Informal lecture notes.

Perfect Competition

  1. Many buyers and sellers
  2. Goods offered are the same (perfect substitutes)
  3. Free entry and exit for firms


Firms are price takers

Average Revenue = Marginal revenue equals price (\(AR=MR=P\))

Imperfect Competition

  • Oligopoly: The market has only a few suppliers, e.g. Internet Providers

  • Monopoly: The market has only one supplier, e.g. ICBC.

  • Entry Barriers: Some form of obstacle blocks potential competitors. The barrier may be due to:
    • First mover advantage (Airbnb)
    • Economies of scale (Boeing)
    • Network effect (Facebook)
    • Advertizing
    • Legal barriers

Profit maximization

We derive the profit maximizing quantity to produce from the firm’s costs.’ When the Marginal Revenue (MR) for a unit is larger than the Marginal Cost (MC) for that unit, then that unit should be produced.

Remember that MR = Price, because of perfect competition. One firm is too small to affect the market price. The firm is a price taker.

If \(P > MC\), then more units should be produced until \(P = MC\).


\[ Average\, revenue\, (AR)=\frac{TR}{Q}\]

\[ Marginal\, revenue\, (MR)= \frac{\Delta TR}{\Delta Q} \]

Under Perfect Competition

\[ Price = Average\, revenue = Marginal\, revenue \]

\[ P=AR=MR \]

At the margin

\[ \Pi = TR - TC\]

If \(MR>MC\), then producing one more would increase profit. Producing one more unit increases profit, because the cost of the next unit is lower than its revenue.

If \(MR<MC\), then producing one less would increase profit. Producing one less unit increases profit, because the cost of the last unit is higher than its revenue. That last unit should NOT have been produced.

Therefore, in order to maximize profit the firm must set:


Under Perfect competition


Business Breakeven Point

The firm will go in business if and only if price \(\geq\) Average costs:

\[ P \geq AC \]

Shutdown point

When the price is such that Price = Average variable cost = Marginal cost or

\[ P=AVC=MC \]

Thus, the firm will keep operating at a loss whenever the market price is such that

\[ P_{Breakeven}>P_{market}>P_{Shutdown}\]

The firm will shutdown when

\[ P_{market} < P_{Shutdown} \]

When $ P_{market} < P_{Shutdown} $, the firm is indifferent between shuting down and operating.

Long Run

In the long run we expect profits to be zero for all firms operating in the business.

\[ P=MC=AC \]