Microeconomics 13th Edition

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McConnell Microeconomics 13CE CH 8 - Perfect Competition
in the Short Run

CHAPTER 8
PERFECT COMPETITION IN THE SHORT RUN

CHAPTER OVERVIEW
This chapter is the first of three closely related chapters analyzing the four basic market models—perfect
competition, monopoly, monopolistic competition, and oligopoly. Here the market models are introduced
and explained, which makes this the longest and perhaps most difficult of the three chapters.
Explanations and characteristics of the four models are outlined at the beginning of this chapter. Then
the characteristics of a perfectly competitive industry are detailed. There is an introduction to the
concept of the perfectly elastic demand curve facing an individual firm in a perfectly competitive industry.
Next, the total, average, and marginal revenue schedules are presented in numeric and graphic form.
Using the cost schedules from the previous chapter, the idea of profit maximization is explored.
The total-revenue—total-cost approach is analyzed first because of its simplicity. More space is devoted
to explaining the MR = MC rule, and to demonstrating that this rule applies in all market structures, not
just in perfect competition.
Next, the firm’s short-run supply schedule is shown to be the same as its marginal-cost curve at all points
above the average-variable-cost curve. Then the short-run competitive equilibrium is discussed at the
firm and industry levels.

WHAT’S NEW
This was Chapter 7 in the 12th edition.

Long run analysis of Perfect competition has been moved to Chapter 9.

A new “Last Word…Fixed Costs: Digging Yourself Out of a Hole” has been added.

Terms and Concepts have been updated to reflect removal of the long run analysis.

INSTRUCTIONAL OBJECTIVES
After completing this chapter, students should be able to:

1. List the four basic market models and characteristics of each.

2. Describe characteristics of a perfectly competitive firm and industry.
3. Explain how a perfectly competitive firm views demand for its product and marginal revenue from
each additional unit sale.
4. Compute average, total, and marginal revenue when given a demand schedule for a perfectly
competitive firm.
5. Use both total-revenue—total-cost and marginal-revenue—marginal-cost approaches to determine
short-run price and output that maximizes profits (or minimizes losses) for a competitive firm.
6. Find the short-run supply curve when given short-run cost schedules for a competitive firm.
7. Explain how to construct an industry short-run supply curve from information on single
competitive firms in the industry.
8. Define and identify terms and concepts listed at the end of the chapter.

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McConnell Microeconomics 13CE CH 8 - Perfect Competition in the Short-Run

COMMENTS AND TEACHING SUGGESTIONS

1. Urge students to practice their understanding of this chapter’s concepts with quantitative
end-of-chapter questions and the relevant interactive microcomputer tutorial software. Assign and
review in class numerical and graphical problems, so that students have “hands-on” experience in
learning this material. It is essential for understanding the next several chapters and grasping the
essence of marginal cost analysis.
2. Examples of “price-taking” situations are readily found in published quotations for commodity,
stock, and currency markets. Such markets approximate the perfectly competitive model.
3. A useful example for demonstrating that profit maximization occurs where MR = MC, not where
MR is much greater than MC, is to ask a student if she would trade $50 for $100 (of course), then
$60 for $100 (of course), then $70 for $100, and so on up to $99.99 for $100. The student should
want to trade as long as her additional “revenue” exceeds her marginal cost. In other words, if
someone can make as much as $.01 more profit, the rational person will trade. It is not the profit
per unit but the total profit that the seller is maximizing! This simple notion bears repeating several
times in different ways, because some students will continue to be puzzled by this despite its
simplicity.
4. Using the overhead for Table 7-4 and starting at output level “4,” move to the next level of output
while asking the students whether the next unit should be added by comparing MR and MC.
5. Review the short run cost concepts developed in Chapter 6, particularly MC, ATC and AVC and
how they are related. Using a Key Graph (Figure 7-6), show how these costs can be used to
evaluate a perfectly competitive firm’s position in the short run. Each of the three cost concepts
has a distinct contribution to make in the decision-making process.
(a) MC determines the best Q of output. The point where MC = MR is always best, whether the
firm is making an economic profit, breaking even, or operating at a loss.
(b) ATC determines profit or loss. Have the students compare price and ATC at the best quantity
of output. If price exceeds ATC, the difference is per unit profit. If Price = ATC the firm is
breaking even and if price is less than ATC the firm is losing money.
(c) AVC determines the shut down point. As long as price exceeds AVC the firm will continue to
operate in the short run.
Review these three steps carefully; they can be used with each of the market structures. For the
individual seller in perfect competition, product price = MR. This is not the case in any of the other
market structures. Stress this difference; it is the basis of the efficient outcome in the long run. (P
= MC = minimum ATC)

STUDENT STUMBLING BLOCKS

There are three fundamental skills that are necessary to engage successfully in economic reasoning. (1)
The ability to use graphs and mathematical reasoning. (2) The ability to use abstract models and
generalize. (3) The ability to use and apply the specialized vocabulary of economics. In this chapter, all
students will find their skills being tested. Struggling students may be ready to bail out.

