Overview
This lecture discusses economic profit and loss in perfectly competitive markets, focusing on how firms decide output levels and whether to enter, stay in, or exit the market.
Perfect Competition Basics
- Perfect competition is a theoretical ideal with no product differentiation and no barriers to entry or exit.
- All firms are price takers; they accept the market price as given.
- The market price is determined by the intersection of market supply and demand curves.
Firm Decision-Making: Output and Profit
- Firms decide how much to produce based on where marginal cost (MC) equals marginal revenue (MR), which is the market price.
- Producing units where MC exceeds MR is irrational, as costs would exceed revenue.
Economic Profit, Zero Profit, and Loss
- Economic profit is calculated as (Price - Average Total Cost) × Quantity produced.
- If a firm's price exceeds its average total cost (ATC) at optimal quantity, it earns positive economic profit.
- If price equals ATC, the firm earns zero economic profit.
- If ATC exceeds price, the firm incurs an economic loss.
Example Firms: A, B, and C
- Firm A: ATC below price; produces at MC=MR; earns positive economic profit.
- Firm B: ATC equals price; produces at MC=MR; earns zero economic profit.
- Firm C: ATC above price; produces at MC=MR; incurs an economic loss.
Short Run vs. Long Run Considerations
- In the short run, firms may stay in the market despite losses if they cover variable and some fixed costs.
- In the long run, firms unable to earn economic profit will exit the market.
Key Terms & Definitions
- Perfect competition — Market structure with many firms, identical products, and free entry/exit.
- Price taker — A firm that must accept the market price.
- Marginal cost (MC) — Cost of producing one more unit.
- Marginal revenue (MR) — Revenue from selling one more unit; equals market price in perfect competition.
- Average total cost (ATC) — Total cost divided by quantity produced.
- Economic profit — Profit after considering both explicit and implicit costs.
- Economic loss — Situation where costs exceed revenues.
Action Items / Next Steps
- Review the calculation of economic profit and loss.
- Understand the difference between short-run and long-run firm behavior in perfect competition.