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CHAPTER
9 In this chapter,
look for the answers to these questions:
 What is a perfectly competitive market?
Firm Behavior in Different  What is marginal revenue? How is it related to total
and average revenue?
Market Structures  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?
© 2009 South-Western, a part of Cengage Learning, all rights reserved 1

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Introduction: A Scenario Characteristics of Perfect Competition

 Three years after graduating, you run your own
business. 1. Many buyers and many sellers.

 You must decide how much to produce, what price 2. The goods offered for sale are largely the same.
to charge, how many workers to hire, etc.
3. Firms can freely enter or exit the market.
 What factors should affect these decisions?
 Your costs (studied in preceding chapter)  Because of 1 & 2, each buyer and seller is a
 How much competition you face “price taker” – takes the price as given.
 We begin by studying the behavior of firms in
perfectly competitive markets.

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The Revenue of a Competitive Firm ACTIVE LEARNING 1

Calculating TR, AR, MR
 Total revenue (TR) TR = P x Q Fill in the empty spaces of the table.

TR Q P TR AR MR
 Average revenue (AR) AR = =P
Q
0 $10 n/a
 Marginal revenue (MR):
∆TR 1 $10 $10
The change in TR from MR =
∆Q
selling one more unit. 2 $10

3 $10

4 $10 $40
$10
5 $10 $50
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ACTIVE LEARNING 1 MR = P for a Competitive Firm

Answers
Fill in the empty spaces of the table.  A competitive firm can keep increasing its output
without affecting the market price.
TR ∆TR
Q P TR = P x Q AR = MR =
Q ∆Q  So, each one-unit increase in Q causes revenue
0 $10 $0 n/a
to rise by P, i.e., MR = P.
$10
1 $10 $10 $10
Notice that $10 MR = P is only true for
2 $10 $20 $10 firms in competitive markets.
MR = P $10
3 $10 $30 $10
$10
4 $10 $40 $10
$10
5 $10 $50 $10
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Profit Maximization Profit Maximization

 What Q maximizes the firm’s profit? (continued from earlier exercise)

 To find the answer, “think at the margin.” Q TR TC Profit MR MC

Profit =
At any Q with
If increase Q by one unit, MR – MC
MR > MC,
revenue rises by MR, 0 $0 $5 –$5
increasing Q $10 $4 $6
cost rises by MC. raises profit. 1 10 9 1
10 6 4
 If MR > MC, then increase Q to raise profit. 2 20 15 5
At any Q with 10 8 2
 If MR < MC, then reduce Q to raise profit. 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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MC and the Firm’s Supply Decision MC and the Firm’s Supply Decision
Rule: MR = MC at the profit-maximizing Q.
If price rises to P2,
At Qa, MC < MR. then the profit-
Costs Costs
So, increase Q maximizing quantity
MC MC
to raise profit. rises to Q2.
P2 MR2
At Qb, MC > MR. The MC curve
So, reduce Q determines the
to raise profit. P1 MR firm’s Q at any price. P1 MR
At Q1, MC = MR. Hence,
Changing Q the MC curve is the
would lower profit. Q firm’s supply curve. Q
Qa Q1 Qb Q1 Q2

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Monopoly Why Monopolies Arise

 A monopoly is a firm that is the sole seller of a The main cause of monopolies is barriers
product without close substitutes. to entry – other firms cannot enter the market.
 The key difference: Three sources of barriers to entry:
A monopoly firm has market power, the ability to
1. A single firm owns a key resource.
influence the market price of the product it sells.
E.g., DeBeers owns most of the world’s
A competitive firm has no market power.
diamond mines
2. The govt gives a single firm the exclusive right
to produce the good.
E.g., patents, copyright laws

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Why Monopolies Arise Between Monopoly and Competition

3. Natural monopoly: a single firm can produce
the entire market Q at lower cost than could Two extremes
several firms.  Perfect competition: many firms, identical
products
Example: 1000 homes
Electricity  Monopoly: one firm
need electricity Cost
ATC slopes In between these extremes: imperfect competition
ATC is lower if downward due
one firm services to huge FC and  Oligopoly: only a few sellers offer similar or
all 1000 homes $80 small MC identical products.
than if two firms $50 ATC  Monopolistic competition: many firms sell
each service similar but not identical products.
Q
500 homes. 500 1000
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Characteristics & Examples Comparing Perfect & Monop. Competition

of Monopolistic Competition
Characteristics: Perfect Monopolistic
 Many sellers competition competition
 Product differentiation number of sellers many many
 Free entry and exit
free entry/exit yes yes
Examples:
the products firms sell identical differentiated
 apartments
 books firm has market power? none, price-taker yes
 bottled water
 clothing
 fast food
 night clubs
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Comparing Monopoly & Monop. Competition

Monopolistic
Monopoly
competition
number of sellers one many

free entry/exit no yes

firm has market power? yes yes Thank You!

close substitutes none many

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