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Unit 10: Market Structure – Perfect Competition

Notes
Figure 10.3: Long Run Supply Curve: Decreasing Cost Industry

Price

S 1
S 2
P 1
E 1
P
E 2
LRS
P 2
D 2

D 1
Quantity
0 Q Q 1 Q 2

This is possible when the Marginal Revenue (MR) of the firm equals its short run Marginal Cost

(MC). As long as MR exceeds MC, it pays for the firm to expand output because by doing so the
firm would add more to its total revenue than to its total costs. On the other hand, as long as

MC exceeds MR, it pays for the firm to reduce output because by doing so the firm will reduce

its total cost more than its total revenue. Thus, the best level of output of any firm is the one at
which MR=MC.
!

Caution Since, a perfectly competitive firm faces a horizontal or infinitely, elastic demand
curve, P=MR, so that the condition for the best level of output can be restated as one of
which P=MR =MC. This can be seen in Figure 10.3 diagrammatically and with calculus as
follows.
A firm usually wants to produce the output that maximises its total profits. Total profits (T) are

Equal to Total Revenue (TR) minus Total Costs (TC). That is,
π = TR – TC .......... (1)
where TR And TC are all functions of output (Q).
Taking the first derivative of p with respect to Q and setting it equal to zero gives

(
(
dp dTR ) dTC )
= - = 0 .......... (2)
dQ dQ dQ
so that
(
(
dTR ) dTC )
= .......... (3)
dQ dQ
Equation (3) indicates that in order to maximise profi ts, a firm produces where Marginal Revenue

(MR) equals Marginal Cost (MC). Since for a perfectly competitive firm, P is constant and
TR = (P).(Q) so that
(
dTR )
= MR = P
dQ
The first order condition for profit maximisation for a perfectly competitive fi rm becomes

P = MR = MC.

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