EC211 · LESSON 07 / 08

7. Competition and market power

A price-taking firm sells at the market price. Even with a loss today, operating can sometimes lose less than shutting down.

Understand

What is this lesson explaining?

Perfect competition has many buyers and sellers of identical products, with each firm too small to affect price. Thus marginal revenue MR equals P. Choose output to maximize TR−TC, not sales.

An interior solution typically has P = MC on increasing MC, but compare it with Q = 0. When fixed cost is unavoidable over the horizon, operate if revenue can cover VC and shut down if P is below minimum AVC. A reported loss alone does not settle the decision.

KEY MODEL

π = PQ − TC

interior candidate:P = MR = MC

operate at Q > 0 only if PQ − VC ≥ 0 there

MRRevenue from another output unitπEconomic profitShutdownTemporarily producing Q = 0

See it on a graph

The graph is right here

Read the axes and original point first. Then change one value at a time and watch the curve or point move.

KEY MODEL

TC=100+2Q+Q²

MC=2+2Q

P=12

E₀=E₁ : Q=5, P, Cost=12

MCAVCATCP₀=MR₀P₁=MR₁

Change market price: 12 money units

P=MC gives Q=5. At this point P covers AVC=7, so the firm operates in the short run. Profit may remain negative after FC=100.

Blue dashed: original · Solid: new state · E₀/A: original point · E₁/B: new point. Coincident points share a label; use the explanation to read each result.

A curve shifts when one of its non-axis conditions changes. An adjusting point on a fixed curve is movement along that curve, not a shift of it.

Quick check

NO TYPING

In the same example, if P = 1, should the firm operate today?

Takeaway

Remember these two ideas

✓

P = 12 and MC = 2 + 2Q give Q = 5. Revenue is 60, VC = 10 + 25 = 35, TC = 135, and profit is −75.

Common mix-upP < ATC does not always imply immediate shutdown; compare avoidable costs.

Assumptions and sources

Example TC = 100 + 2Q + Q², with 100 unavoidable today and divisible Q. If some fixed costs are avoidable, include them in the operating comparison.

Pindyck & Rubinfeld, Microeconomics, 9th Global Edition, ch. 8, pp. 299–300, 311–312 (PDF 301–302, 313–314); original examples and questions.