In this lecture,

look for the answers to these questions

• What is a perfectly competitive market?

• What is marginal revenue? How is it related to
total and average revenue?
• How does a competitive firm determine the
quantity that maximizes profits?
• When might a competitive firm shut down in the
short run? Exit the market in the long run?
• What does the market supply curve look like in
the short run? In the long run?
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 Introduction: A Scenario
▪ Three years after graduating, you run your own
business.
▪ You must decide how much to produce, what price
to charge, how many workers to hire, etc.
▪ What factors should affect these decisions?
▪ Your costs (studied in preceding chapter)
▪ How much competition you face
▪ We begin by studying the behavior of firms in
perfectly competitive markets.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Characteristics of Perfect Competition

1. Many buyers and many sellers.

2. The goods offered for sale are largely the same.

3. Firms can freely enter or exit the market.

▪ Because of 1 & 2, each buyer and seller is a

“price taker” – takes the price as given.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 The Revenue of a Competitive Firm
▪ Total revenue (TR) TR = P x Q

TR
▪ Average revenue (AR) AR = =P
Q
▪ Marginal revenue (MR):
∆TR
The change in TR from MR =
∆Q
selling one more unit.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 ACTIVE LEARNING 1
Calculating TR, AR, MR
Fill in the empty spaces of the table.

Q P TR AR MR

0 $10 n/a

1 $10 $10

2 $10

3 $10

4 $10 $40
$10
5 $10 $50
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 ACTIVE LEARNING 1
Answers
Fill in the empty spaces of the table.
TR ∆TR
Q P TR = P x Q AR = MR =
Q ∆Q
0 $10 $0 n/a
$10
1 $10 $10 $10
Notice that $10
2 $10 $20 $10
MR = P $10
3 $10 $30 $10
$10
4 $10 $40 $10
$10
5 $10 $50 $10
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 MR = P for a Competitive Firm
▪ A competitive firm can keep increasing its output
without affecting the market price.
▪ So, each one-unit increase in Q causes revenue
to rise by P, i.e., MR = P.

MR = P is only true for

firms in competitive markets.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Profit Maximization
▪ What Q maximizes the firm’s profit?
▪ To find the answer, “think at the margin.”
If Q increases by one unit,
revenue rises by MR,
cost rises by MC.
▪ If MR > MC, then increase Q to raise profit.
▪ If MR < MC, then reduce Q to raise profit.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Profit Maximization
(continued from earlier exercise)

Q TR TC Profit MR MC
∆ Profit =
At any Q with
MR – MC
MR > MC,
0 $0 $5 –$5
increasing Q $10 $4 $6
raises profit. 1 10 9 1
10 6 4
2 20 15 5
At any Q with 10 8 2
MR < MC, 3 30 23 7
10 10 0
reducing Q 4 40 33 7
raises profit. 10 12 –2
5 50 45 5

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 MC and the Firm’s Supply Decision
Rule: MR = MC at the profit-maximizing Q.

At Qa, MC < MR. Costs

So, increase Q MC
to raise profit.
At Qb, MC > MR.
So, reduce Q
to raise profit. P1 MR

At Q1, MC = MR.
Changing Q
Q
would lower profit. Q a Q1 Q b

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 MC and the Firm’s Supply Decision
If price rises to P2,
then the profit- Costs
maximizing quantity
MC
rises to Q2.
P2 MR2
The MC curve
determines the
firm’s Q at any price. P1 MR
Hence,
the MC curve is the
firm’s supply curve. Q
Q1 Q2

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.