Principles of MicroEconomics:

Econ102

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……………meets the conditions of:

Many buyers and sellers: all participants are small relative to the market.

All firms selling identical products

No barriers to new firms entering the market.

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Price taker: A buyer or seller that is unable to affect the market price.

A Perfectly Competitive Firm Faces a Horizontal Demand

Curve

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Profit: Total revenue minus total cost.Profit = TR – TC

where,

Total Revenue (TR): Price multiplied by quantity, units or output produced.

TR=P x Q

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Average revenue (AR): Total revenue divided by the number of units sold.

Q

TRAR

or ,quantityin Change

revenue in total Change Revenue Marginal

Q

TRMR

PQ

QP

Q

TRAR

so,

Marginal revenue (MR): Change in total revenue from selling one more unit.

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NUMBER OF BUSHELS

(Q)

MARKET PRICE

(PER BUSHEL)

(P)

TOTAL REVENUE

(TR)

AVERAGE REVENUE

(AR)

MARGINAL REVENUE

(MR)

0

1

2

3

4

5

6

7

8

9

10

$4

4

4

4

4

4

4

4

4

4

4

$0

4

8

12

16

20

24

28

32

36

40

-

$4

4

4

4

4

4

4

4

4

4

-

$4

4

4

4

4

4

4

4

4

4

For a firm in a perfectly competitive market, price is equal to both AR and MR.

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QUANTITY(BUSHELS)

(Q)

TOTALREVENUE

(TR)

TOTALCOSTS

(TC)

PROFIT

(TR-TC)

MARGINAL REVENUE

(MR)

MARGINAL COST

(MC)

0

1

2

3

4

5

6

7

8

9

10

$0.00

4.00

8.00

12.00

16.00

20.00

24.00

28.00

32.00

36.00

40.00

$1.00

4.00

6.00

7.50

9.50

12.00

15.00

19.50

25.50

32.50

40.50

-$1.00

0.00

2.00

4.50

6.50

8.00

9.00

8.50

6.50

3.50

-0.50

$4.00

4.00

4.00

4.00

4.00

4.00

4.00

4.00

4.00

4.00

$3.00

2.00

1.50

2.00

2.50

3.00

4.50

6.00

7.00

8.00

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Conclusions:

The PMLO is where the difference between total revenue and total cost is the greatest.

The PMLO is also where the marginal revenue equals marginal cost, or MR=MC.

One more conclusion:

For a firm in a perfectly competitive industry, price is equal to marginal revenue, or P=MR. So, it logically follows that P=MC, because MR=MC

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Profit = (P x Q) TC

Q

QP )(

Q

ProfitQ

TC

,Profit

ATCPQ

Profit = (P ATC)Q

Or

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When P > ATC, the firm makes a profit

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When P = ATC, the firm breaks even (its total cost equals its total revenue)

When P < ATC, the firm experiences losses

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In the short-run a firm suffering losses has two choices:

Continue to produce: Only if TR is greater than its variable costs.

Stop production by shutting down temporarily

Sunk cost: A cost that has already been paid and that cannot be recovered.

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Shutdown point :The minimum point on a firm’s average variable cost curve; if the price falls below this point, the firm shuts down production in the short run.

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Long-run Competitive Equilibrium:The situation in which the entry and exit of firms have resulted in the typical firm just breaking even.

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Long-run Supply Curve:A curve showing the relationship in the long run between market price and the quantity supplied.

In the long-run, a perfectly competitive market will supply whatever amount of a good consumers demand at a price

determined by the minimum point on the typical firm’s average total cost curve.

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Allocative Efficiency:The situation where every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it. For allocative efficiency to hold, firms must charge a price equal to marginal cost.

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Productive Efficiency:

The situation where every good or service is produced at the lowest possible cost. For productive efficiency to hold, firms must produce at the minimum point of average total cost.