Firm Behavior Under Perfect

Competition
.
 Fill in the Blanks
Firms Maximize Profit at the quantity
where the difference between Total
________ and ________ Cost is
greatest.
At this profit-maximizing level of
output , _________ = _________.
 Fill in the Blanks
Firms Maximize Profit at the quantity
where the difference between Total
Revenue and Total Cost is
greatest.

At this profit-maximizing level of

output , MR = MC.
 Firm Behavior

In economics and business, "firm behavior" refers to the actions and

decisions made by a company, particularly concerning resource
allocation, production, pricing, and market strategies, often analyzed
through the lens of profit maximization and other objectives.

•Economic Perspective:

•Profit Maximization: Firms are often assumed to act in a way that

maximizes their profits, though behavioral models also consider
other factors.

•Resource Allocation: Firms make decisions about how to allocate

their resources (labor, capital, materials) to achieve their goals.
Production Decisions: Firms decide what to produce, how
much to produce, and how to produce it efficiently.

Pricing Strategies: Firms determine how to price their products

or services to attract customers and maximize profits.

Market Strategies: Firms develop strategies to enter, compete

in, and exit markets.
 Meaning of Market
What are markets

the concept of a market is any structure that allows buyers and

sellers to exchange any type of goods, services and information.
The exchange of goods or services, with or without money, is a
transaction.

• Goods and service

• Buyers and sellers
• A place or region
• Given price
Perfect Competitiven Market

Classification of Market
Main features of Perfect Competition Market
Main features of Perfect Competition Market

Example: Agricultural products

 Meaning of Perfect Competition Market

Nature of demand and AR, MR Curve of a firm

Out put Price TR AR MR

1 10 10 10 10 Demand and AR, MR Curve of a firm
2 10 20 10 10
3 10 30 10 10
Price
4 10 40 10 10
5 10 50 10 10 Price=AR=MR
6 10 60 10 10
7 10 70 10 10
8 10 80 10 10 Output
 The Competitive Firm
• The Firm’s Demand Curve under Perfect
Competition
– Perfectly Elastic (Horizontal)
– Can sell as much as it wants at the market
price.
 Demand Curve for a Firm under
Perfect Competition
D Industry S
supply
curve
Price per Bushel

A B C E Industry
3 3 demand
in Chicago

curve
Firm’s demand
curve
S
D
0 1 2 3 4 0 100 200 300 400
Truckloads of Corn Total Sales in Chicago
Sold by Farmer Jasmine in Thousands of Truckloads
per Year per Year
(a) (b)
 DEMAND AS SEEN BY A
PURELY COMPETITIVE SELLER
Perfectly Elastic Demand
Price Taker Role
Total Revenue = P x Q
Average Revenue = P
Marginal Revenue = P
For
 DEMAND AS SEEN BY A
PURELY COMPETITIVE SELLER
Product Price (P) Quantity Total Marginal
(Average Revenue) Demanded (Q) Revenue (TR) Revenue (MR)

131 0 0
 DEMAND AS SEEN BY A
PURELY COMPETITIVE SELLER
Product Price (P) Quantity Total Marginal
(Average Revenue) Demanded (Q) Revenue (TR) Revenue (MR)

131 0 0
] 131
131 1 131
 DEMAND AS SEEN BY A
PURELY COMPETITIVE SELLER
Product Price (P) Quantity Total Marginal
(Average Revenue) Demanded (Q) Revenue (TR) Revenue (MR)

131 0 0
] 131
131 1 131]
131
131 2 262
 DEMAND AS SEEN BY A
PURELY COMPETITIVE SELLER
Product Price (P) Quantity Total Marginal
(Average Revenue) Demanded (Q) Revenue (TR) Revenue (MR)

131 0 0
] $131
131 1 131]
131
131 2 262]
131
131 3 393
 DEMAND AS SEEN BY A
PURELY COMPETITIVE SELLER
Product Price (P) Quantity Total Marginal
(Average Revenue) Demanded (Q) Revenue (TR) Revenue (MR)

$131 0 $ 0
] $131
131 1 131]
131
131 2 262]
131
131 3 393]
131
131 4 524
 DEMAND AS SEEN BY A
PURELY COMPETITIVE SELLER
Product Price (P) Quantity Total Marginal
(Average Revenue) Demanded (Q) Revenue (TR) Revenue (MR)

131 0 0
] 131
131 1 131]
131
131 2 262]
131
131 3 393]
131
131 4 524]
131
131 5 655]
131
131 6 786]
131
131 7 917]
131
131 8 1048]
131
131 9 1179]
131
131 10 1310
 DEMAND AS SEEN BY A
PURELY COMPETITIVE SELLER
Product Price (P) Quantity Total Marginal
(Average Revenue) Demanded (Q) Revenue (TR) Revenue (MR)

