ECO101H1 Lecture Notes - Marginal Revenue, Perfect Competition, Demand Curve
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Topic 8 – Perfect Competition
(Week eight Nov 1st - Nov 10th)
2. Total Revenue, Marginal Revenue, and Average Revenue;
3. Profit Maximizing Output
-- MC = MR = P;
-- Firm’s MC curve = Firm’s SS curve (if P > AVC);
-- Shut down point;
4. Level of Profits;
5. Entry and exit;
6. Short-Run and Long-Run Impact of a shift in Demand;
7. Long-Run market supply curve;
-- Many buyers and sellers of identical product (so action of each buyer or seller exerts no impact on the
-- Freedom of entry and exit of firms (no barrier to entry/exit)
-- Each firm is a price taker, meaning each firm faces an infinitely elastic demand curve at the market price;
--- In the short run, the number of firms is fixed;
In the long run, the number of firms can vary.
Individual Firm Market
TR/AR/MR for perfectly competitive firm
Q X P
TR / Q (price)
(the revenue of producing an additional unit of output)
(is price, since the firm faces perfectly
MR = P for perfectly competitive firm.
dd = market price
DD/SS – market demand/supply
dd/ss – Individual firm’s demand/
-- At what level of output should a firm choose to produce to maximize profit?
Perfectly competitive firm produces at the profit-maximizing level where MR = MC.
-- Firm’s supply curve and MC curve
Therefore, the supply curve of a perfectly competitive firm is its MC curve, and it reflects the
-- Shut Down Point: Application 1 – A barber shop with 6-month lease
Question: Should the barber ship stay open until the lease expires?
1. Revenue: Q = 100; P = $15.
TR = 100 X 15 = $1,500.
2. Costs: lease is $500/mo.; wages for barbers and other variable costs total $1,200/mo.
TC = TFC + TVC = $1,700/mo. (assume no implicit costs).
-- If the shop stays open: profit = -$200;
If the shop shuts down: profit = -$500 (the shop still needs to pay the lease);
-- Therefore, the shop should stay open as long as total revenue can cover total variable cost. (fixed costs
are not calculated since the firm needs to pay them anyway.)
TR > TVC also means P > AVC (TR/Q > TVC/Q)
Production level (ss curve):
When P > AVC (the firm stays open), ss = MC curve;
When P < AVC (the firm shuts down), ss=0.
Q1 Q0 Q2 Quantity
MR = P
At Q1, MR > MC: the revenue of producing an additional unit of
output exceeds the cost of it; the firm should expand
At Q2, MR < MC: the cost of producing an additional unit of
output exceeds the revenue of it; the firm should
At Q0, MR = MC: the revenue of producing an additional unit of
output equals the cost of it; this is the profit –
maximizing level of output for the firm.
15 16 17 Quantity
The firm’s supply curve measures:
-- quantity of output a firm is willing to produce at certain price.
If the price if 10, which is also the firm’s MR, the firm will produce at
15 units where MC is 10 = MR.
In essence, because the firm’s marginal cost curve determines the
quantity of goods the firm is willing to supply at given price, it is the
competitive firm’s supply curve.
Level of Profit
Q: if MR = MC and the firm is producing at a profit-maximizing level of output, is the firm then earning an
A: not sufficient information. To calculate economic profit, ATC is needed. (compare P with ATC).
Level of Profit:
TR > TC Economic Profits (TR/Q) > (TC/Q) P > ATC
TR = TC Breaks Even (TR/Q) = (TC/Q) P = ATC
TR < TC Economic Loss (TR/Q) < (TC/Q) P < ATC
1. Economic Profits (P > ATC)
2. Zero Economic Profit (P = ATC: Breaks Even)
1. Firms shut down if TR < TVC (fixed costs are
2. TR < TVC (TR/Q) < (TVC/Q)
P < AVC;
3. Firm’s supply curve = firm’s MC curve where P >
(P > AVC, ss = MC;
P < AVC, ss=0.)
Profit-Maximizing Output: 10 (MC=MR)
Profit = (P-ATC) X Q = (25-20) X 10 = 50
Profit-Maximizing Output: 10 (MC=MR)
Profit = 0 since ATC = P
Note: in the short run it’s not necessarily the shut
down point, since the firm can still cover its variable
Topic 8 perfect competition (week eight nov 1st - nov 10th) Outline: definition, total revenue, marginal revenue, and average revenue, profit maximizing output. - firm"s mc curve = firm"s ss curve (if p > avc); - shut down point: level of profits, entry and exit, short-run and long-run impact of a shift in demand, long-run market supply curve; - many buyers and sellers of identical product (so action of each buyer or seller exerts no impact on the market price); - freedom of entry and exit of firms (no barrier to entry/exit) - each firm is a price taker, meaning each firm faces an infinitely elastic demand curve at the market price; -- in the short run, the number of firms is fixed; In the long run, the number of firms can vary. Total revenue (the revenue of producing an additional unit of output) Dd/ss market demand/supply dd/ss individual firm"s demand/ market price supply.