Using graphs to demonstrate the relationship between variables is a habit for economics instructors. The
message the graph is sending is instantly received: the communication complete (for the teacher). Keep
in mind that the curves you have drawn may not be “speaking” as clearly to the students. There are so
many graphs in the chapters on market structure that the students can easily get lost. Take time to put
numbers on the axis and work out the actual amount of total profit or loss in your examples. By taking a
little extra time with the concepts in perfect competition, the following discussion about other market
structures will be easier for students to understand.

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It must be emphasized in the analysis as to whether the focus of the discussion is on the individual firm or
the industry; likewise, whether the focus is on the firm or industry in the short run or the long run.

Productive efficiency is relatively easy to explain and show graphically.

Vocabulary in this chapter is also a problem. Students’ “everyday” definition of competition is totally
different from the narrow meaning that is applied in discussing the market structure of Perfect
Competition. Students are likely to question the usefulness of a model that is so far removed from actual
business conditions. One helpful analogy is that we are, in a sense, creating a laboratory experiment that
eliminates all outside influences and focuses on only one determining consideration, i.e. price. Similarly,
a physicist might wish to create a vacuum to study the impact of gravity on a feather and a bowling ball.

LECTURE NOTES
I. Learning objectives – After reading this chapter, students should be able to:
1. The four basic market structures.
2. List the conditions required for perfectly competitive markets.
3. Convey how firms in perfect competition maximize profit or minimize losses in the short-run.
4. Explain why a competitive firm's marginal cost curve is the same as its supply curve.

II. Four Market Models

A. The models are addressed in Chapters 8-11; characteristics of the models are summarized in
Table 8.1.
B. Perfect competition entails a large number of firms, standardized product, and easy entry (or
exit) by new (or existing) firms.
C. At the opposite extreme, perfect monopoly has one firm that is the sole seller of a product or
service with no close substitutes; entry is blocked for other firms.
D. Monopolistic competition is close to perfect competition, except that the product is
differentiated among sellers rather than standardized, and there are fewer firms.
E. An oligopoly is an industry in which only a few firms exist, so each is affected by the
price-output decisions of its rivals.
III. Perfect Competition: Characteristics and Occurrence
A. The characteristics of perfect competition:
1. Perfect competition is rare in the real world, but the model is important.
a. The model helps analyze industries with characteristics similar to perfect
competition.
b. The model provides a context in which to apply revenue and cost concepts developed
in previous chapters.
c. Perfect competition provides a norm or standard against which to compare and
evaluate the efficiency of the real world.

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2. Many sellers means that there are enough so that a single seller has no impact on price by
its decisions alone.
3. The products in a perfectly competitive market are homogeneous or standardized; each
seller’s product is identical to its competitor’s.
4. Individual firms must accept the market price; they are price takers and can exert no
influence on price.
5. Freedom of entry and exit means that there are no significant obstacles preventing firms
from entering or leaving the industry.
B. There are four major objectives to analyzing perfect competition.
1. To examine demand from the seller’s viewpoint,
2. To see how a competitive producer responds to market price in the short run,
3. To explore the nature of long-run adjustments in a competitive industry (covered in
Chapter 9), and
4. To evaluate the efficiency of competitive industries (covered in Chapter 9).
IV. Demand from the Viewpoint of a Competitive Seller
A. The individual firm will view its demand as perfectly elastic.
1. Table 8-2 and Figures 8-1 and 8-7a illustrate this.
2. The demand curve is not perfectly elastic for the industry: It only appears that way to the
individual firm, since they must take the market price no matter what quantity they
produce.
3. Note from Figure 8-1 that a perfectly elastic demand curve is a horizontal line at the
price.
B. Definitions of average, total, and marginal revenue:
1. Average revenue is the price per unit for each firm in perfect competition.
2. Total revenue is the price multiplied by the quantity sold.
3. Marginal revenue is the change in total revenue and will also equal the unit price in
conditions of perfect competition. (Key Question 3)
V. Profit Maximization in the Short-Run: Two Approaches
A. In the short run the firm has a fixed plant and maximizes profits or minimizes losses by
adjusting output; profits are defined as the difference between total costs and total revenue.
B. Three questions must be answered.
1. Should the firm produce?
2. If so, how much?
3. What will be the profit or loss?
C. An example of the total-revenue—total-cost approach is shown in Table 8-3. Note that the
costs are the same as for the firm in Table 8.2 in the previous chapter.
1. Firm should produce if the difference between total revenue and total cost is profitable, or
if the loss is less than the fixed cost.

