Econ 140 chapter 11

Perfect Competition
Prepared by Dr. L. Al-Khalifa

1. What are the conditions of perfect competition?

A market is perfectly competitive when:
1. Many firms are selling identical product.
2. Many buyers demand that product.
3. Entry into the industry is not restricted
4. Firms already in the industry have no advantage over potential new entrants.
5. Firms and buyers are well informed about each firm’s price for the product
6. The output of a single firm is small relative to the demand
7. Each firm is a price taker, that is, a single firm cannot affect the price of its product. The industry
supply and demand determine the market price.
8. Each firm faces a perfectly elastic demand curve, although the market demand curve is not
perfectly elastic.
Price
S of all firms Price Each firm faces a perfectly elastic D curve
If it raises the price, no one will buy from it
3
3 D or MR
D

output
output
2. How to calculate economic profit, total revenue TR, average revenues AR and Marginal revenue
MR?
- The firm’s total economic profit equals its total revenue minus its total opportunity cost.
- Total revenue, TR, is the number of units sold times the price per unit, P X Q.
- Average revenue, AR, is total revenue per unit sold, that is, total revenue divided by quantity. For
a perfectly competitive firm AR = P
- Marginal revenue, MR, is the change in total revenue brought about by a one unit increase in the
quantity sold. For a perfectly competitive firm MR = P and the firm demand curve is also the MR
curve.

3. What are the firm’s short run decisions in perfect competition?

In the short-run, the number of firms in the industry and the sizes of their plant are fixed. A firm short run
decisions are:
a. Whether to shut down temporarily
- The firm shut down if the market Price is less than average variable cost, P< AVC.
- The firm may shut down or produce if the market price equals average variable cost, P=AVC. In
this case total loss = total fixed cost, TFC.
- The firm produces if the market price is more than average variable cost, P> AVC.

b. If the firm decides to produce, how much to produce

- The firm produces the quantity that minimizes the loss if the industry is making losses but losses
should not be above the total fixed cost.
- The firm produces the quantity that maximizes the profit if the industry is making profit.
- The quantity that minimizes the losses or maximizes the profit is the quantity at which MC = MR.

4. What is the marginal analysis?

- To maximize the profit in the short run, the firm produce the quantity at which marginal revenue
(MR) = marginal cost (MC).
- As long as MR > MC, producing an extra unit of output adds to the firm’s total profit.
- If the marginal revenue from an additional unit of output is less than its marginal cost, MR< MC,
producing the unit is not profitable.

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 Econ 140 chapter 11
Perfect Competition
Prepared by Dr. L. Al-Khalifa

5. What is the short-run equilibrium?

- The short-run equilibrium market price and quantity are determined by the intersections of the
short-run industry supply curve and demand curve.
- The short-run industry curve shows how the industry’s quantity supplied varied as the price varies.
It is the horizontal sum of the supply curves in the industry.

Price
9 Short-run industry supply curve
8
7
6
5
4
3
2
1 Demand
0
1 2 3 4 5 6 7 8 9 10 11 12 13 Quantity

- At the short-run equilibrium, an individual firm may be making an economic profit, earning a
normal profit, or incurring an economic loss.
- If the Price exceeds Average Total Cost, the firm earns an economic profit.
- If the Price is equal to Average Total Cost, the firm earns a normal profit (breaks-even)
- If the Price is less than Average Total Cost, the firm incurs an economic loss.

6. What are the firm decisions in the long run?

- In the long-run, firms can enter or exit the industry and change the scale of their operations (the
plant size).
- The firm must decide:

a) Whether to change plant size

- Firms change their plant size whenever doing so is profitable. If the price of the product exceeds
the minimum long-run average cost, firms expand their plants.
- In the long rum P = minimum ATC

b) Whether to remain in the industry

- If firms in an industry are making an economic profit, new ones enter. As a result, the industry
supply curve shifts rightward, the price of the product falls, the total quantity sold increases, and
the economic profits of the existing ones decline and all firms break-even.
- If firms in an industry are incurring loss, some exit the industry. As a result, the industry supply
curve shifts leftward, the price of the product rises, the total quantity sold decreases, and the
economic profits of the existing ones increase and all firms break-even.

7. What is the long-run equilibrium?

- The long run equilibrium occurs in a competitive industry when:
a) Economic profits are zero so that entry and exist stop.
b) Long-run average cost is at its minimum so that no firm has an incentive to change the size of its
plant.

