COMM1100 Chap.6 Firm Costs and the Competitive Supply Decision
Firm Costs and the Competitive Supply Decision
Behind every supply curve is a firm deciding how much to produce. The Week 2 practice set asks you to complete a cost table for a small cafe, and the Week 3 tutorial puts several identical cafes into a market and asks what happens to price and profit.
Both rest on five cost concepts and two decision rules.
This chapter separates fixed and variable cost, computes average and marginal cost, and shows why a price-taking firm keeps producing while price covers marginal cost but opens only if price covers average cost.
It then adds identical firms together to build market supply and uses entry and exit to explain why the long-run competitive price settles at the minimum of average cost.
The cost side matters for business decisions well beyond the tests.
Whether a cafe should hire another worker, extend its hours or close in a quiet month all depend on comparing price with marginal and average cost, and the case study may ask you to judge a firm’s pricing against exactly these benchmarks.
What this chapter covers
- 01
Fixed, variable and total cost
- 02
Average total cost and marginal cost from a cost table
- 03
The price taker's horizontal demand curve
- 04
Producing while price is at least marginal cost
- 05
Minimum average cost as the lowest price worth opening at
- 06
Market supply from identical firms
- 07
Entry, exit and the long-run price
Worked example · free
Completing a cost table for a bike-hire kiosk
- +1Total cost is 50 + 20 = $70, 50 + 40 = $90 and 50 + 60 = $110 for 1, 2 and 3 attendants.
- +1Average total cost is 70/10 = $7.00, 90/18 = $5.00 and 110/24 = $4.58 per hire.
- +1Marginal cost is 20/10 = $2.00, 20/8 = $2.50 and 20/6 = $3.33 per hire for the 1st, 2nd and 3rd attendant.
- +1At $3 the kiosk hires two attendants (MC $2.50 is covered; $3.33 is not) and serves 18 hires, but price is below average cost of $5.00, so it makes a loss.
Key terms
- Fixed cost
- A cost that does not change with output in the period considered, such as rent or equipment hire.
- Variable cost
- A cost that rises with output, such as wages for the workers needed to produce more.
- Average total cost
- Total cost divided by the quantity produced.
- Marginal cost
- The change in total cost divided by the change in quantity when output increases.
- Long-run equilibrium
- The competitive outcome after entry and exit, where price equals the minimum of average total cost and economic profit is zero.
- Break-even price
- The lowest price at which a firm covers its average total cost, equal to minimum average total cost.
Firm Costs and the Competitive Supply Decision FAQ
Why does a competitive firm face a horizontal demand curve?
Because many rivals sell an identical product. If the firm charged more it would lose its customers, and in the long run it cannot profitably charge less because the market price already sits at the minimum of average cost.
Why use marginal cost to choose output but average cost to decide whether to open?
Marginal cost tells you whether one more unit adds more to revenue than to cost, which sets the best quantity. Average cost tells you whether total revenue at that quantity covers total cost, which decides whether operating is worthwhile.
What happens in the long run if firms are making economic profit?
New firms enter because the market offers more than their next best option. Market supply shifts right and the price falls until it reaches the minimum of average total cost, where economic profit is zero and entry stops.
How do I build market supply from identical firms?
At each price, find how much one firm would supply using its marginal cost schedule, then multiply by the number of firms. Where that schedule meets market demand is the equilibrium price and quantity.
Why does marginal cost rise as output grows?
In the course examples each extra worker or hour costs the same, but adds less output than the one before, because equipment and space are fixed. Dividing a constant extra cost by a shrinking extra output gives a rising cost per unit.
Assessment move
Practise building a cost table from scratch until you can do it in five minutes, writing the formula at the top of each column and the units beside every number. Then answer the same three questions every time: how much at a given price, what profit at that price, and what happens in the long run. Explaining entry and exit in two sentences is a reliable short-answer pattern for the tests.
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