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McConnell Microeconomics 13CE CH 8 - Perfect Competition
in the Short Run

2. In the short run, the firm should produce that output at which it maximizes its profit or
minimizes its loss.
3. The profit or loss can be established by subtracting total cost from total revenue at each
output level.
4. The firm should not produce, but should shut down in the short run if its loss exceeds its
fixed costs. Then, by shutting down its loss will just equal those fixed costs.
5. Graphical representation is shown in Figures 8-2a and b. Note: The firm has no control
over the market price.
D. Marginal-revenue—marginal-cost approach (see Table 8-4 and Figure 8-3).
1. MR = MC rule states that the firm will maximize profits or minimize losses by producing
at the point at which marginal revenue equals marginal cost in the short run.
2. Three features of this MR = MC rule are important.
a. Rule assumes that marginal revenue must be equal to or exceed minimum-average-
variable cost or firm will shut down.
b. Rule works for firms in any type of industry, not just perfect competition.
c. In perfect competition, price = marginal revenue, so in perfectly competitive
industries the rule can be restated as the firm should produce that output where P =
MC, because P = MR.
3. Using the rule on Table 8-4, compare MC and MR at each level of output. At the tenth
unit MC exceeds MR. Therefore, the firm should produce only nine (not the tenth) units
to maximize profits.
4. Profit maximizing case: The level of profit can be found by multiplying ATC by the
quantity, 9 to get $880 and subtracting that from total revenue which is $131 x 9 or
$1179. Profit will be $299 when the price is $131. Profit per unit could also have been
found by subtracting $97.78 from $131 and then multiplying by 9 to get $299. Figure 8-3
portrays this situation graphically.
5. Loss-minimizing case: The loss-minimizing case is illustrated when the price falls to $81.
Table 8-5 is used to determine this. Marginal revenue does exceed average variable cost
at some levels, so the firm should not shut down. Comparing P and MC, the rule tells us
to select output level of 6. At this level the loss of $64 is the minimum loss this firm
could realize, and the MR of $81 just covers the MC of $80, which does not happen at
quantity level of 7. Figure 8-4 is a graphical portrayal of this situation.
6. Shut-down case: If the price falls to $71, this firm should not produce. MR will not
cover AVC at any output level. Therefore, the minimum loss is the fixed cost and
production of zero. Figure 8-4 illustrates this situation, and it can be seen that the $100
fixed cost is the minimum possible loss.
7. CONSIDER THIS … The Still There Motel
a. Over time a motel might experience a decrease in demand.
b. Despite the decrease in demand, it’s still profitable to remain open rather than shut
down (Price is greater than minAVC).
c. To increase the falling profits, the hotel owner cuts back on maintenance thereby
lowering the costs.

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E. Marginal cost and the short-run supply curve can be illustrated by hypothetical prices such as
those in Table 8-2. At price of $151 profit will be $480; at $111 the profit will be $138
($888-$750); at $91 the loss will be $3.01; at $61 the loss will be $100 because the latter
represents the close-down case.
1. Note that Table 8.2 gives us the quantities that will be supplied at several different price
levels in the short-run.
2. Since a short-run supply schedule tells how much quantity will be offered at various
prices, this identity of marginal revenue with the marginal cost tells us that the marginal
cost above AVC will be the short-run supply for this firm (see Figure 8-6 Key Graph).

F. Determining equilibrium price for a firm and an industry:

1. Total-supply and total-demand data must be compared to find the most profitable price
and output levels for the industry. (See Table 8.4)
2. Figures 8.7a and b show this analysis graphically; individual firm supply curves are
summed horizontally to get the total-supply curve S in Figure 8.7b. If product price is
$111, industry supply will be 8000 units, since that is the quantity demanded and
supplied at $111. This will result in economic profits similar to those portrayed in Figure
8.3.
3. Loss situation similar to Figure 8.4 could result from weaker demand (lower price and
MR) or higher marginal costs.
G. Firm vs. industry: Individual firms must take price as given, but the supply plans of all
competitive producers as a group are a major determinant of product price.

VI. Last Word…Fixed Costs: Digging Yourself Out of a Hole

A. Since a firm faces fixed costs in the short run, those fixed costs can be viewed as a hole the
firm hopes to fill each month by generating enough revenue from the units produced and
sold.
B. If the financial hole is exactly filled, the firm breaks-even; if the hole is more than full, the
firm has received economic profit.
C. The hole gets bigger when the firm produces when it should have shut down because the firm
is incurring an even greater loss by producing.
D. A decrease in price is often temporary so shutting down is also often temporary.
1. Production of oil has different costs at different wells, so as price changes it may be
desirable to shut down some of the wells whose variable costs are too high.
2. Seasonal resorts often shut down in the “off season” because prices at that time are too
low.
3. During the recession of 08–09, many industries like electric generating plants, factories
making fiber optic cable, auto factories, chemical plants, textile mills, etc. “mothballed”
their facilities until the economy improves.
E. Many firms plan to re-open, but economic conditions do not always improve enough for them
to do so.
QUIZ

