5. Perfect Competition

The Golden Rule

MC = MR A firm will maximize profit or minimize losses by producing at the point where Marginal Revenue equals Marginal Cost.

Allocative Efficiency

P = MC Resources are allocated among firms and industries to obtain a mix or products most desired by consumers.

Productive Efficiency

P = min ATC Goods are produced using the least costly production methods.

AR

TR / unit of a product sold

TR

TR = Price x Quantity

Per Unit vs. Lump Sum

*A per unit tax or subsidy affects the variable costs*, therefore MC, AVC, and ATC will shift. This will affect the quantity produced. *A lump sum tax or subsidy only affects fixed costs*, therefore only AFC and ATC will shift. MC stays the same. This will have no effect on the quantity produced.

What happens to quantity if variable costs increases/decreases?

*An increase in Variable costs* will cause the AVC and MC to increase, causing the supply curve to decrease (it will shift to the left). *A decrease in Variable Costs* will cause AVC and MC to decrease, causing an increase in the supply curve (it will shift to the right).

At every different price, the MR=MC point changes the .... and the break-even point is obtained when ...

*At every different price, the MR=MC point changes the quantity supplied*. At a lower price, a lower quantity will be supplied and at a higher price, a higher quantity will be supplied. *The break even point is obtained when the MR=MC point intersects with the ATC.*

Profit Maximization in the Long-Run

*In the long run all firms are efficient and break even, they make no economic profit.*

Profit Maximization in the Short Run

*MC = MR* A firm will maximize profit or minimize losses by producing at the point where marginal revenue equals marginal cost.

Revenue Under Competitive Conditions

*MR = D = AR = P* *Demand curve* facing individual sellers is *perfectly elastic*.

What happens to quantity if fixed costs increase/decrease?

*Nothing.* Quantity stays the same because a change in fixed costs doesn't affect the marginal costs (supply curve).

Going from short-run to long-run

1. *Entry of firms eliminates economic profit* - supply curve increases and shifts to the right. 2. *Exit of firms eliminate economic losses* - supply curve decreases and shifts to the left.

Characteristics of a Perfectly Competitive Market

1. *Large number of producers* 2. *Homogenous product* (Identical products, perfect substitutes) 3. *Low Barriers*, easy for firms to enter and exit the industry 4. *Price Takers*, firms have no control over the price 5. Efficient 6. Seller has no need to advertise its product 7. Perfectly elastic demand curve 8. Zero profit in the long run - normal profit

Characteristics of MC=MR rule

1. Firms would rather produce than shut down 2. *MR = MC* is profit maximization in *all markets* 4. Competitive markets maximize at P=MC

Going from long-run to long-run

A firm in the long run makes no economic profit, so firms have no incentive to either enter or exit the market. If for some other reason the demand curve shifts, this will shortly result in an increase in price, which will get back to normal as soon as the supply increases as well. *From the long run to the long run the only thing that changes is the quantity.*

The Shut Down Rule

A firm should continue to produce as long as the price is above the AVC. *When P<AVC a firm should shut down in the short run.*

MR

Additional revenue received resulting from the sale of an extra unit of output.

Price Takers

Buyers and sellers in a competitive market that must accept the price that the market determines.

What is the supply curve in the short-run for the individual firm in a perfectly competitive market?

For the individual firm the supply curve in the short-run is *MC above AVC*

Profit

Profit = TR - TC