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price
$5
10 quantity
The firm can sell 20 units for $5.
price
$5
20 quantity
The firm can sell 30 units for $5.
price
$5
30 quantity
The firm can sell 40 units for $5.
price
$5
40 quantity
The firm can sell 50 units for $5.
price
$5
50 quantity
So all these points are on the demand
curve for the firm’s product.
price
$5
quantity
Connecting these points, we have the
demand curve for the firm’s product.
price
$5 demand
quantity
The demand curve for the perfectly
competitive firm’s product is a
horizontal line at the market price.
price
quantity
Recall: Total Revenue
price
market price D = MR
quantity
Optimal Output Level
Recall:
To maximize profit, the firm will produce at
the output level where MR = MC.
So the firm will produce where the MR and
MC curves intersect.
Draw your axes; label them quantity and $.
Quantity
Draw your ATC, AVC, and MC curves. (Make sure
MC intersects ATC and AVC at the minimum.)
$
ATC AVC
MC
Quantity
Draw the D = MR curve horizontal
at the market price.
$ D = MR
ATC AVC
MC
Quantity
If the market price is P1 ,
the quantity produced will be Q1.
$ D = MR
P1
ATC AVC
MC
Q1 Quantity
If the market price is P2 ,
the quantity produced will be Q2.
$
ATC D = MR
P2
AVC
MC
Q2 Quantity
If the market price is P3 ,
the quantity produced will be Q3.
$
ATC AVC
P3
D = MR
MC
Q3 Quantity
If the market price is P4 ,
the quantity produced will be Q4.
$
ATC AVC
P4
D = MR
MC
Q4 Quantity
If the market price is P5 ,
the quantity produced will be Q5.
$
ATC AVC
D = MR
P5
MC
Q5 Quantity
Price P5 was the minimum of the AVC curve
(the shutdown point). If the price fell any
lower than P5 the firm would produce no
output.
The p.c. firm’s short run supply curve
The firm’s supply curve shows the quantity the firm
will produce at each price.
The P, Q values we have shown, therefore, are
points on the firm’s supply curve.
But those points are all on the firm’s MC curve.
So, the firm’s supply curve is the part of the MC
curve that is above the minimum of the AVC curve.
The p.c. firm’s short run supply curve
$ Supply
ATC
AVC
MC
Quantity
The market short run supply curve
length Area
width
We also know TR = P . Q.
So, if we can find a rectangle
P TR
whose length is P and whose
width is Q, then its area must Q
be total revenue.
To determine Total Cost, first remember
ATC = TC / Q
So, ATC . Q = TC
To determine Total Cost, first remember
ATC = TC / Q
So, ATC . Q = TC
ATC TC
Now, if we can find a rectangle
Q
whose length is ATC and whose
width is Q, then its area is TC.
Then to determine profit,
we just subtract the TC area from the TR area.
Graphing Profit:
The six steps
Step 1 a. Draw your axes and label them Q and $.
( Label the origin 0.)
$
0 Quantity
Step 1b. Draw the firm’s ATC curve. (If the price is below the
minimum of ATC, you will also need to draw the AVC curve.)
$ MC
ATC
P
0 Quantity
Step 1 c. Draw the MC curve and D=MR curve. (For a
positive profit, D must be at least partly above ATC.)
$ MC
ATC
P
D = MR
0 Quantity
Step 2: Determine the profit-maximizing
output (Q*) by finding where MR = MC.
$ MC ATC
P
D = MR
0
Q* Quantity
Step 3: Find your TR = PQ rectangle.
$ MC ATC
P
D = MR
0
Q* Quantity
Step 4: Determine ATC at the profit-maximizing
output level.
$ MC ATC
P
D = MR
ATC
0
Q* Quantity
Step 5: Find your TC = ATC . Q rectangle.
$ MC ATC
P
D = MR
Q* Quantity
Step 6: Find profit p = TR - TC.
$ MC ATC
P
profit D = MR
Q* Quantity
You follow the same steps to
draw a firm that is making a loss
or breaking even (zero profits).
$ MC
ATC
AVC
P
D = MR
0 Quantity
Step 2: Determine the profit-maximizing
output (Q*) by finding where MR = MC.
$ MC
ATC
AVC
P
D = MR
0 Quantity
Q*
Step 3: Find your TR = PQ rectangle.
$ MC
ATC
AVC
P
D = MR
0 Quantity
Q*
Step 4: Determine ATC at the profit-maximizing
(or loss-minimizing) output level.
$ MC
ATC
ATC
AVC
P
D = MR
0 Quantity
Q*
Step 5: Find your TC = ATC . Q rectangle.
$ MC
ATC
ATC
AVC
P
D = MR
0 Quantity
Q*
Step 6: Find profit (or loss) p = TR - TC.
$ MC
ATC
AVC
loss
P
D = MR
0 Quantity
Q*
A firm that is breaking even
(zero profits)
Step 1: Draw & label the curves & axes. To break even,
make D tangent to the minimum of ATC.
$ MC
ATC
D = MR
P
0 Quantity
Step 2: Determine the profit-maximizing
output (Q*) by finding where MR = MC.
$ MC
ATC
D = MR
P
0 Q* Quantity
Step 3: Find your TR = PQ rectangle.
$ MC
ATC
D = MR
P
0 Q* Quantity
Step 4: Determine ATC at the profit-maximizing
output level.
$ MC
ATC
D = MR
ATC = P
0 Q* Quantity
Step 5: Find your TC = ATC . Q rectangle.
$ MC
ATC
D = MR
ATC = P
0 Q* Quantity
Step 6: Find profit p = TR - TC.
$ MC
ATC
D = MR
ATC = P
0 Q* Quantity
Adapting to Changes
in Demand
Constant Cost Industry
long run
P1= P2
supply curve
Q1 Q2
Increasing Cost Industry
Q1 Q2 Q
Decreasing Cost Industry
It will increase.
Now we have a decreasing cost industry. That means
that as the industry expands and infrastructure
improves, the cost of production decreases.
So visualize all the cost curves, including the ATC,
sliding down.
So the industry supply curve is shifting to the right,
and the ATC and other cost curves are sliding down.
As the supply increases, what happens to the price of the
product?
It falls.
But the price does not fall back to where it was before the
demand change, which was at the minimum of the old
ATC curve.
It keeps dropping until we are back to zero economic
profits under the new conditions, which is at the bottom
of the new, lower, ATC curve.
So what has happened as a result of the increase
in demand in this decreasing cost industry?
P1
P2 long run
supply curve
Q1 Q2 Q
Good Things about Perfect Competition
• Costs are minimized.
Competition forces efficient operation. Inefficient firms
will have losses and be forced out of business.
• P = MC
The price (which comes from the demand curve) is the
amount that consumers value a good.
MC is the cost of producing an additional unit of a good.
So firms produce up to the point where the amount that
consumers value a good is equal to the amount it costs to
produce an additional unit of the good.