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McConnell Microeconomics 13CE CH 8 - Perfect Competition
in the Short Run

1. For a perfectly competitive seller, price equals:

A. average revenue.
B. marginal revenue.
C. total revenue divided by output.
D. all of these.
Answer: D

2. For a perfectly competitive firm total revenue:

A. is price times quantity sold.
B. increases by a constant absolute amount as output expands.
C. graphs as a straight upsloping line from the origin.
D. has all of these characteristics.
Answer: D

3. In the standard model of pure competition, a profit-maximizing entrepreneur will shut down in
the short run if:
A. Marginal cost is greater than average revenue
B. Average cost is greater than average revenue
C. Average fixed cost is greater than average revenue
D. Total revenue is less than total variable costs
Answer: D

4. In a typical graph for a perfectly competitive firm, the intersection of the total cost and total
revenue curves would be:
A. A point of maximum economic profit
B. A point of minimum economic loss
C. A point where MR = MC
D. A break-even point
Answer: D

5. The wage rate increases in a perfectly competitive industry. This change will result in a(n):
A. Decrease in average total cost for a firm in the industry
B. Decrease in average variable cost for a firm in the industry
C. Increase in the marginal cost curve for a firm in the industry
D. Increase in short-run supply curve for a firm in the industry
Answer: C

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McConnell Microeconomics 13CE CH 8 - Perfect Competition in the Short-Run

6. In the short run a perfectly competitive firm that seeks to maximize profit will produce:
A. where the demand and the ATC curves intersect.
B. where total revenue exceeds total cost by the maximum amount.
C. that output where economic profits are zero.
D. at any point where the total revenue and total cost curves intersect.
Answer: B

7. A firm reaches a break-even point (normal profit position) where:

A. marginal revenue cuts the horizontal axis.
B. marginal cost intersects the average variable cost curve.
C. total revenue equals total variable cost.
D. total revenue and total cost are equal.
Answer: D

8. In the short run the individual competitive firm's supply curve is that segment of the:
A. average variable cost curve lying below the marginal cost curve.
B. marginal cost curve lying above the average variable cost curve.
C. marginal revenue curve lying below the demand curve.
D. marginal cost curve lying between the average total cost and average variable cost curves.
Answer: B

9. A perfectly competitive firm's short-run supply curve is:

A. perfectly elastic at the minimum average total cost.
B. upsloping and equal to the portion of the marginal cost curve that lies above the average
variable cost curve.
C. upsloping and equal to the portion of the marginal cost curve that lies above the average total
cost curve.
D. upsloping only when the industry has constant costs.
Answer: B

10. Resource costs increase in a perfectly competitive industry. This change will result in a(n):
A. Increase in average fixed cost for a firm in the industry
B. Decrease in average variable cost for a firm in the industry
C. Decrease in the marginal cost curve for a firm in the industry
D. Decrease in the short-run supply curve for a firm in the industry

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McConnell Microeconomics 13CE CH 8 - Perfect Competition
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Answer: D

Questions

1. Briefly state the basic characteristics of perfect competition, monopoly, monopolistic competition, and
oligopoly. Under which of these market classifications does each of the following most accurately fit? (a)
a supermarket in your hometown; (b) the steel industry; (c) a Saskatchewan wheat farm; (d) the chartered
bank in which you have or your family has an account; (e) the automobile industry. In each case justify
your classification. LO 8.1

Answer: Perfect competition: very large number of firms; standardized products; no control over price:
price takers; no obstacles to entry; no nonprice competition.

Monopoly: one firm; unique product; with no close substitutes; much control over price: price maker;
entry is blocked; mostly public relations advertising.

Monopolistic competition: many firms; differentiated products; some control over price in a narrow
range; relatively easy entry; much nonprice competition: advertising, trademarks, brand names.
Oligopoly: few firms; standardized or differentiated products; control over price circumscribed by
mutual interdependence: much collusion; many obstacles to entry; much nonprice competition,
particularly product differentiation.

(a) Hometown supermarket: oligopoly. Supermarkets are few in number in any one area; their size
makes new entry very difficult; there is much nonprice competition. However, there is much price
competition as they compete for market share, and there seems to be no collusion. In this regard, the
supermarket acts more like a monopolistic competitor. Note that this answer may vary by area. Some
areas could be characterized by monopolistic competition while isolated small towns may have a
monopoly situation.
(b) Steel industry: oligopoly within the domestic production market. Firms are few in number; their
products are standardized to some extent; their size makes new entry very difficult; there is much
nonprice competition; there is little, if any, price competition; while there may be no collusion, there does
seem to be much price leadership.
(c) A Saskatchewan wheat farm: perfect competition. There are a great number of similar farms; the
product is standardized; there is no control over price; there is no nonprice competition. However, entry
is difficult because of the cost of acquiring land from a present proprietor. Of course, government
programs to assist agriculture complicate the purity of this example.
(d) Chartered bank: monopolistic competition. There are many similar banks; the services are
differentiated as much as the bank can make them appear to be; there is control over price (mostly interest
charged or offered) within a narrow range; entry is relatively easy (maybe too easy!); there is much
advertising. Once again, not every bank may fit this model—smaller towns may have an oligopoly or
monopoly situation.
(e) Automobile industry: oligopoly. There are the Big Three automakers, so they are few in number;
their products are differentiated; their size makes new entry very difficult; there is much nonprice
competition; there is little true price competition; while there does not appear to be any collusion, there
has been much price leadership. However, imports have made the industry more competitive in the past
two decades, which has substantially reduced the market power of the North American automakers.

