Demand as Seen by a Purely Competitive Seller

 Purely Competitive Seller as “PRICE TAKERS”

 Perfectly Elastic Demand

= (6-5)/5

(131-131)/131

= 1

Or simply alpha or infinity symbol

 Average, Total, and Marginal Revenue

Average Revenue: Total revenue from the sale of a product divided by the quantity of product
sold.
Total Revenue: Total number of dollars received by a firm from a sale of product.
Marginal revenue: The change in total revenue (or the extra revenue) that results from selling
one more unit of output.

Curves:
 Total revenue (TR):A straight line that slopes upward to the right. Its slope is
constant because each extra unit of sales increases TR by price.
 Demand curve ( D):Horizontal, indicating perfect price elasticity.
  Marginalrevenue (MR) curve:Coincides with the demand curve because the
product price (and hence MR) is constant.
 Average revenue (AR) curve: Equals price and therefore also coincides with the
demand curve.

Profit Maximization in the Short Run

The short run is the concept that, within a certain period in the future, at least one input is fixed
while others are variable. AR = P = MR

Q = TR
Purely competitive firm cannot attempt to maximize its profit by raising or lowering the
price it charges.

The only variable that the firm can control is its output. As a result, the purely
competitive firm attempts to maximize its economic profit (or minimize itseconomic loss) by
adjusting its output through changes in the amount of variable resources (materials, labor) it
uses.

MR = MC Rule: A method of determining the total output at which economic profit is at a maximum or
losses at a minimum.

3 Features

1. The rule applies only if producing is preferable to shutting down. We will show shortly that if
marginal revenue does not equal or exceed average variable cost, the firm will shut down rather
than produce the amount of output at which MR= MC.
2. The rule is an accurate guide to profit maximization for all firms whether they are purely
competitive, monopolistic, monopolistically competitive, or oligopolistic.
3. The rule can be restated as P = MC when applied to a purely competitive firm. Because the
demand schedule faced by a competitive seller is perfectly elastic at the going market price,
product price and marginal revenue are equal. So under pure competition (and only under pure
competition) we may substitute P for MR in the rule: When producing is preferable to shutting
down, the competitive firm that wants to maximize its profit or minimize its loss should produce
at that point where price equals marginal cost ( P = MC ).

Profit-Maximizing Case (P > ATC)

Suppose first that the market price, and therefore marginal revenue, is $131, as shown in column 6.
What is the profit-maximizing output? Every unit of output up to and including the ninth unit represents
greater marginal revenue than marginal cost of output.

Loss-Minimizing Case (ATC > P > AVC)

Now let’s assume that the market price is $81 rather than $131. Should the firm still produce? If so, how
much? And what will be the resulting profit or loss? The answers, respectively, are “Yes,” “Six units,” and
“A loss of $64.”

Shutdown Case (AVC > P)

Suppose now that the market yields a price of only $71. Should the firm produce? No, because at every
output level the firm’s average variable cost is greater than the price (compare columns 3 and 8 of the
table in Figure 8.4 ). The smallest loss it can incur by producing is greater than the $100 fixed cost it will
lose by shutting down (as shown by column 9). The best action is to shut down.
Marginal Cost and Short-Run Supply

 Price and quantity supplied have a direct relationship.

Let’s observe quantity supplied at each of these prices:

• Price P1 is below the firm’s minimum average variable cost, so at this price the firm won’t
operate at all. Quantity supplied will be zero, as it will be at all other prices below P2.
• Price P2 is just equal to the minimum average variable cost. The firm will supply Q2 units of
output (where MR2 = MC) and just cover its total variable cost. Its loss will equal its total fixed
cost. (Actually, the firm would be indifferent as to shutting down or supplying Q2 units of output,
but we assume it produces.)
• At price P3 the firm will supply Q3 units of output to minimize its short-run losses. At any of the
other prices between P2 and P4 the firm will also minimize its losses by producing and supplying
the quantity at which MR (= P ) = MC.
• The firm will just break even at price P4. There it will supply Q4 units of output (where MR4 =
MC), earning a normal profit but not an economic profit. Total revenue will just cover total cost,
including a normal profit, because the revenue per unit (MR4 = P4 ) and the total cost per unit
(ATC) are the same.
• At price P5 the firm will realize an economic profit by producing and supplying Q5 units of
output. In fact, at any price above P4 the firm will obtain economic profit by producing to the
point where MR (= P ) = MC.

Note that each of the MR (5 P) 5 MC intersection points labelled b, c, d and e in Figure 8.6
indicates a possible product price (on the vertical axis) and the corresponding quantity that the
firm would supply at that price (on the horizontal axis). Thus, points such as these are on the
upsloping supply curve of the competitive firm. Note, too, that quantity supplied would be zero
at any price below the minimum average variable cost (AVC).

Short-run supply curve: Solid segment of the marginal-cost curve MC. It tells us the amount of
output the firm will supply at each price in a series of prices.

Firm and Industry: Equilibrium Price

Which of the various possible prices will actually be the market equilibrium price?
Market equilibrium: The price at which the total quantity supplied of the product equals the
total quantity demanded.

Market Price and Profits

Will these conditions of market supply and demand make this a profitable or unprofitable
industry?
Economic Profit = (111 – 93.75) x 8

Economic Profit = 17.25 x 8

Economic Profit =138

Total Economic Profit = Economic Profit x Number of Identical Firms

Total Economic Profit = 138 x 1 000

Total Economic Profit = 138 000