$131 0 $ 0
] $131
131 1 131]
131
131 2 262]
131 Graphically
3 393]
131
131
131 4 524]
131
Presented…
5 655]
131
131
131 6 786]
131
131 7 917]
131
131 8 1048]
131
131 9 1179]
131
131 10 1310
DEMAND, MARGINAL REVENUE, AND TOTAL
REVENUE IN PURE COMPETITION

1179
TR
1048
Price and revenue
917

786

655

524

393

262

131
D = MR
0
1 2 3 4 5 6 7 8 9 10
Quantity Demanded (sold)
 The Competitive Firm
• Short-Run Equilibrium for the Perfectly
Competitive Firm
▪ Marginal revenue = Price
▪ Profit-maximizing level of output: MC = MR

▪ So, a perfectly competitive firm should

maximize profit by producing the output where
Price = Marginal Cost
 The Competitive Firm
• D = MR = AR at all levels of output
• D = MR = AR = MC at the equilibrium level
of output
Short-Run Equilibrium of the
Perfectly Competitive Firm
Revenue and Cost per Bushel

MC AC

B
3.00
D = MR = AR
2.25
A
1.50

0 50,000
1 bushel = 30 kg
Bushels of Corn per Year
S-R Equilibrium of Competitive
Firm w/ Lower Price

MC AC
Revenue and Cost
per Busel

A
2.25

1.50
B D = MR = P

0 30,000

Bushels of Corn per Year

 SHORT RUN PROFIT MAXIMIZATION
Two Approaches...
First:
Total Revenue - Total Cost Approach
The Decision Process:
•Should the firm produce?
•What quantity should be produced?
•What profit or loss will be realized?
The Decision Rule:
Produce in the short-run if the firm
can realize
1) a profit (or)
2) a loss less than its fixed costs
SHORT RUN PROFIT MAXIMIZATION
Two Approaches...
First:
Total Revenue - Total Cost Approach
Applied
The Decision Process:
•Should the firm produce?
Graphically
•What quantity should be produced?
•What profit or loss will be realized?
…
The Decision Rule:
Produce in the short-run if the firm
can realize
1) a profit (or)
2) a loss less than its fixed costs
 TOTAL REVENUE-TOTAL COST APPROACH
h e ?
e t Total n Total
s e t i o Price: 131
a
uTotal iz Fixed Variable Total Total
y o i m
n Product
a x Cost Cost Cost Revenue Profit
Ca t m
fi 0 100 0 100 0 - 100
o
pr 1 100 90 190 131 - 59
2 100 170 270 262 -8
3 100 240 340 393 + 53
4 100 300 400 524 + 124
5 100 370 470 655 + 185
6 100 450 550 786 + 236
7 100 540 640 917 + 277
8 100 650 750 1048 + 298
9 100 780 880 1179 + 299
10 100 930 1030 1310 + 280
 TOTAL REVENUE-TOTAL COST APPROACH

Total Total Price: 131

Total Fixedl Variable Total Total
t a
gTo Coste Cost Cost
Product
u
Revenue Profit
i n e n
h 0 ev$ 100 0 100 0 - 100
a p 1R 100
r
G st &2 90 190 131 - 59
o 100 170 270 262 -8
C 3 100 240 340 393 + 53
4 100 300 400 524 + 124
5 100 370 470 655 + 185
6 100 450 550 786 + 236
7 100 540 640 917 + 277
8 100 650 750 1048 + 298
9 100 780 880 1179 + 299
10 100 930 1030 1310 + 280
TOTAL REVENUE-TOTAL COST APPROACH
$1,800 Break-Even Point
1,700 (Normal Profit)
1,600
1,500

Total revenue and total cost

1,400
1,300
Total
1,200 Maximum
1,100 Revenue Economic
1,000
900 Profits
800 299
700
600
Total
500 Cost
400
300
200
Break-Even Point
100 (Normal Profit)
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14
SHORT RUN PROFIT MAXIMIZATION
Two Approaches...
First:
Total Revenue - Total Cost Approach
Second:
Marginal Revenue - Marginal Cost
Approach
MR = MC Rule
Three Characteristics of MR=MC Rule:
• The rule applies only if producing
is preferred to shutting down
• Rule applies to all markets
• Rule can be restated P=MC
MARGINAL REVENUE-MARGINAL COST APPROACH

Avera Avera Avera Price Total

Total ge ge ge Margi = Econo
Prod Fixed Varia Total nal Margi mic
uct Cost ble Cost Cost nal Profit/L
0 The Cost Reve - oss
$100
1 $100.00 $90.00 $190.00 90 $nue
131 - 59
2 same profit
50.00 85.00 135.00 80 131 -8
3 33.33 80.00 113.33 70 131 + 53
4 maximizing
25.00 75.00 100.00 60 131 + 124
5
6
result!
20.00 74.00
16.67 75.00
94.00 70
91.67 80
131
131
+ 185
+ 236
7 14.29 77.14 91.43 90 131 + 277
8 12.50 81.25 93.75 110 131 + 298
9 11.11 86.67 97.78 130 131 + 299
10 10.00 93.00 103.00 150 131 + 280
MARGINAL REVENUE-MARGINAL COST APPROACH