2. Strictly speaking, perfect competition is relatively rare. Then why study it? LO 8.2

Answer: It can be shown that perfect competition results in low-cost production (productive
efficiency)—through long-run equilibrium occurring where P equals minimum ATC—and allocative
efficiency—through long-run equilibrium occurring where P equals MC. Given this, it is then possible to

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analyze real world examples to see to what extent they conform to the ideal of plants producing at their
points of minimum ATC and thus producing the most desired commodities with the greatest economy in
the use of resources.

3. Use the following demand schedule to determine total revenue and marginal revenue for each possible
level of sales: LO 8.3

a. What can you conclude about the structure of the industry in which this firm is operating? Explain.
b. Graph the demand, total-revenue, and marginal-revenue curves for this firm.
c. Why do the demand and marginal-revenue curves coincide?
d. “Marginal revenue is the change in total revenue associated with additional units of output.” Explain in
words and graphically, using the data in the table.

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Answer: Table:

Product Price ($) Quantity Demanded Total Revenue ($) Marginal Revenue
($)
2 0 0 NA
2 1 2 2
2 2 4 2
2 3 6 2
2 4 8 2
2 5 10 2

(a) The industry is perfectly competitive—this firm is a “price taker.” The firm is so small relative to
the size of the market that it can change its level of output without affecting the market price.

(b) See graph.

(c) The firm’s demand curve is perfectly elastic; MR is constant and equal to P.

(d) True. When output (quantity demanded) increases by 1 unit, total revenue increases by $2. This
$2 increase is the marginal revenue. Figure: The change in TR is measured by the slope of the TR line, 2
(= $2/1 unit).

4. “Even if a firm is losing money, it may be better to stay in business in the short run.” Is this statement
ever true? Under what condition(s)? LO 8.3

Answer: Yes, a firm may want to stay in business even if it is losing money. For example, assume the
firm has a fixed cost of $1,000 which it must pay even if it stops production. Now assume that average
variable cost is $10 per unit and price of the product is $15 per unit. Finally assume that output equals 100
units using the MR=MC rule. This implies total revenue equals $1,500, variable cost equals $1,000, and
total cost equals $2,000 (the sum of variable and fixed cost). The firm is losing money because profit
equals -$500 (=$1500 - $2000). However, this loss is less than the fixed cost it would incur in the short
run if it shut down, which equals a $1,000. Thus, it is better to stay in business and lose $500 rather than
close down and lose a $1000 in the short run.
In conclusion, as long as price exceeds the average variable cost the firm should produce in the short run
given fixed cost are present by definition.

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5. Consider a firm that has no fixed costs and which is currently losing money. Are there any situations in
which it would want to stay open for business in the short run? If a firm has no fixed costs, is it sensible
to speak of the firm distinguishing between the short run and the long run? LO 8.3

Answer: No, the firm will want to shut down. This follows because the firm is losing money, but there
are no fixed costs. Since there are no fixed costs, only variable cost, revenue must be less than total
variable cost or price is less than average variable cost (the shut-down rule). In other words, the firm can
shut down and lose nothing because there are no fixed costs or it can keep producing and earn a negative
profit.

In a more general sense, a firm with no fixed cost is really in the long run. By definition, the short run
implies there are fixed cost present that the firm cannot get of paying either implicitly or explicitly. The
long run implies all factors and costs can adjust to the economy.

6. Why is the equality of marginal revenue and marginal cost essential for profit maximization in all
market structures? Explain why price can be substituted for marginal revenue in the MR = MC rule when
an industry is perfectly competitive. LO 8.4

Answer: If the last unit produced adds more to costs than to revenue, its production must necessarily
reduce profits (or increase losses). On the other hand, profits must increase (or losses decrease) so long as
the last unit produced—the marginal unit—is adding more to revenue than to costs. Thus, so long as MR
is greater than MC, the production of one more marginal unit must be adding to profits or reducing losses
(provided price is not less than minimum AVC). When MC has risen to precise equality with MR, the
production of this last (marginal) unit will neither add nor reduce profits.

