Chapter 12 Firms in a Perfectly Competitive Market

There are three main characteristics in a perfectly competitive market: 1) many buyers and sellers, 2) Consumers believe that all firms in perfectly competitive markets sell identical (or homogeneous) products. 3) It's very easy to enter and exit the specific market.

Perfectly competitive firms are also known as price takers. They must take the price given by the market because their influence on price is insignificant.

Individual price takers won't raise their prices because then their consumers will outsource to get the product elsewhere from similar producers. And then price takers won't lower their prices because why would they take less money than the market price.

Yes, they are allowed to sell all they want at the market price because each producer provides only a small fraction of industry output.

When the market price for wheat increases, say as a result of an increase in market demand, the price-taking firm will receive a higher price for all its output. When the market price decreases, say as a result of a decrease in market demand, the price-taking firm will receive a lower price for all its outputs.

Total revenue (TR) is the revenue that the firm receives from the sale of its products. Total revenue from a product equals the price of the good (P) times the quantity (q) of units sold.

Average revenue (AR) equals total revenue divided by the number of units of the product sold (TR ÷ q, or [P × q] ÷ q).

Marginal revenue (MR) is the additional revenue derived from the production of one more unit of the good. (MR= Change in TR/Change in quantity)

Firms maximize profits when marginal revenue equals marginal cost because the expansion of output creates additional profits for the firms. A firm should always produce at the output where its Marginal Revenue equals its marginal cost.

1st Step) The first step is to find where MR=MC, then proceed straight down to the horizontal axis to find quantity (q), which is the profit-maximizing output level. 2nd step) At q*, go straight up to the demand curve and then to the left to find the market price, (P). Once you have identified (P) and (q), you can find total revenue at the profit-maximizing output level because the last step is to find the total cost. 3rd step) Again, go straight up from q* to the average total cost (ATC) curve and then left to the vertical axis to compute the average total cost per unit. If we multiply AVC by the output level, we can find the total cost. (TC=ATC x Q)

If total revenue is less than total cost at q*, the firm is generating economic profits.

If total revenue is equal to total cost at q*, there are zero economic profits (or a normal rate of return).

If total revenue is greater than total cost at q*, the firm is generating economic profits.

Variable costs are costs that vary with output.

Wages, raw materials, transportation, and electricity.

If a firm cannot generate enough revenues to cover its variable costs, it will have larger losses if it operates than if it shuts down (when losses are equal to fixed costs). That is, the firm will shut down if its total revenue (p × q) is less than its variable costs (VC).