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Perfect Competition
Chapter 11
Profit Maximization
• Economic profit is total revenue less
total costs which consist of implicit and
explicit costs.
• Economic profit differs from
accounting profit in that accounting
profit does not consider implicit costs.
• Normal profit is the opportunity cost of
the resources owned by the firm
• Assumption of profit maximization
What is a perfectly competitive
firm?
A firm with the following attributes:
1. Standardized product
2. A price taker
3. Factors of production are mobile in the
long-run
4. The firm and consumers have perfect
information
2 assumptions about short-run
production
1. Number of firms is fixed
2. Each firm has some fixed inputs
Profit maximization in the short-run
We ask the question:
How does a firm choose a level of output
in the short-run with the objective of
maximizing profit?
1. Compare total revenue and total cost
2. Compare marginal revenue and marginal
cost
Where is the short-run supply
curve?
It is represented by the upward sloping
section of the marginal cost curve
beginning where AVC = MC.
Short-run industry supply
The horizontal aggregate of individual firm
supply curves.
The short-run competitive
equilibrium
How is price determined in the short-run?
Is the short-run competitive
equilibrium efficient?
A competitive equilibrium is allocatively
efficient when there is no room for further
mutually beneficial exchange.
Producer Surplus
A measure of “how much better off a firm
is as a result of having supplied its profit
maximizing level of output”.
Perfect Competition in the long-run
Firms may enter and leave the industry.
Firms may change their scale of
production by changing all inputs.
Firms earning a loss will shut down.
Adjustment process from short-run
to long-run
How long will it take?
Depends on
• Degree that firms are identical in technology,
cost structure, and efficiency.
• How long does it take to adjust capital stock?
• How long does it take for new firms to enter?
Socially desirable properties of the
long-run outcome
• P=MC in short-run and long-run
– Allocative efficiency
• Mutual gains to buyers and sellers are maximized.
• All firms earn an economic profit of zero
– Buyers do not pay more than what it costs the
firms to produce.
There is no such thing as a free
market
• The market is not costless
The long-run market supply curve
Varies depending on cost conditions
3 cases
– All firms have identical LAC curves
– All firms have horizontal LAC curves
– Changing input prices
Price elasticity of supply
• A measure of responsiveness of quantity
supplied to changes in prices