In perfect competition, the demand curve is perfectly elastic; price is constant regardless of the quantity
demanded. Thus MR is equal to price. This being so, P can be substituted for MR in the MR = MC rule.
(Note, however, that it is not good practice to use MR and P interchangeably, because in imperfectly
competitive models, price is not the same as marginal revenue.)

7. “That segment of a competitive firm’s marginal-cost curve that lies above its average variable-cost
curve constitutes the short-run supply curve for the firm.” Explain using a graph and words. LO 8.4

Answer: The firm will not produce if P < AVC. When P > AVC, the firm will produce in the short run at
the quantity where P (= MR) is equal to its increasing MC. Therefore, the MC curve above the AVC
curve is the firm’s short-run supply curve, it shows the quantity of output the firm will supply at each
price level. See Figure 8.6 for a graphical illustration.

The LAST WORD If a firm's current revenues are less than its current variable costs, when should it shut
down? If it decides to shut down, should we expect that decision to be final? Explain using an example
that is not in the textbook.
Answer: The firm should shut down immediately. If the firm were to continue production in this case it
would be adding to its losses. That is, not only would the firm have to pay for its fixed cost it would also
be paying more for the variable costs in excess of revenue. In this case, it is best for the firm to just to
shut down and take the loss on the fixed cost (minimize losses).
However, this may only be a temporary case. If the price of the product were to rise then the revenue may
be sufficient to cover the variable costs. The firm will once again start production because they can start
to fill the financial hole generated by the fixed costs.
Examples will vary.

Problems

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1. A perfectly competitive firm finds that the market price for its product is $20. It has a fixed cost of
$100 and a variable cost of $10 per unit for the first 50 units and then $25 per unit for all successive units.
Does price exceed average variable cost for the first 50 units? What about for the first 100 units? What is
the marginal cost per unit for the first 50 units? What about for units 51 and higher? For each of the first
50 units, does MR exceed MC? What about for units 51 and higher? What output level will yield the
largest possible profit for this perfectly competitive firm? (Hint: Draw a graph similar to Figure 8.2 using
data for this firm.) LO 8.3

Answer: Yes; Yes; the MC per unit is $10 per unit for the first 50 units; the MC per unit is $25 per unit
for subsequent units; Yes, MR > MC; For units 51 and up, MR < MC; Producing 50 units will maximize
profit.

Feedback: Consider the following example. A perfectly competitive firm finds that the market price for
its product is $20. It has a fixed cost of $100 and a variable cost of $10 per unit for the first 50 units and
then $25 per unit for all successive units.

Does price exceed average variable cost for the first 50 units? Yes, price ($20) exceeds average variable
cost for the first 50 units since AVC for the first 50 units is $10 per unit [= ($10 per unit X 50 units)/50
units].

What about for the first 100 units? Yes, price ($20) exceeds average variable cost for the first 100 units
since AVC for the first 100 units is $17.50 per unit [= ($10 per unit X 50 units + $25 per unit X 50
units)/100].
What is the marginal cost per unit for the first 50 units? What about for units 51 and higher? For each of
the first 50 units, does MR exceed MC? What about for units 51 and higher? The MC is $10 per unit for
the first 50 units and the MC is $25 per unit for subsequent units. For each of the first 50 units, MR > MC
since $20 > $10 and for units 50 and up, MR < MC since $20 < $25.
What output level will yield the largest possible profit for this perfectly competitive firm? The firm will
produce 50 units to maximize profit because the MC of the 51st unit exceeds marginal revenue.

2. A wheat farmer in perfectly competitive can sell any wheat he grows for $10 per bushel. His five
hectares of land show diminishing returns because some are better suited for wheat production than
others. The first hectare can produce 1000 bushels of wheat, the second hectare 900, the third 800, and so
on. Draw a table with multiple columns to help you answer the following questions.
a.How many bushels will each of the farmer’s five hectares produce?
b.How much revenue will each hectare generate?
c. What are the TR and MR for each hectare?
d. If the marginal cost of planting and harvesting a hectare is $7000 per hectare for each of the five
hectares, how many hectares should the farmer plant and harvest? LO 8.3

Answers: The student should end up constructing a table similar to the following.

The farmer should plant and harvest four hectares.

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McConnell Microeconomics 13CE CH 8 - Perfect Competition in the Short-Run

Feedback: Consider the following example. A perfectly competitive wheat farmer can sell any wheat he
grows for $10 per bushel. His five hectares of land show diminishing returns because some are better
suited for wheat production than others. The first hectare can produce 1000 bushels of wheat, the second
hectare 900, the third 800, and so on. Also assume the marginal cost of planting and harvesting an hectare
is $7000 per hectare for each of the five hectares.
Table:

