Goldwasser
AP Microeconomics
Name _______________
Module 22- Graphing Perfect Competition
Before You Read the Module:
Summary
This module shows how to evaluate perfectly competitive firms in different situations and determine their
profitability.
Module Objectives
Review these objectives before you read the module. Place a “y” on the line when you understand each of the
following:
___ Objective 1. How to evaluate a perfectly competitive firm's situation using a graph
___ Objective 2. How to determine a perfect competitor's profit or loss
___ Objective 3. How a firm decides whether to produce or shut down in the short run
While You Read the Module
Key Terms
Define these key terms as you read the module.
Break-even price
Shut-down price
Short-run individual supply curve
List questions or difficulties from your initial reading of the module.
While You Read the MODULE
Fill-in-the-Blanks
Fill in the table completing the following statements. Terms may be used more than once. If you find
yourself having difficulties) please refer to the reading.
(1)
(4)

(2)
(5)
(3)
(6)
Assume a firm is selling 100 units of output. If the market price is $10 and the firm's average total
cost is $8, the firm's profit per unit equals (1) ______ and its total profit equals (2) ______ .
 The minimum average total cost of a price-taking firm is called its (3) ______.
 Because it cannot be changed in the short run, a firm's (4) ______ cost is irrelevant to its decision
about whether to produce or shut down in the short run. A firm should shut down in the short run if
price is below (5) ______ . If the firm does not shut down in the short run, its individual supply
curve is equal to its (6) ______ curve.
Module Review
Graphing Perfect Competition
It is important that you are able to graph perfectly competitive firms, showing correctly drawn and
labeled cost curves (e.g., MC, ATC) and the P/MR/AR curve. You will have to show a perfectly
competitive firm's profit maximizing output level on the graph. And you need to be able to do this for
each of the possible short-run situations the firm may face. These include:
 earning a profit
 earning a normal profit
 incurring a loss (when the firm should shut down in the short run)
 incurring a loss (when the firm should continue to produce in the short run)
As you learn and practice these graphs (which you must do if you want to do well on the AP exam),
realize that you are really learning only one graph. Don't try to "memorize" the graph for each possible
case. Learn the basic graph and the one difference between the four situations.
To draw a graph of a perfectly competitive market, first correctly label your axes. Your vertical axis is
measuring costs and prices; the horizontal axis measures the firm's level of output. A perfectly
competitive firm is a price-taking producer, so the firm can sell as much as it would like at the market
price and the demand curve facing this individual firm is a horizontal line (perfectly elastic). As this
module explains, the fact that perfectly competitive firms are price takers means that MR = P. Get into
the habit of labeling the horizontal demand curve with all three labels so you always have the relevant
label on the graph. If you don't completely understand why MR = P = D and the line is horizontal,
review the module and make sure you fully get it before you go on! After drawing the demand curve, add
the MC curve, with its basic "swoosh" shape. Once you have MR and MC, you can find their intersection
and draw a line down to the horizontal axis to determine the profit-maximizing level of output. Label this
output. Once you find the profit-maximizing output, every value you find for the firm will be determined
at this output level. To determine which situation the firm is facing (profit, normal profit, loss), you will
need to know the total revenue and the total cost.
Remember, Profit = TR - TC Total revenue is TR = P x Q. Once you identify the profit maximizing
output, you know P and Q. Multiply these and you get the area of the rectangle under the demand curve
out to Q*. To find TC, (and therefore know which situation the firm is facing), you need to add the ATC
curve. Total cost is found by multiplying the average total cost (total cost per unit) by the number of
units produced. The only difference between the four situations the firm could face is where the ATC
curve is drawn. If, at the profit maximizing quantity, ATC is below price, the firm receives more from
selling its output than it costs the firm to produce the output and the firm earns a profit. If, at the optimal
quantity, price exactly equals ATC, the firm earns a normal profit. If, at the optimal quantity, the price the
firm receives is less than it costs to make each unit of output (that is, price is less than ATC), the firm
incurs a loss. The only difference between the graphs is whether the ATC curve is drawn above, below, or
equal to the price at the profit maximizing Q. Make sure the ATC curve is U-shaped and that MC crosses
at the minimum ATC (Review the previous modules if you don't remember why this must be true.) Then
draw it above price to show a loss, equal to price to show a normal profit, and below price to show a
profit. These different cases are shown on the graphs below. If you want to distinguish a loss, shut-down
situation from a loss, produce situation, add the AVC curve into your graph. Use the shut-down rule to
determine where AVC must be in each case. If you don't need to distinguish a situation in which the firm
wants to shut down in the short run from a situation in which the firm continues to produce at a loss in
the short run, you don't need the AVC curve on your graph!
So, you aren't trying to memorize four different graphs; you are learning one graph. The only difference
among the graphs is the relationship between the placement of the ATC curve and the price. Everything
else remains the same on every single perfect competition graph! And isn't learning only one graph so
much easier?

The profitability conditions for a perfectly competitive firm can be summarized as follows: When P >
minimum ATC:, the firm earns a positive economic profit in the short run and firms enter the
industry in the long run. When P = minimum ATC, the firm earns zero economic profit in the short
run and firms do not enter or exit the industry in the long run. When P < minimum ATC:, the firm
earns a negative economic profit in the short run and firms exit the industry in the long run.

The production conditions for a perfectly competitive firm can be summarized as follows: When P <
minimum Ave (the shut-down price), the firm shuts down production in the short run because it
cannot cover its variable cost of production. The firm's profit when it produces 0 units of output in
the short run is the negative of its fixed cost. When P > minimum Ave (the shut-down price), the firm
produces at the point which Me = MR in the short run. If P < minimum ATC but is still above the
minimum AVC, the firm is covering all of its variable cost and part of its fixed cost.