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Q Figure 1.0 Showing A Profit Maximization in A Perfect Competitive Market

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36 views2 pages

Q Figure 1.0 Showing A Profit Maximization in A Perfect Competitive Market

Uploaded by

geophrey kajoki
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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P MC

P MR=D

ATC

AVC

Q Q
Figure 1.0 showing a profit maximization in a
Perfect competitive market

D=MR p

Q
Firm market
Figure 1.1 figure1.2
PROFIT MAXIMIZATION; In a perfectly competitive market, profit maximization occurs
when a firm produces the quantity of output where its marginal cost (MC) equals the market
price. (shown Fig 1.0)
Perfect Competition: This market structure assumes many buyers and sellers, identical products,
free entry and exit, and perfect information. This means individual firms are "price takers" – they
cannot influence the market price. They can only choose how much to produce at that given
price.

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Marginal Cost (MC): This is the additional cost of producing one more unit of output.
Profit Maximization Rule: MC = P: A firm maximizes profit where MC equals the market price
(P). Here's the logic:
If MC < P: The firm can increase profit by producing one more unit because the revenue from
selling that unit (P) is greater than the cost of producing it (MC).
If MC > P: The firm is losing money on the last unit produced because the cost of producing it
(MC) is greater than the revenue it generates (P). It should decrease production.
Only when MC = P is there no further opportunity to increase profit by changing output. At this
point, the firm is producing the optimal quantity. That is usually happens in a short run.
In the long run, due to free entry and exit, perfectly competitive firms earn only normal profit.
This means they earn enough to cover all their costs, including the opportunity cost of their
resources (what they could have earned elsewhere). If firms are earning economic profit (profit
above and beyond normal profit), new firms enter the market, increasing supply and driving
down the price until economic profit disappears. Conversely, if firms are experiencing losses,
some will exit, decreasing supply and driving the price back up until normal profit is restored. In
essence, perfect competition forces firms to be as efficient as possible. They must produce at the
lowest possible cost to survive in the long run, ultimately benefiting consumers with lower
prices.
ELASTICITY OF THE MARKET
In a perfect competitive market, the demand curve faced by an individual firm is perfectly elastic
(horizontal), meaning that the firm can sell any quantity at the prevailing market price. This is
because the firm is a price-taker and cannot influence the market price. (shown Fig 1.1)
SHUT DOWN
In a perfect competitive market, the shutdown situation refers to the decision of a firm to
temporarily cease production and operations when the market conditions make it unprofitable to
continue producing.
Short Run: In the short run, where at least one factor of production is fixed (such as the firm's
capital or equipment), a firm may choose to shut down if the market price falls below the firm's
minimum average variable cost (AVC). The minimum AVC represents the lowest cost the firm
can incur to produce an additional unit of output. If the market price is below the minimum AVC,
the firm will lose less money by shutting down than by continuing to produce. In this case, the
firm will continue to incur its fixed costs, but it will avoid the variable costs associated with
production.
Long Run: In the long run, where all factors of production can be adjusted, a firm may choose to
shut down if the market price falls below the firm's minimum average cost (AC). The minimum
AC represents the lowest cost the firm can incur to produce a unit of output. If the market price is
below the minimum AC, the firm will lose money by continuing to operate and should shut
down. In the long run, the firm can adjust all its factors of production, including its capital and
equipment, to minimize its costs. The decision to shut down in the long run is more permanent,
as the firm can exit the market entirely and avoid all its costs. In contrast, the short-run shutdown
decision is more temporary, as the firm can resume production once market conditions improve
and the price rises above the minimum AVC.

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