The first step is to calculate the revenue generated by each hectare (column 3). Each entry, the hectare's
revenue, is found by multiplying the price per bushel by the hectare's yield. The revenue generated by the
first hectare is $10,000 (=$10 x 1000), the second hectare $9000 (=$10 x 900), the third hectare $8000
(=$10 x 800), etc...
The next step is to calculate total revenue (column 4). Total revenue equals the sum of revenue generated
by each successive hectare being cultivated. Total revenue for the first hectare is $10,000, total revenue
for first and second hectare is $19,000 (=$10,000 + $9,000), total revenue for the first, second, and third
hectare is $27,000 (= $10,000 +$ 9,000 + $8,000), etc...
The final step is to calculate marginal revenue (column 5). Marginal revenue equals the change in total
revenue as each successive hectare is cultivated. Marginal revenue for the first unit is $10,000 because as
we move from cultivating zero hectares to one hectare out total revenue changes by $10,000. The
marginal revenue for the second hectare equals $9000, which is the total revenue of the second hectare
minus the revenue generated by the first hectare (=$19,000 - $10,000). etc...
Using our MC=MR rule, the farmer should plant and harvest 4 hectares. Marginal revenue for the fourth
hectare equals $7,000 and the marginal cost equals $7,000.

3. Karen runs a print shop that makes posters for large companies. It is a very competitive business. The
market price is currently $1 per poster. She has fixed costs of $250. Her variable costs are $1000 for the
first thousand posters, $800 for the second thousand, and then $750 for each additional thousand posters.
What is her AFC per poster (not per thousand!) if she prints 1000 posters? 2000? 10,000? What is her
ATC per poster if she prints 1000? 2000? 10,000? If the market price fell to 70 cents per poster, would
there be any output level at which Karen would not shut down production immediately? LO 8-3

Answers: AFC per poster is $0.25 for 1000, $0.125 for 2000, $0.025 for 10,000. ATC per poster is $1.25
for 1000 posters, $1.025 for 2000 posters, and $0.805 for 10,000. Shutdown is determined by AVC. The
AVC per poster for more than 2000 posters is $0.75 per poster, so Karen will shut down if the price falls
to 70 cents per poster.

Feedback: Consider the following example. The market price is currently $1 per poster. She has fixed
costs of $250. Her variable costs are $1000 for the first thousand posters, $800 for the second thousand,
and then $750 for each additional thousand posters.
What is her AFC per poster (not per thousand!) if she prints 1000 posters? 2000? 10,000?
To calculate average fixed cost (AFC) divide total fixed cost by the number of posters being produced
(=Total Fixed Cost / # of posters).

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McConnell Microeconomics 13CE CH 8 - Perfect Competition
in the Short Run

Therefore, her AFC for a 1000 posters is $0.25 (=$250/1000), for 2000 posters $0.125 (=$250/2000), and
for 10,000 posters $0.025 (=$250/10,000).
What is her ATC per poster if she prints 1000? 2000? 10,000?
Before we calculate the average total cost (ATC) per poster we need to find the average variable cost
(AVC) per poster using the information above. The AVC is found by dividing the total variable cost by
the number of posters produced.
AVC for 1000 posters is $1.00. This is the total variable cost of $1000 divided by the number of posters,
1000 (=$1000/1000).
AVC for 2000 posters is $0.90. This is the total variable cost $1800, $1000 for the first 1000 and $800 for
the second 1000, divided by the total number of posters 2000 (=$1800/2000).
AVC for 10,000 posters is $0.78. This is the total variable cost of 7800, $1000 for the first 1000, $800 for
the second 1000, and $6000 for the next 8000 ($750 per 1000 or 8x$750), divided by 10,000 posters
(=$7800/10,000).
Now we can find her ATC, which equals the sum of her average fixed cost and her average variable cost
(=AFC+AVC).
ATC for 1000 posters is $1.25 (=$0.25 + $1.00). ATC for 2000 posters is $1.025 (=$0.125 + $0.90).
ATC for 10,000 is $0.805 (=$0.025 + $0.78).
Since the price is 70 cents per poster Karen will shut down because average variable cost never falls
below 75 cents per poster.

4. Assume the following cost data are for a firm in perfect competition: LO 8.3

a. At a product price of $56, will this firm produce in the short run? If it is preferable to produce, what
will be the profit-maximizing or loss-minimizing output? What economic profit or loss will the firm
realize per unit of output?
b. Answer the questions in part (a) assuming product price is $41.
c. Answer the questions in part (a) assuming product price is $32.
d. In the table below, complete the short-run supply schedule for the firm (columns 1 and 2) and indicate
the profit or loss incurred at each output (column 3).

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McConnell Microeconomics 13CE CH 8 - Perfect Competition in the Short-Run

e. Now assume that there are 1500 identical firms in this competitive industry; that is, there are 1500
firms, each of which has the cost data shown in the table. Complete the industry supply schedule (column
4).
f. Suppose the market demand data for the product are as follows:

What will be the equilibrium price? What will be the equilibrium output for the industry? For each firm?
What will profit or loss be per unit? Per firm? Will this industry expand or contract in the long run?

