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Oktaviani Charra
Maura B. Alexandrina
Perfect competition is
a market in which

• many firms sell identical

products to many buyers
• there are no restrictions on entry
• established firms have no
advantage over new ones
• sellers and buyers are well
informed about the price
• the firms are price takers
How does it arise?
If the minimum efficient scale of a
single producer is small relative to
the market demand for the good or

There are plenty of rooms for other


The market act in perfect

competition manner.
producer would produce at
minimum efficient scale

Parkin, Michael, 2012, Economics, 10th

Edition, Pearson Education Ltd.,
Global Edition
TR = P x Q
MR = P = AR = D for firm’s product
D is horizontal
Firm’s Decision

• How to produce at minimum cost?

 Producing at minimum efficient
scale when the LRAC is at minimum.
• What quantity to produce
 MR = MC
• Whether to enter or exit the market
 Shutdown decision
Firm’s Output

• Produces at the quantity
when the economic profit
is the highest
• Which is when TR curve
is above the TC curve and
at the largest gap
Firm’s Output Decision

Producing at maximum profit
 MC = MR

Then what happen when the occurring

price rises?
 Firm would increase production.
 Reflect the law of supply.
Firm’s Output

• Producer would
continue to produce
until they get all the
profit from each goods
produced, which stops
at the MR=MC point.
• In the graph, after the
9th output, adding
output would result in
Shutdown Decision
• At MC = MR, when P < ATC, the firm
experiences economic loss.
• Economic Loss = TFC + (AVC – P) x Q
• Firm compare the loss between:
• Shutting down, Total Loss = TFC
• Keep producing and see if TR can cover
• Therefore…
• TFC > TR > TVC keep producing
• TFC, TVC > TR shut down
• Below the shutdown point,
the firm shuts down.
• At the shutdown point, it’s
indifferent between shutting
down and producing.
Because any revenue
Shutdown point is wouldn’t cover the AFC.
the minimum AVC. • Above the shutdown point,
the firm produces loss-
minimizing output and
incurs a loss less than TFC.
Firm’s Supply Curve
is derived from the MC and AVC

• P > minimum AVC, produce at


• P < minimum AVC, produce no

output & temporarily shut down.
 After few markets shut down and get out
MC from the market, the supply decrease and the
reflects price would rise again.
• P = minimum AVC, temporarily
Shutdown shut down or produce output at
point minimum AVC
Parkin, Michael, 2012, Economics, 10th Edition,
Pearson Education Ltd., Global Edition
Market Supply

• At prices below $17, all

firms shut down. The
quantity supplied is zero.
• At $17, each firm is
indifferent between
shutting down or
producing. All firms may
produce 0 to 7000
Output & Price
at Equilibrium
in the Short Run
• Remember S reflects MC.
• The Equilibrium price is
given price that would
determine the MR.
• Profit maximizing output
is at the equilibrium. It’s
when MC = MR.
• Equilibrium gives the
profit maximizing
Output & Price
at Equilibrium
in the Short Run
• Shift or change in demand
would change the
• The Equilibrium price
would change. Which
means the MR also
• The MR=MC point moves.
• The supply would move as
Parkin, Michael, 2012, Economics, 10th Edition,
Pearson Education Ltd., Global Edition

Profit or Loss in the Short Run

• Producing at profit maximizing output won’t
necessarily result in profit.
• There’s ATC to be considered.  (P-ATC) x Q
Entry & Exit in the Long Run
• New firms enter market when existing
firms are making profit
 P at (MC=MR) > ATC
 market price falls and profit decrease
• Firms exit market when they are
incurring loss.
 market price rises and loss decrease
• Entry and exit stop when firms
make zero economic profit. This
is the long run equilibrium.
Parkin, Michael, 2012, Economics, 10th Edition,
Pearson Education Ltd., Global Edition

Entry & Exit

in the Long Run
Increase in Demand
• Initially increasing price
• Higher price attracts new firms to enter
• Firms keep entering until price return
at zero economic profit
Decrease in Demand
• Initially decreasing price below zero
economic profit (loss)
• Loss attracts firms to exit
• Firms keep exiting until price return
at zero economic profit
Parkin, Michael, 2012, Economics, 10th Edition,
Pearson Education Ltd., Global Edition

Example for
Decrease in Demand
Change in Supply

• First firm to use new technology make

economic profit
• More firms use new technology
• Supply increase and lower the price
• Firms that use old technology with the
new lower price incur economic loss
from zero economic profit
• Old technology firms exit
Efficient Use of Resources

• Resource use is efficient when we

produce the goods and services that
people value most highly
• We can test whether resources are
allocated efficiently by comparing
marginal social benefit and marginal
social cost

• If the people who consume a good or service

are the only ones who benefit from it, then
the market demand curve measures the
benefit to the entire society and is the
marginal social benefit curve.
• If the firms that produce a good or
service bear all the costs of producing
it, then the market supply curve is the
marginal social cost curve.
Equilibrium and

• Resources are used efficiently when

marginal social benefit equals
marginal social cost.
• Total surplus : consumer surplus +
producer surplus
• When the market for a good or service
is in equilibrium, the gains from a
trade is maximized
Efficiency in a
• Consumers get most
value from their
budgets at all points
on the market
demand curve.
• D = MSB.
• Producers get most
value out of their
resources at all points
on the market supply
• S = MSC.
Efficiency in a

• Each firm would make

zero economic profit
• Each firm would
produce at the lowest
possible LRAC.