Nov 14, 2011
Economics – Lecture #16
Perfect competition is an industry in which
Many firms sell identical products to many buyers.
There are no restrictions to entry into the industry.
Established firms have no advantages over new ones.
Sellers and buyers are well informed about prices.
o Corn, rice
How Perfect Competition Arises
Perfect competition arises:
When firm’s minimum efficient scale is small relative to market demand so there
is room for many firms in the industry.
And when each firm is perceived to produce a good or service that has no unique
characteristics, so consumers don’t care which firm they buy from.
In perfect competition, each firm is a price taker.
A price taker is a firm that cannot influence the price of a good or service.
No single firm can influence the price—it must “take” the equilibrium market
Each firm’s output is a perfect substitute for the output of the other firms, so the
demand for each firm’s output is perfectly elastic.
Economic Profit and Revenue
The goal of each firm is to maximize economic profit, which equals total revenue minus
Total cost is the opportunity cost of production, which includes normal profit.
A firm’s total revenue equals price, P, multiplied by quantity sold, Q, or P × Q.
A firm’s marginal revenue is the change in total revenue that results from a one-
unit increase in the quantity sold. Nicole Wallenburg
Nov 14, 2011
The demand for a firm’s product is perfectly elastic because one firm’s sweater is
a perfect substitute for the sweater of another firm.
The market demand is not perfectly elastic because a sweater is not a perfect
substitute for other goods.
A perfectly competitive firm’s goal is to make maximum economic profit, given the
constraints it faces.
The firm must decide:
1. How to produce at minimum cost
2. What quantity to produce
3. Whether to enter or exit a market
You studied 1 last week. We now look at the firm’s output decision—the quantity to
produce. On Wednesday we look at entry and exit decisions.
The Firm’s Output Decision
Spreadsheet Analysis and Supply Decision
The firm can use a spreadsheet to determine the profit-maximizing output.
Figure 12.2 on the next slide shows how the firm determines its profit-maximizing output
in a spreadsheet
Total Total Economic
Quantity revenue cost profit
0 0 22 -22
1 25 45 -20
2 50 66 -16
3 75 85 -10