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The Perfectly Competitive Firm

The Perfectly Competitive Firm. In This Chapter:. What is a perfectly competitive market? What is marginal revenue, and why is it perfectly elastic for the perfectly competitive firm? How does a competitive firm determine the quantity that maximizes profits?

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The Perfectly Competitive Firm

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  1. The Perfectly Competitive Firm

  2. In This Chapter: • What is a perfectly competitive market? • What is marginal revenue, and why is it perfectly elastic for the perfectly competitive firm? • How does a competitive firm determine the quantity that maximizes profits? • When might a competitive firm shut down in the short run? • What does the market supply curve look like in the short run? In the long run?

  3. Market Structure for Perfectly Competitive Firms • Free entry and exit to industry • Homogenous product – identical so no consumer preference • Large number of buyers and sellers – no individual seller can influence price • Sellers are price takers – have to accept the market price • Perfect information available to buyers and sellers

  4. MC and the Firm’s Supply Decision At Qa, MC < MR. So, increase Qto raise profit. At Qb, MC > MR. So, reduce Qto raise profit. At Q1, MC = MR. Changing Qwould lower profit. Costs MC P1 MR Q Q1 Qa Qb 0 Rule: MR = MC at the profit-maximizing Q.

  5. AC MC AC D1 = AR1 P1 AR1 = MR1 Qe Loss in Perfect Competition P $ S D O O Q (thousands) Q (millions) (a) Industry (b) Firm

  6. $ MC AC S D = AR Pe AR = MR AC D O Q (thousands) (b) Firm Profit in Perfect Competition P O Qe Q (millions) (a) Industry

  7. S1 Se LRAC P1 AR1 D1 PL ARL DL D Equilibrium in Perfect Competition P $ Profits return to normal O O QL Q (thousands) Q (millions) (a) Industry (b) Firm

  8. The LR Market Supply Curve One firm Market P P LRATC MC long-run supply P = min. ATC Q Q (market) (firm) 0 The LR market supply curve is horizontal at P = minimum ATC. In the long run, the typical firm earns zero profit.

  9. CONCLUSION: The Efficiency of a Competitive Market Profit-maximization: MC = MR Perfect competition: P = MR So, in the competitive equilibriumP = MC So, the competitive equilibrium is efficient, maximizes total surplus. 0

  10. Shutdown Conditions for the Perfectly Competitive Firm Shutdown: A short-run decision not to produce anything because the firm cannot cover AVC When to Shut Down: Firms cannot cover the AVC Therefore MR is lower than the AVC curve Fixed costs must be paid anyway, therefore the AFC does not enter into their decision 0

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