1. Perfect Competition

2. Output Decisions: Revenues, Costs, and Profit Maximization Perfect Competition perfect competition An industry structure in which there are many firms, each small relative to the industry, producing virtually identical products and in which no firm is large enough to have any control over prices. In perfectly competitive industries, new competitors can freely enter and exit the market. homogeneous products Undifferentiated products; products that are identical to, or indistinguishable from, one another.

3. Output Decisions: Revenues, Costs, and Profit Maximization Perfect Competition If a representative firm in a perfectly competitive market raises the price of its output above £2.45, the quantity demanded of that firm’s output will drop to zero. Each firm faces a perfectly elastic demand curve, d. £ £

4. Output Decisions: Revenues, Costs, and Profit Maximization Total Revenue (TR) and Marginal Revenue (MR) total revenue (TR) The total amount that a firm takes in from the sale of its product: the price per unit times the quantity of output the firm decides to produce (P x q). marginal revenue (MR) The additional revenue that a firm takes in when it increases output by one additional unit. In perfect competition, P = MR.

5. Output Decisions: Revenues, Costs, and Profit Maximization Comparing Costs and Revenues to Maximise Profit The Profit-Maximising Level of Output If price is above marginal cost, as it is at 100 and 250 units of output, profits can be increased by raising output; each additional unit increases revenues by more than it costs to produce the additional output. Beyond q* = 300, however, added output will reduce profits. At 340 units of output, an additional unit of output costs more to produce than it will bring in revenue when sold on the market. Profit-maximizing output is thus q*, the point at which P* = MC. £ MC= £2.50 MC=£4 MC=£5.70

6. Output Decisions: Revenues, Costs, and Profit Maximization Comparing Costs and Revenues to Maximize Profit The Profit-Maximizing Level of Output As long as marginal revenue is greater than marginal cost, even though the difference between the two is getting smaller, added output means added profit. Whenever marginal revenue exceeds marginal cost, the revenue gained by increasing output by 1 unit per period exceeds the cost incurred by doing so. The profit-maximizing perfectly competitive firm will produce up to the point where the price of its output is just equal to short-run marginal cost—the level of output at which P* = MC. The profit-maximizing output level for all firms is the output level where MR = MC.

7. Output Decisions: Revenues, Costs, and Profit Maximisation Comparing Costs and Revenues to Maximise Profit A Numerical Example Profit Analysis for a Simple Firm £ (1) q (2) TFC (3) TVC (4) MC (5) P = MR (6) TR (P x q) (7) TC (TFC + TVC) (8) PROFIT (TR TC) 0 10 0 15 0 10 -10 1 10 10 10 15 15 20 -5 2 10 15 5 15 30 25 5 3 10 20 5 15 45 30 15 4 10 30 10 15 60 40 20 5 10 50 20 15 75 60 15 6 10 80 30 15 90 90 0

8. Output Decisions: Revenues, Costs, and Profit Maximization The Short-Run Supply Curve At any market price, the marginal cost curve shows the output level that maximises profit. Thus, the marginal cost curve of a perfectly competitive profit-maximising firm is the firm’s short-run supply curve. This is true except when price is so low that it pays a firm to shut down. £

9. Key Terms • average fixed cost (AFC) • average total cost (ATC) • average variable cost (AVC) • fixed cost • homogeneous product • marginal cost (MC) • marginal revenue (MR) • perfect competition • total cost (TC) • total fixed costs (TFC) or overheads • total revenue (TR) • total variable cost (TVC) • total variable cost curve • variable cost • 1. TC = TFC + TVC • 2. AFC = TFC/q • 3. Slope of TVC = MC • 4. AVC = TVC/q • 5. ATC = TC/q = AFC + AVC • 6. TR = P x q • 7. Profit-maximising level of output for all firms: MR = MC • 8. Profit-maximising level of output for perfectly competitive firms: P = MC