Perfect competition
- Both consumers and producers have perfect knowledge; this leads to all firms having the same cost structure.
- Firms are price takers as they have such a small market share they have no market power and so take the equilibrium price of the market.
- Generally AR = P, however here AR = P = MR as the price is constant.
- Given that the price remains constant, irrespective of output, the product of the price and the quantity of units sold gives total revenue.
- Profit maximisation occurs where MC = MR, which assuming the firms objectives are profit maximisation this point will be the firms equilibrium output.
- The vertical distance between MR and ATC is the profit per unit sold. This value, multiplied by the quantity of output give the supernormal profits of the firm.
- If AR(P) > ATC then supernormal profits are made by the firm.
- If AR(P) = ATC then normal profits are made by the firm.
- If AR(P) < ATC then losses are made by the firm.
- So then if the ATC curve is above the MC curve then the firm makes a loss. This can be shown diagrammatically as shown below, where the shaded area represents losses.
- In the long run the firm will close, as the firm shown above cannot pay for all their factors of production. A firm will remain producing in the short run as long as the revenue is enough to pay for their variable costs.
Homework
Read up to page 24 in the study guide.
These notes are from a lesson on 7/9/2004.
