Download Economics, by R. Glenn Hubbard and Anthony Patrick O'Brien

Principles of Microeconomics:
Econ102
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……………meets the conditions of:
 Many buyers and sellers: all participants are
small relative to the market.
 All firms selling identical products
 No barriers to new firms entering the market.
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Price taker:
A buyer or seller that is unable to affect the market
price.
A Perfectly Competitive Firm
Faces a Horizontal Demand
Curve
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Economic Profit:
Total revenue (TR) minus total economic costs (TEC)
Versus
Accounting Profit:
Total revenue (TR) minus total accounting costs (TAC)
Where…….
Total Revenue = Price multiplied by quantity/output
(PxQ)
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Average revenue (AR):
Total revenue divided by the number of units sold.
TR
AR 
Q
TR P  Q
so, AR 

P
Q
Q
Marginal revenue (MR):
Change in total revenue from selling one more unit.
Change in total revenue
TR
Marginal Revenue 
, or MR 
Change in quantity
Q
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NUMBER OF
BUSHELS
(Q)
MARKET PRICE
(PER BUSHEL)
(P)
TOTAL
REVENUE
(TR)
AVERAGE
REVENUE
(AR)
MARGINAL
REVENUE
(MR)
0
1
2
3
4
5
6
7
8
9
10
$4
4
4
4
4
4
4
4
4
4
4
$0
4
8
12
16
20
24
28
32
36
40
$4
4
4
4
4
4
4
4
4
4
$4
4
4
4
4
4
4
4
4
4
For a firm in a perfectly competitive market, price is equal to both AR and MR.
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QUANTITY
(BUSHELS)
(Q)
TOTAL
REVENUE
(TR)
TOTAL
COSTS
(TC)
PROFIT
(TR-TC)
0
1
2
3
4
5
6
7
8
9
10
$0.00
4.00
8.00
12.00
16.00
20.00
24.00
28.00
32.00
36.00
40.00
$1.00
4.00
6.00
7.50
9.50
12.00
15.00
19.50
25.50
32.50
40.50
-$1.00
0.00
2.00
4.50
6.50
8.00
9.00
8.50
6.50
3.50
-0.50
MARGINAL
REVENUE
(MR)
MARGINAL
COST
(MC)
$4.00
4.00
4.00
4.00
4.00
4.00
4.00
4.00
4.00
4.00
$3.00
2.00
1.50
2.00
2.50
3.00
4.50
6.00
7.00
8.00
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Conclusions:

The PMLO is where the difference
between total revenue and total cost is
the greatest.

The PMLO is also where the marginal
revenue equals marginal cost, or
MR=MC.
One more conclusion:

For a firm in a perfectly competitive
industry, price is equal to marginal
revenue, or P=MR. So, it logically
follows that P=MC, because MR=MC
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Profit = (P x Q)  TC
( P  Q ) TC
Profit


Q
Q
Q
Or
Profit
 P  ATC,
Q
Profit = (P  ATC)Q
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When P > ATC, the firm makes a profit
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When P = ATC, the firm breaks even (its total cost equals its total revenue)
When P < ATC, the firm experiences losses
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In the short-run a firm suffering losses has two choices:

Continue to produce: Only if TR is greater than its variable costs.

Stop production by shutting down temporarily
Sunk cost:
A cost that has already been paid and that cannot be recovered.
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Shutdown point :
The minimum point on a firm’s average variable cost curve; if the price falls
below this point, the firm shuts down production in the short run.
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Long-run Competitive Equilibrium:
The situation in which the entry and exit of firms
have resulted in the typical firm just breaking even.
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Long-run Supply Curve:
A curve showing the relationship in the long run between
market price and the quantity supplied.
In the long-run, a perfectly competitive market will supply
whatever amount of a good consumers demand at a price
determined by the minimum point on the typical firm’s average
total cost curve.
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Allocative Efficiency:
The situation where every good or service is produced up to the
point where the last unit provides a marginal benefit to consumers
equal to the marginal cost of producing it. For allocative efficiency
to hold, firms must charge a price equal to marginal cost.
Productive Efficiency:
The situation where every good or service is produced at the
lowest possible cost. For productive efficiency to hold, firms must
produce at the minimum point of average total cost.
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