Topic 14
The supply curve shows the quantities of a good or service that potential suppliers are willing
and able to supply. In this topic, we apply the tools developed in the previous unit to explain
the behaviour of firms in a perfectly competitive market and to derive the supply curve.
Perfect competition
Requirements
• large number of buyers
• large number of sellers
• no collusion between sellers
• homogeneous goods.
• buyers and sellers have complete freedom of entry and exit
• buyers and sellers have perfect knowledge
• no government intervention.
• factors of production are perfectly mobile
Some more formulas
Total revenue
The income brought into the firm from selling its products.
𝑇𝑅 𝑃 𝑄
Average revenue
The revenue generated per unit sold.
𝑇𝑅
𝐴𝑅
𝑄
Marginal revenue
The increase in total revenue that results from the sale of one additional unit.
∆𝑇𝑅
𝑀𝑅
∆𝑄
and
𝑃 𝑀𝑅 𝐴𝑅
Profit maximisation
𝑀𝑅 𝑀𝐶
If
𝑀𝑅 𝑀𝐶
profit can be increased by increasing production
If
𝑀𝑅 𝑀𝐶
TR declines and profit can be increased by decreasing production.
Profit position of the firm
Normal profit
𝑃 𝑀𝐶
and
𝐴𝑅 𝑃 𝐴𝐶
Economic profit
𝑃 𝑀𝐶
and
𝐴𝑅 𝑃 𝐴𝐶
Economic loss
𝑃 𝑀𝐶
and
𝐴𝑅 𝑃 𝐴𝐶
Shutdown point
If
𝑃 𝐴𝑅 𝐴𝑉𝐶
keep on producing – part of fixed cost is covered
If
𝑃 𝐴𝑅 𝐴𝑉𝐶
shutdown – no point in keeping the firm going
If
𝑃 𝐴𝑅 𝐴𝑉𝐶
shutdown point – firm has to decide whether to keep on producing or shutdown
Breakeven point
If
𝑃 𝐴𝑅 𝑀𝑅 𝐴𝐶
normal profit
Supply curve of firm
The rising part of the firm’s MC curve above the minimum of AVC.
Long-run equilibrium
If economic profit, firms enter the market, supply curve shifts rightward, excess supply,
competition amongst sellers force the price down (until Qd = Qs).
If economic loss, firms leave the market, supply curve shifts leftward, excess demand,
competition amongst buyers force the price up (until Qd = Qs).
If normal profit, no incentive for firm to enter or leave market, Qd = Qs, market (and firm)
in equilibrium.
Imperfect competition
Perfect Monopoly Monopolistic Oligopoly
competition competition
Freedom of Easy Barriers to Easy Difficult
entry entry
Other Many None Less than Few
competitors perfect
competition
Characteristics Homogenous Unique Differentiated Differentiated and
of product unique
Price setting Price taker Price setter Limited price Limited price setting
setting
Interdependence None None None Between firms