Answer: (a) Yes; 8 units; the total economic profit equals $62.96. (b) Yes; 6 units; the total economic
profit (loss) equals -$39.00. (c) The firm will not produce; the firm shuts down and incurs the loss of
$60.00 (fixed cost).
(d) and (e)

(1) (2) (3) (4)

Quantity Quantity
supplied, Profit (+) supplied,
Price single firm or loss (-) 1500 firms

$26 0 $-60 0
32 0 -60 0
38 5 -55.00 7500
41 6 -39.00 9000
46 7 -7.98 10500
56 8 62.96 12000
66 9 144.00 13500

(f) $46; 10,500; 7 units; per-unit loss is -$1.14; the loss per firm is -$7.98; industry will contract.

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McConnell Microeconomics 13CE CH 8 - Perfect Competition
in the Short Run

Feedback: Consider the following example.

Part a: At a product price of $56, will this firm produce in the short run? If it is preferable to produce,
what will be the profit-maximizing or loss-minimizing output? What economic profit or loss will the firm
realize per unit of output?
The rule is to produce at the level of output where Marginal Revenue equals (or is greater than if we are
using integers) Marginal Cost as long as revenue is sufficient to cover fixed cost (Price is greater than
Average Fixed Cost).
In the case above the market is competitive so Marginal Revenue equals the price of $56. From the table
above we see that the marginal cost for the 8th unit is $55 and the marginal cost of 9th unit is $65. The firm
will want to produce 8 units where the marginal revenue of $56 is greater than the marginal cost of $55.
For the 9th unit of output this is not the case.
We also need to verify that price exceeds average variable cost at this level of production. The answer is
yes, average variable cost is $40.63 which is less than the price of $56.
At this level of production the firm will earn a positive economic profit per unit of $7.87 (= $56 (price of
product) - $48.13 (average total cost for the 8th unit). The total economic profit equals $62.96 (=8
(number of units sold) x $7.87 (profit per unit)).
Part b: Answer the questions in part (a) assuming product price is $41.
The same process is applied here.

The price of $41, which is marginal revenue, is greater than the marginal cost of the 6th unit in the table
above. Beyond this level of production marginal cost exceeds marginal revenue. Thus, the firm will
produce 6 units as long as price covers average variable cost.
The average variable cost for 6 units is $37.50, which is less than the price. The firm will produce the 6
units of output.
At this level of production the firm will earn a negative economic profit per unit or loss per unit of -$6.50
(= $41 (price of product) - $47.50 (average total cost for the 6th unit). The total economic profit (loss)
equals -$39.00 (=6 (number of units sold) x (-$6.50) (loss per unit)).
Part c: Answer the questions in part (a) assuming product price is $32.
We could go through the same exercise here. However, by recognizing that the price of $32 is below
average variable cost at all levels of production the firm will not produce. Thus, the firm shuts down and
incurs the loss of $60.00 (fixed cost).
Part d and e: Using the table below, complete the short-run supply schedule for the firm (columns 1 and
2) and indicate the profit or loss incurred at each output (column 3). Now assume that there are 1500

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McConnell Microeconomics 13CE CH 8 - Perfect Competition in the Short-Run

identical firms in this competitive industry; that is, there are 1500 firms, each of which has the cost data
shown in the table. Complete the industry supply schedule (column 4).

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McConnell Microeconomics 13CE CH 8 - Perfect Competition
in the Short Run

(1) (2) (3) (4)

Quantity Quantity
supplied, Profit (+) supplied,
Price single firm or loss (-) 1500 firms

$26 0 $-60 0
32 0 -60 0
38 5 -55.00 7500
41 6 -39.00 9000
46 7 -7.98 10500
56 8 62.96 12000
66 9 144.00 13500

Part f:
Suppose the market demand data for the product are as follows:

What will be the equilibrium price? What will be the equilibrium output for the industry? For each firm?
What will profit or loss be per unit? Per firm? Will this industry expand or contract in the long run?
To determine the equilibrium price we look at the total quantity demanded schedule and the total quantity
supplied schedule (for the 1500 firms above) to find the price where quantity demanded equals quantity
supplied.

This occurs at the price of $46 where quantity demanded = 10,500 and quantity supplied = 10,500. The
quantity 10,500 is the equilibrium output for the industry. Note that at prices below $46 quantity
demanded exceeds quantity supplied and at prices above $46 quantity supplied exceeds quantity
demanded.
The equilibrium output for each firm is 7 units (= 10500 (industry output)/ 1500 (number of firms)).
Since the equilibrium price of $46 is below the average total cost for 7 units of output at the firm level
there will be a loss. The per-unit loss for the firm is -$1.14 (= $46 (price) - $47.14 (average total cost for 7
units)).
The loss per firm is -$7.98 (= 7 units produced) x (-$1.14) (loss per unit)).
This industry will contract due to the negative economic profit (or economic loss).

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