MICROECONOMICS: Theory &
Applications
Chapter 9: Profit Maximization in Perfectly
Competitive Markets
By
Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
10th Edition, Copyright 2009
PowerPoint prepared by Della L. Sue, Marist College
Learning Objectives




Outline the conditions that characterize perfect
competition.
Explain why it is appropriate to assume profit
maximization on the part of firms.
Show why the fact that a competitive firm is a price
taker implies that the demand curve facing the firm is
perfectly horizontal.
Explore a competitive firm’s optimal output choice in
the short run and how the firm’s short-run supply
curve may be derived through this output selection.
(continued)
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Learning Objectives
(continued)

Delineate how the short-run industry supply curve is
determined from individual firms’ short-run supply
curves.
 Define the conditions characterizing long-run
competitive equilibrium.
 Understand how the long-run industry supply curve
describes the relationship between price and industry
output over the long run, taking into account how
input prices may be affected by an industry’s
expansion/contraction.
 Analyze the extent to which the competitive market
model applies.
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Assumptions of Perfect Competition
Large numbers of buyers and sellers
 Free entry and exit
 Homogeneous products
 Perfect information

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Profit Maximization

ASSUMPTION: firms select an output level so
as to maximize profit, defined as the
difference between revenue and cost
 “Survivor Principle” – the observation that in
competitive markets, firms that do not
approximate profit-maximizing behavior fail,
and that survivors are those firms that,
intentionally or not, make the appropriate
profit-maximizing decisions.
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The Demand Curve Facing
The Competitive Firm
Price taker – a firm that takes prices as given
and does not expect its output decisions to
affect price
 Total revenue – price times the quantity sold
 Average revenue (AR) – total revenue divided
by output
 Marginal revenue (MR) – the change in total
revenue when there is a one-unit change in
output

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The Competitive Firm’s Demand
Curve
[Figure 9.1]
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Table 9.1
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Short-Run Profit Maximization

Total profit (π) – the
difference between
total revenue and
total cost

Figure 9.2
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Short-Run Profit Maximization Using
Per-unit Curves

Average profit per
unit (π/q) – total profit
divided by number of
units sold

Figure 9.3
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Operating at a Loss in the Short-Run
[Figure 9.4]
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The Perfectly Competitive Firm’s
Short-Run Supply Curve

Short-run firm supply curve –
a graph of the systematic
relationship between a
product’s price and a firm’s
most profitable output level

Shutdown point – the
minimum level of average
variable cost below which
the firm will cease operations

Figure 9.5
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Output Response to a Change in Input
Prices
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[Figure 9.6]
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The Short-Run Industry Supply Curve

Short-run industry supply
curve – the horizontal sum
of the individual firms’
marginal cost curves

Assumption – variable input
prices remain constant at all
levels of industry output

Figure 9.7
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Long-Run Competitive Equilibrium I

Zero economic profit – the
point at which total profit is
zero since price equals the
average cost of production;
“normal” economic return

Figure 9.8
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Long-Run Competitive Equilibrium II

Characteristics:
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The firm is maximizing profit and producing
where LMC=price.
There is no incentive for firms to enter or
leave the industry.
The combined quantity of output of all the
firms at the prevailing wage equals the total
quantity consumers wish to purchase at that
price.
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Long-Run Competitive Equilibrium
[Figure 9.9]
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Zero Profit When Firms’ Cost Curves
Differ?

When all firms in a competitive industry
have identical cost curves, each firm earns
zero economic profit in long-run equilibrium.
 What happens if cost curves differ among
firms?

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There is a tendency for factor inputs to receive
compensation equal to their opportunity costs.
This process leads to the zero-profit equilibrium.
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The Long-Run Industry Supply Curve
the long-run relationship between price
and industry output
 depends on whether input prices are
constant, increasing, or decreasing as
the industry expands or contracts

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The Long-Run Industry Supply Curve
[Three Classifications]
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Constant-cost industry: an industry in which
 expansion of output does not bid up input prices
 long-run average production cost per unit remains
unchanged, and
 the long-run industry supply curve is horizontal
Increasing-cost industry: an industry in which
 expansion of output leads to higher long-run average
production costs
 the long-run industry supply curve slopes upward
Decreasing-cost industry: an industry in which
 the long-run industry supply curve slopes downward
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Constant-Cost Industry
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[Figure 9.10]
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Increasing-Cost Industry
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[Figure 9.11]
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Decreasing-Cost Industry [Figure 9.12]
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Comments on the Long-Run
Supply Curve

The long-run supply curve is not derived by
summing the long-run marginal cost curves of an
industry’s firms.

A movement along the long-run industry supply
curve is accompanied with the assumptions that
conditions of supply remain constant, such as:
 Technology
 conditions of input supply factors
 government regulations
 weather conditions
(continued)
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Comments on the Long-Run
Supply Curve
(continued)

Although the industry may never attain a
long-run equilibrium in reality, what is
important is that there is a tendency for the
industry to move in the direction indicated by
the theory.

Economic profit is zero along a competitive
industry’s long-run supply curve.

In reality, the process of adjustment from a
short-run equilibrium to a long-run equilibrium
may vary from the theoretical description.
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When Does the Competitive
Model Apply?

The assumptions of perfect competition are
stringent and are likely to be satisfied fully in very
few real-world markets.

However, many market come close enough to
satisfying the assumptions of perfect competition to
make the model useful.

And it is useful to assess the effect of deviations
from the assumptions in a real-world market.
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The Mathematics Behind Perfect
Competition

First-order condition for finding the profitmaximizing output level: MC = P0
 Second-order condition: The slope of the
marginal cost curve must be positive.
 NOTE:
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Price is constant
No distinction is made between long-run and
short-run profit maximization
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