$800 FC

Q FC VC TC $700 VC
TC
0 $100 $0 $100 $600
1 100 70 170 $500

Costs
2 100 120 220
$400
3 100 160 260
$300
4 100 210 310
$200
5 100 280 380
$100
6 100 380 480
$0
7 100 520 620 0 1 2 3 4 5 6 7
Q
CHAPTER 13 THE COSTS OF PRODUCTION 0
EXAMPLE 2: Marginal Cost

Q TC MC $200 Marginal Cost (MC)

Recall,
is $175
the change in total cost from
0 $100
$70 producing
$150 one more unit:
1 170
50 $125 ∆TC

Costs
2 220 MC =
$100 ∆Q
40
3 260 Usually,
$75
MC rises as Q rises, due
50 to diminishing marginal product.
4 310 $50
70 Sometimes (as here), MC falls
5 380 $25
100 before rising.
6 480 $0
140 (In other0 examples,
1 2 3 MC 4 may
5 6be 7
7 620 constant.) Q
CHAPTER 13 THE COSTS OF PRODUCTION 1
 $200
$175
$150
ATC
$125

Costs
AVC
$100
AFC
MC $75
$50
$25
$0
0 1 2 3 4 5 6 7
Q
CHAPTER 13 THE COSTS OF PRODUCTION 2
 EXAMPLE 3: LRATC with 3 Factory Sizes
Firm can choose
from 3 factory Avg
sizes: S, M, L. Total
Cost ATCS ATCM
Each size has its ATCL
own SRATC curve.
The firm can
change to a
different factory
size in the long
run, but not in the Q
short run.

CHAPTER 13 THE COSTS OF PRODUCTION 3

 MARGINAL REVENUE, MARGINAL COST,
AND PROFIT MAXIMIZATION
● profit Difference between total revenue and total cost.
π(q) = R(q) − C(q)
● marginal revenue Change in revenue resulting from a
one-unit increase in output.
Figure 8.1

Profit Maximization in the Short Run

A firm chooses output q*, so that

profit, the difference AB between
revenue R and cost C, is
maximized.
At that output, marginal revenue
(the slope of the revenue curve)
is equal to marginal cost (the
slope of the cost curve).

Δπ/Δq = ΔR/Δq − ΔC/Δq = 0

MR(q) = MC(q)

4
 Characteristics of Perfect Competition

1. Many buyers and many sellers

2. The goods offered for sale are largely the same.

3. Firms can freely enter or exit the market.

 Because of 1 & 2, each buyer and seller is a

“price taker” – takes the price as given.

CHAPTER 14 FIRMS IN COMPETITIVE MARKETS 5

 The Revenue of a Competitive Firm
 Total revenue (TR) TR = P x Q

TR
 Average revenue (AR) AR = =P
Q
 Marginal Revenue (MR):
∆TR
The change in TR from MR =
∆Q
selling one more unit.

CHAPTER 14 FIRMS IN COMPETITIVE MARKETS 6

 MC and the Firm’s Supply Decision
Rule: MR = MC at the profit-maximizing Q.
At Qa, MC < MR. Costs
So, increase Q
MC
to raise profit.
At Qb, MC > MR.
So, reduce Q
to raise profit. P1 MR=
AR=
At Q1, MC = MR. P
Changing Q
would lower profit. Q
Q a Q1 Q b

CHAPTER 14 FIRMS IN COMPETITIVE MARKETS 7

 Market Supply: Assumptions
1) All existing firms and potential entrants have
identical costs.
2) Each firm’s costs do not change as other firms
enter or exit the market.
3) The number of firms in the market is
• fixed in the short run
(due to fixed costs)
• variable in the long run
(due to free entry and exit)

CHAPTER 14 FIRMS IN COMPETITIVE MARKETS 8

 The Zero-Profit Condition
 Long-run equilibrium:
The process of entry or exit is complete –
remaining firms earn zero economic profit.
 Zero economic profit occurs when P = ATC.
 Since firms produce where P = MR = MC,
the zero-profit condition is P = MC = ATC.
 Recall that MC intersects ATC at minimum ATC.
 Hence, in the long run, P = minimum ATC.

CHAPTER 14 FIRMS IN COMPETITIVE MARKETS 9

 The LR Market Supply Curve

In the long run, The LR market supply

the typical firm curve is horizontal at
earns zero profit. P = minimum ATC.

One firm Market

P MC P

LRATC
P=
long-run
min. supply
ATC

Q Q
(firm) (market)
CHAPTER 14 FIRMS IN COMPETITIVE MARKETS 10
 SR & LR Effects of an Increase in Demand
A firm begins in …but then an increase
long-run to…driving
…leadingeq’m… SR profits to zero
Over time, profits
in demandinduce entry,
raises P,…
andfirm.
profits for the restoring long-run
shifting eq’m.
S to the right, reducing P…

P One firm P Market

MC S1

S2
Profit ATC B
P2 P2
A C long-run
P1 P1 supply
D2
D1
Q Q
(firm) Q1 Q2 Q3 (market)
CHAPTER 14 FIRMS IN COMPETITIVE MARKETS 11
Why the LR Supply Curve Might Slope Upward
 The LR market supply curve is horizontal if
1) all firms have identical costs, and
2) costs do not change as other firms enter or
exit the market.
 If either of these assumptions is not true,
then LR supply curve slopes upward.

CHAPTER 14 FIRMS IN COMPETITIVE MARKETS 12

 1) Firms Have Different Costs
 As P rises, firms with lower costs enter the market
before those with higher costs.
 Further increases in P make it worthwhile
for higher-cost firms to enter the market,
which increases market quantity supplied.
 Hence, LR market supply curve slopes upward.
 At any P,
• For the marginal firm,
P = minimum ATC and profit = 0.
• For lower-cost firms, profit > 0.
CHAPTER 14 FIRMS IN COMPETITIVE MARKETS 13
CHAPTER SUMMARY
 For a firm in a perfectly competitive market,
price = marginal revenue = average revenue.
 If P > AVC, a firm maximizes profit by producing
the quantity where MR = MC. If P < AVC, a firm
will shut down in the short run.
 If P < ATC, a firm will exit in the long run.
 In the short run, entry is not possible, and an
increase in demand increases firms’ profits.
 With free entry and exit, profits = 0 in the long run,
and P = minimum ATC.
CHAPTER 14 FIRMS IN COMPETITIVE MARKETS 16