Perfect Competition

The Firm's Output Decision

• A perfectly competitive firm chooses the output that maximizes it's economic profit
• We can determine the profit-maximizing output by looking at the firm's total revenue and total cost curves

• If $MR>MC$ economic profit increases if output increases
• If $MR<MC$ economic profit decreases if output increases
• If $MR=MC$ economic profit decreases if output changes; profit maximized

Temporary Shutdown Decision

• When taking economic loss, a firm must decide whether to exit or stay in the market
• If the firm stays in the market, if must dcide whether to produce something or shut down temporarily
• The decsion will be the one that minimizes the firm's loss

Calculating economic loss:

$Loss=TFC+TVC-TR=TFC+(AVC-P)\times Q$

TFC - Total fixed cost

TVC - total variable cost

TR - total revenue

• If the firm shuts down, Q is 0 and the firm still has to pay it's TFC

The Shutdown Point

• When it is indifferent between producing and shutting down
• When AVC is at it minimum
  • Also the point at which the MC curve crosses the AVC curve
• The firm incurs a loss equal to TFC from either action

• The firm incurs a loss equal to the red rectangle

The Firm's Supply Curve

• A perfectly competitive firm's supply curve shows how the firm's profit-maximizing output varies as the market price varies, other things remain the same
• Linked to the marginal cost cruve
• Produces nothing below the shutdown point

The Firm's Demand Curve

• Perfectly elastic (0 slope)
• Equals to the firm's marginal revenue curve

Entry and Exit

• New firm enters an industry in which existing firms make an economic profit

• Firms exit an industry in which they incur an economic lossb

• When new firms enters the market, the market supply increases and the market price falls

• In the long run, the price falls until firms are making zero economic profit

• When firms exit the market, the market supply decreases and the market price rises

• In the long run, the price continues to rise until firms make zero economic profit

Techonological Change

• New technologies that lowers costs and constantly being discovered
  • Allows a firm to produce at lower average cost and marginal cost
  • Cost curve shift downward
• Firms that adopt the new technology mak an economic profit
• New techonology firm enter and old technology firms either exit or adopt the new technologies
• Industry supply increases and the industry supply curve shifts rightward
• This continues until a new long-run equilibrium emerges in which all firms use the new technologies, the price equals minimum average cost, and each firm makes zero economic profit