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Short-run outcomes for perfectly competitive firms

The average cost and average variable cost curves divide the marginal cost curve into three segments, as shown in [link] . At the market price, which the perfectly competitive firm accepts as given, the profit-maximizing firm chooses the output level where price or marginal revenue, which are the same thing for a perfectly competitive firm, is equal to marginal cost: P = MR = MC.

Profit, loss, shutdown

The graph shows how the marginal cost curve reveals three different zones: above the zero-profit point, between the zero profit point and the shutdown point, and below the shutdown point.
The marginal cost curve can be divided into three zones, based on where it is crossed by the average cost and average variable cost curves. The point where MC crosses AC is called the zero-profit point. If the firm is operating at a level of output where the market price is at a level higher than the zero-profit point, then price will be greater than average cost and the firm is earning profits. If the price is exactly at the zero-profit point, then the firm is making zero profits. If price falls in the zone between the shutdown point and the zero-profit point, then the firm is making losses but will continue to operate in the short run, since it is covering its variable costs. However, if price falls below the price at the shutdown point, then the firm will shut down immediately, since it is not even covering its variable costs.

First consider the upper zone, where prices are above the level where marginal cost (MC) crosses average cost (AC) at the zero profit point. At any price above that level, the firm will earn profits in the short run. If the price falls exactly on the zero profit point where the MC and AC curves cross, then the firm earns zero profits. If a price falls into the zone between the zero profit point, where MC crosses AC, and the shutdown point, where MC crosses AVC, the firm will be making losses in the short run—but since the firm is more than covering its variable costs, the losses are smaller than if the firm shut down immediately. Finally, consider a price at or below the shutdown point where MC crosses AVC. At any price like this one, the firm will shut down immediately, because it cannot even cover its variable costs.

Marginal cost and the firm’s supply curve

For a perfectly competitive firm, the marginal cost curve is identical to the firm’s supply curve starting from the minimum point on the average variable cost curve. To understand why this perhaps surprising insight holds true, first think about what the supply curve means. A firm checks the market price and then looks at its supply curve to decide what quantity to produce. Now, think about what it means to say that a firm will maximize its profits by producing at the quantity where P = MC. This rule means that the firm checks the market price, and then looks at its marginal cost to determine the quantity to produce—and makes sure that the price is greater than the minimum average variable cost. In other words, the marginal cost curve above the minimum point on the average variable cost curve becomes the firm’s supply curve.

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Questions & Answers

Ayele, K., 2003. Introductory Economics, 3rd ed., Addis Ababa.
Widad Reply
can you send the book attached ?
Ariel
?
Ariel
What is economics
Widad Reply
the study of how humans make choices under conditions of scarcity
AI-Robot
U(x,y) = (x×y)1/2 find mu of x for y
Desalegn Reply
U(x,y) = (x×y)1/2 find mu of x for y
Desalegn
what is ecnomics
Jan Reply
this is the study of how the society manages it's scarce resources
Belonwu
what is macroeconomic
John Reply
macroeconomic is the branch of economics which studies actions, scale, activities and behaviour of the aggregate economy as a whole.
husaini
etc
husaini
difference between firm and industry
husaini Reply
what's the difference between a firm and an industry
Abdul
firm is the unit which transform inputs to output where as industry contain combination of firms with similar production 😅😅
Abdulraufu
Suppose the demand function that a firm faces shifted from Qd  120 3P to Qd  90  3P and the supply function has shifted from QS  20  2P to QS 10  2P . a) Find the effect of this change on price and quantity. b) Which of the changes in demand and supply is higher?
Toofiq Reply
explain standard reason why economic is a science
innocent Reply
factors influencing supply
Petrus Reply
what is economic.
Milan Reply
scares means__________________ends resources. unlimited
Jan
economics is a science that studies human behaviour as a relationship b/w ends and scares means which have alternative uses
Jan
calculate the profit maximizing for demand and supply
Zarshad Reply
Why qualify 28 supplies
Milan
what are explicit costs
Nomsa Reply
out-of-pocket costs for a firm, for example, payments for wages and salaries, rent, or materials
AI-Robot
concepts of supply in microeconomics
David Reply
economic overview notes
Amahle Reply
identify a demand and a supply curve
Salome Reply
i don't know
Parul
there's a difference
Aryan
Demand curve shows that how supply and others conditions affect on demand of a particular thing and what percent demand increase whith increase of supply of goods
Israr
Hi Sir please how do u calculate Cross elastic demand and income elastic demand?
Abari

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Source:  OpenStax, Microeconomics. OpenStax CNX. Aug 03, 2014 Download for free at http://legacy.cnx.org/content/col11627/1.10
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