Avera Avera Avera Price Total

Total ge ge ge Margi = Econo
Prod Fixed Varia Total nal Margi mic
uct Cost ble Cost Cost nal Profit/L
0 Cost Reve - oss
$100

2
Graphic
1 $100.00 $90.00 $190.00 90
50.00 85.00 135.00 80
$nue
131
131
- 59
-8
3
4 ally
33.33 80.00 113.33 70
25.00 75.00 100.00 60
131
131
+ 53
+ 124
5 20.00 74.00 94.00 70 131 + 185
6 16.67 75.00 91.67 80 131 + 236
7 14.29 77.14 91.43 90 131 + 277
8 12.50 81.25 93.75 110 131 + 298
9 11.11 86.67 97.78 130 131 + 299
10 10.00 93.00 103.00 150 131 + 280
MARGINAL REVENUE-MARGINAL COST APPROACH

Profit Maximization Position

$200
Cost and Revenue
Economic Profit MC
150
$131.00 MR
ATC
100 AVC
$97.78

50

0
1 2 3 4 5 6 7 8 9 10
MARGINAL REVENUE-MARGINAL COST APPROACH

Profit Maximization Position

$200
Cost and Revenue
Economic Profit MC
150
$131.00 MR
MR = MC ATC
100 AVC
Optimum
$97.78

Solution
50

0
1 2 3 4 5 6 7 8 9 10
MARGINAL REVENUE-MARGINAL COST APPROACH

Loss Minimization Position

If the price is lowered
from 131 to 81…
the MR=MC rule still applies

…but the MR = MC point

changes.
MARGINAL REVENUE-MARGINAL COST APPROACH

Loss Minimization Position

200
Cost and Revenue
Economic Loss MC
150

ATC
100 AVC
91.67
81.00 MR
50

0
1 2 3 4 5 6 7 8 9 10
MARGINAL REVENUE-MARGINAL COST APPROACH

Short-Run Shut Down Point

200
Cost and Revenue MC
150

ATC
100 AVC
71.00 MR
50 Minimum AVC
is the Shut-Down
Point
0
1 2 3 4 5 6 7 8 9 10
MARGINAL REVENUE-MARGINAL COST APPROACH

Marginal Cost & Short-Run Supply

Observe the impact upon
profitability as price is changed
Quantity Maximum Profit (+)
Price Supplied Or Minimum Loss (-)
151 10 +480
131 9 +299
111 8 +138
91 7 -3
81 6 -64
71 0 -100
61 0 -100
MARGINAL REVENUE-MARGINAL COST APPROACH

Marginal Cost & Short-Run Supply

Break-even

Cost and Revenue, (dollars)

(Normal Profit) MC
Point
P5 MR5
ATC
P4 MR4
AVC
P3 MR3
P2 MR2
P1 MR1
Do not
Produce –
Below AVC
Q2 Q3 Q4 Q5
Quantity Supplied
MARGINAL REVENUE-MARGINAL COST APPROACH

Marginal Cost & Short-Run Supply

Yields the Supply
Cost and Revenue, (dollars)
Short-Run MC
Supply Curve
P5 MR5

P4 MR4
P3 MR3
P2 MR2
P1 MR1
No
Production
Below AVC
Q2 Q3 Q4 Q5
Quantity Supplied
MARGINAL REVENUE-MARGINAL COST APPROACH

Marginal Cost & Short-Run Supply

MC2
S2
Cost and Revenue, (dollars)
MC1
S1

AVC2

AVC1

Higher Costs Move the

Supply Curve to the Left

Quantity Supplied
MARGINAL REVENUE-MARGINAL COST APPROACH

Marginal Cost & Short-Run Supply

Cost and Revenue, (dollars)

Lower Costs Move MC1
S1
the Supply Curve
to the Right MC2
S2

AVC1

AVC2

Quantity Supplied
SHORT-RUN COMPETITIVE EQUILIBRIUM
The Competitive Firm “Takes” its
Price from the Industry Equilibrium
S= Σ MC’s
P P
Economic
ATC Profit S=MC

11 D 11
1 1

AVC
D
8 Q 8000 Q
Firm Industry
(price taker)
Why is profit maximised when MR = MC?

At production levels of MR = MC, the difference between the total

revenue and total cost is maximum which serves as our
requirement for producer’s equilibrium and leads to profit
maximization.

A firm maximizes profit when marginal revenue (MR) equals

marginal cost (MC) because producing an additional unit where
MR > MC adds to profit, while producing where MR < MC reduces
profit, and at the point where MR = MC, there's no further profit to
be gained or lost.
 END
.