Chapter 11 Quiz
1. In perfect competition,___________________________________.
a. there are many firms that sell identical products
b. firms in the industry have advantages over firms that plan to enter the industry
c. there are few buyers
d. buyers and sellers are not well informed

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 Econ 140 chapter 11
Perfect Competition
Prepared by Dr. L. Al-Khalifa

2. A price taker firm faces a demand cuve that ___________________.

a. is perfectly elastic b. has an elasticity of zero
c. is unitary elastic d. is perfectly inelastic

3. A competitive firm’s revenue minus total cost equals its________________.

a. income b. opportunity cost
c. normanl profit d. economic profit

4. in perfect competition, the firm’s marginal revenue ____________________.

a. is less than its average revenue b. equal its normal profit
d. exceeds the price it charges d. equals its average revenue

5. The return that a firm's entrepreneur can expect to obtain in the best alternative business is
__________________.
a. economic profit
b. external profit
c. normal profit (part of the firm opportunity cost)
d. upnormal profit

Table 2
Quantity Price
100 $5
101 5
6. Using table 2, what is the marginal revenue, MR, from selling 101 units of output rather than 100?
a. $5 b. $500
c. $505 d. none of the above

7. The break-even point is the output level at which__________________________.

a. AFC = MR b. TFC = TR
c. TC = TR d. AVC = MR

8. Economic profit is maximized when____________________.

a. marginal revenue is greater than marginal cost b. marginal revenue equals marginal cost.
c. total revenue equals total cost. d. marginal revenue is less than marginal cost.

Prices and
Costs MC

ATC (Figure 2)
P4 D

P3 C AVC

P2 B

P1 A
output
Q1 Q2 Q3 Q4

9. According to figure 2, the shut-down point is_________.

a. A b. B
c. C d. D

10. According to figure 2, the breaking- even point is________.

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 Econ 140 chapter 11
Perfect Competition
Prepared by Dr. L. Al-Khalifa
a. A b. B
c. C d. D

11. According to figure 2, if the price is P1, the firm will supply___________.
a. zero or Q1 b. zero
c. Q3 d. Q2

12. According to figure 2, if the price is P3, the firm will supply___________.
a. zero or Q3 b. zero
c. Q3 d. Q2

13. A firm shuts down if price falls below the minimum of_________________.
a. average total cost b. average fixed cost
C. marginal cost d. average variable cost

14. If a perfectly competitive firm is incurring an economic loss in the short-run, it

________________________.
a. always shuts down immediately.
b. continues to operate until either the price rises or its costs fall so that it no longer has an economic
loss.
c. shuts down if P > min AVC
d. shuts down if P < min AVC

15. The short-run industry supply curve industry supply curve is ___________________.
a. the sum of the quantities supplied by all the firms
b. undefined because the number of firms is constant in the short run
c. vertical at the total level of output being produced by all firms
d. horizontal at the current market price

Price and costs MC

5
ATC
4

3 MR (Figure 3)

0
1 2 3 4 5 6 Quantity

16. The firm illustrated in Figure 3 will produce how much output?
a. 1 unit b. 3 units
c. 4 units d. 5 units

17. The firm illustrated in Figure 3 is ________________________.

a. earning economic profit b. earning a normal profit
c. incurring an economic loss d. in long-run equilibrium

18. A perfectly competitive firm is definitely suffering an economic loss when _______________.
a. MR > MC b. P > ATC
c. P < ATC d. P > AVC

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 Econ 140 chapter 11
Perfect Competition
Prepared by Dr. L. Al-Khalifa

19. In the long run, a perfectly competitive firm can ________________________.

a. earn economic profit b. earn a normal profit
c. incur an economic loss d. all the above are possible

20. As new firms enter an industry_______________________.

a. the price falls and the economic profit of each existing firm increases
b. the price falls and the economic profit of each existing firm decreases.
c. the price rises and the economic profit of each existing firm increases.
d. the price rises and the economic profit of each existing firm decreases.

21. If firms in an industry are incurring an economic loss, then as some exit, the price _______ and the
surviving firms’ economic lossses _____________.
a. rises; do not change b. rises; become smaller
c. falls; become larger d. falls; become smaller

Prices and
Costs of CDs MC (the firm supply curve from B upwards)

4 ATC

3 C AVC (C is the firm breaking even point)

(B is the firm shut down point)
2 B

1 A
Output of CDs per day
20 30 50

22. If the price is 1 BD, the firm will supply……..

a. zero b. zero or 20
c. 20 d. 50

23. If the price 2 BD, the firm will supply……..

a. zero b. zero or 30
c. 30 d. 20

24. The maximum loss the firm can incur is equal to__________________.
a. Total cost
b. Total variable cost
c. Total Fixed cost
d. Marginal cost

25.
Output TR TC
20 200 300
30 300 350
40 400 400
50 500 450
According to these statistics, the firm will supply__________.
a. 20 b. 30
c. 40 d. 50

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Econ 140 chapter 11
Perfect Competition
Prepared by Dr. L. Al-Khalifa