MGEA02H3 Chap.7 Perfect Competition and Industry Supply
Perfect Competition and Industry Supply
The price-taking firm
A perfectly competitive firm faces a horizontal demand curve at the market price, so marginal revenue equals price and output is chosen where P = MC. It earns a profit above minimum average cost, operates at a loss between minimum average cost and minimum average variable cost, and shuts down below that, losing its fixed cost.
Its short-run supply curve is marginal cost above the shut-down price.
Industry supply and the long run
Industry supply adds the firms’ quantities at each price. In the long run free entry and exit drive price to the minimum of average cost, the number of firms adjusts to market demand, and the outcome maximises the gain to society.
Recent finals pair this with a two-panel diagram question.
What the answer keys reward
The keys set price equal to marginal cost for output, use the full total cost for profit and the stated fixed cost for the shut-down test, and round the number of firms to a whole number. Long-run items name the minimum of average cost, set demand equal to long-run supply and divide by output per firm.
Diagram questions earn marks for the short-run loss or profit rectangle and for exit or entry restoring zero profit.
How this topic connects to later chapters
The competitive outcome is the benchmark for every later market structure.
Monopoly and oligopoly losses in chapters 8 and 9 are measured against it, the externality chapter asks why even a competitive market can produce the wrong quantity when costs fall on third parties, and the trade chapter reuses the long-run logic when a world price below minimum average cost drives domestic firms out.
What this chapter covers
- 01
Price taking and P = MR = MC
- 02
Shut-down and break-even prices
- 03
Short-run firm and industry supply
- 04
Long-run entry, exit and zero profit
- 05
A per-unit tax in the short and long run
- 06
Efficiency of competitive equilibrium
Worked example · free
A price-taking firm at two market prices
- 3MC = 4q + 20; at $100, q = 20 and profit is 2,000 − 1,650 = $350.
- 3At $70, q = 12.5 and profit is 875 − 1,012.50 = −$137.50.
- 2Minimum AVC is $60 at q = 10, so at $70 the firm operates.
Key terms
- Price Taker
- A price taker is a firm too small to affect the market price, so it sells any quantity at that price.
- Shut-Down Price
- The shut-down price is the minimum of average variable cost, below which the firm produces nothing.
- Break-Even Price
- The break-even price is the minimum of average cost, at which economic profit is zero.
- Long-Run Supply Curve
- The long-run supply curve shows industry output after entry and exit, horizontal at minimum average cost in a constant-cost industry.
- Constant-Cost Industry
- A constant-cost industry is one where entry does not raise input prices, so long-run supply is horizontal at minimum average cost.
Perfect Competition and Industry Supply FAQ
Why does a firm keep producing while it makes a loss?
If price covers average variable cost, producing earns enough to pay every avoidable cost and part of the fixed cost. Shutting down would leave the whole fixed cost unpaid, so operating gives the smaller loss.
How is the number of firms found in the long run?
Price settles at the minimum of average cost. Read market quantity from demand at that price, then divide by each firm’s output at the minimum of average cost, rounding to a whole number of firms.
Who bears a per-unit tax in a competitive industry?
In the short run buyers and sellers share it according to the slopes of demand and industry supply. In the long run firms exit until price rises by the full tax, so buyers bear all of it.
What happens to a firm’s output when fixed cost rises?
Nothing in the short run, because marginal cost and the output rule are unchanged; only profit falls. In the long run the higher break-even price raises the market price, so some firms leave and industry output falls.
Exam move
For one cost function, compute the shut-down and break-even prices, then find output and profit at a price in each of the three regions. Finally trace a demand increase through the short run to the long run. Draw one two-panel diagram per week, firm beside industry, and trace a shock to its long-run outcome.
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