-run average cost curve

Productive Efficiency
Firms that do not reach minimum long-run average cost curve must, to avoid continued losses, either adjust their size or leave the industry Thus, perfect competition produces output at the least possible cost per unit in the long run

Allocative Efficiency
Just because production occurs at the least possible cost does not mean that the allocation of resources is the most efficient one possible The goods being produced may not be the ones consumers most prefer  they may be producing the wrong goods efficiently from the perspective of minimum costs

Allocative efficiency occurs when firms produce the output that is most valued by consumers How do we know that perfect competition guarantees allocative efficiency? The answer lies with the market supply and demand curves

The demand curve reflects the marginal value that consumers attach to each unit  the market price is the amount of money that people are willing and able to pay for the final unit they consume We also know that, in both the short run and the long run, the equilibrium price in perfect competition equals the marginal cost of supplying the last unit sold

Marginal cost measures the opportunity cost of all resources employed by the firm to produce the last unit sold  the supply and demand curves intersect at the combination of price and quantity at which the marginal value, or the marginal benefit that consumers attach to the final unit purchased, just equals the opportunity cost of the resources employed to produce that unit  there is no way to reallocate resources to increase the total utility consumers reap from production

What’s So Perfect About Perfect Competition
This should not be taken to mean that market exchange confers no net benefits to participants Market exchange benefits both consumers and producers Recall that consumers garner a surplus from market exchange because the maximum amount they would be willing to pay for each unit of the good exceeds the amount they in fact pay Exhibit 14 depicts a market in short-run equilibrium

Exhibit 14: Consumer Surplus and Producer Surplus
Consumer surplus is shown by the blue shaded area, which is the area below the demand curve but above the market clearing price of $10. Dollars per unit Producers also derive a net benefit, or a surplus, from market exchange because the amount they receive for their output exceeds the minimum amount they would require to supply that amount in the short run. Consumer S surplus e $10 Producer surplus Recall that the short-run market supply curve is the sum of that portion of each firm’s marginal cost curve at or above the minimum point on its average variable cost curve  point m on the market supply curve S. D 5 m Quantity per period , , ,000

Point m implies a price of $5 with each firm willing to supply 100,000 units. At prices below $5, quantity supplied is zero because firms could not cover variable costs and would shut down. Dollars per unit If the price increases to $6, firms increase their quantity supplied until their marginal cost equals $6  output increases from 100,000 to 120,000, and total revenue increases from $500,000 to $720,000. Part of the increased revenue covers the higher marginal cost of production. However, the balance of the increased revenue is a bonus to producers, who would have been willing to supply 100,000 units for only $5  producer surplus is shown by the red shaded area. Consumer S surplus e $10 Producer surplus 6 D 5 m Quantity per period , , ,000

In the short run, producer surplus is the total revenue producers are paid minus their variable cost of production Dollars per unit In our example, the market-clearing price is $10 per unit, and producer surplus is the red shaded area under the price but just above the supply curve. Consumer S surplus e The combination of consumer surplus and producer surplus shows the gains from voluntary exchange. 10 Producer surplus 6 D Productive and allocative efficiency in the short run occurs at point e, which also is the combination of price and quantity that maximizes the sum of consumer and producer surplus. 5 m Quantity per period , , ,000

Producer Surplus Producer surplus is not the same as economic profit
Any price that exceeds average variable cost will result in a short-run producer surplus, even though that price could result in a short-run economic loss The definition of producer surplus ignores fixed cost, because fixed cost is irrelevant to the firm’s short-run production decision

Perfect Competition CHAPTER 8 © 2003 South-Western/Thomson Learning.

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Perfect Competition CHAPTER 8 © 2003 South-Western/Thomson Learning.

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