KRUGMAN'SMICROECONOMICS for AP*

Graphing Perfect Competition

Margaret Ray and David Anderson

Micro:

Econ:

23

59

Module

What you will learnin this Module:• How to evaluate a perfectly

competitive firm’s situation using a graph.

• How to determine a perfect competitor’s profit or loss.

• How a firm decides whether to produce or shut down in the short run.

Perfect Competition Graphs

How is this perfectly competitive firm doing? Is it earning a profit or a loss?

MC

ATC

P=D

Perfect Competition Graphs• Profit maximizing

output = 5

• Profit per unit is ($8 - $6) = $2

• Profit is profit per unit times the number of units. $2 x 5 = $10

MC

ATC

P=D

Perfect Competition Graphs

A firm earning a profit.

MC

ATC

P=D

Perfect Competition Graphs

A firm experiencing a loss.

ATC

ATCP

Q*

MC

P=MR=d=AR

$

Output

Loss

Perfect Competition Graphs

A firm earning a

normal profit.

ATC

P=ATC

Q*

MC

P=MR=d=AR

$

Output

The Short-run Production Decision

• When a firm is earning negative profits (a loss), will it continue to produce in the short run?

• Compare the losses from producing at P = MC with the losses from shutting down (producing 0)

• The shut-down rule

• Shut down iff;

• TR < TVC

• P < AVC

Perfect Competition Graphs

The shut-down price

ATC

P=ATC

Q*

MC

P=MR=d=AR

$

Output

Shut-down Price

A

AVC

The Long Run

• When a firm is earning negative profits (a loss), in the long run, it will exit the industry.