Short on time? This page is the recap. For explanations, graphs and worked examples, use the full study guide.
Recap
- Features: many small buyers and sellers, an identical product, no barriers to entry or exit, good information. No firm has market power.
- Each firm is a price taker: its demand curve is horizontal at the market price, so P = MR = AR = d.
- Profit is maximised where MC = MR = P, on the rising part of MC.
- Short run: price can be above minimum ATC (profit) or below it (loss). The firm keeps producing while P ≥ AVC.
- Long run: profit attracts entry (supply right, price falls); losses cause exit (supply left, price rises). This stops when P = minimum ATC and economic profit is zero.
- Prices as signals: the price tells buyers the marginal cost of production and tells sellers buyers’ marginal benefit, and gives both a reason to respond.
Key relationships
| Relationship | How to use it |
|---|---|
| Profit = (P − ATC) × q | Read ATC at the chosen q, not at its minimum |
| TR = P × q; TC = ATC × q | Profit = TR − TC |
| P = MC | Allocative efficiency (marginal benefit = marginal cost) |
| P = minimum ATC | Productive efficiency (efficient scale); long run only |
| Number of firms = Q ÷ q | Long run: market quantity at P = min ATC ÷ output per firm |
| Industry type | Long-run supply | Long-run price after demand rises |
|---|---|---|
| Constant cost | horizontal | unchanged |
| Increasing cost | upward-sloping | higher |
| Decreasing cost | downward-sloping | lower |
Assumptions behind the model
- Identical firms with the same cost curves; no barriers, so the number of firms can change in the long run.
- Efficiency conclusions assume no externalities (Unit 6).
Mistakes to avoid
- Drawing a downward-sloping demand curve for the firm.
- Choosing output where P − ATC is largest instead of where MC = MR.
- Measuring the profit rectangle at minimum ATC instead of at the chosen q.
- Saying entry raises each firm’s output (it falls; market output rises).
- Forgetting to draw the market and firm side by side with the same price.
- Claiming productive efficiency in the short run.
Quick self-check
- P = $14, q = 200 where MC = MR, ATC = $11. Profit? ((14 − 11) × 200 = $600 economic profit.)
- What happens in the long run? (Firms enter, supply shifts right, price falls to minimum ATC, profit falls to zero.)
- In an increasing-cost industry, demand rises permanently. Long-run price? (Higher than before, because each firm’s costs rise as the industry grows.)
Next: practice questions.