Perfect Competition and Firm Supply: every key term you need (+ practice quiz)
25 flashcard terms for Intermediate Microeconomics Topic 6, written to match the course framework. Study them here, then drill them as interactive flashcards, or test yourself with the 15-question quiz — free, no account needed.
Acting as though the market price is fixed regardless of one's own output. It is an approximation justified when each seller is tiny relative to the market and products are undifferentiated.
Conditions for perfect competition
Many small buyers and sellers, a homogeneous product, full information and free entry and exit. Together they make the individual firm face a horizontal demand curve at the market price.
Firm demand curve under competition
A horizontal line at the market price, because any attempt to charge more loses every customer and charging less is needlessly wasteful when all output sells at the going price.
Total revenue for a competitive firm
Price multiplied by quantity, growing linearly in output since price does not fall as the firm expands. This linearity is what makes marginal revenue equal price.
Marginal revenue
The change in total revenue from selling one more unit. Under price taking it equals the market price, whereas any firm facing a downward-sloping demand curve sees it fall below price.
Profit maximisation rule
Produce where marginal revenue equals marginal cost, provided marginal cost is rising there. Below that output an extra unit adds more revenue than cost; above it the reverse holds.
Second-order condition for output choice
Marginal cost must cut marginal revenue from below at the chosen quantity. An intersection on a falling stretch of marginal cost identifies a profit minimum rather than a maximum.
Shutdown rule in the short run
Operate only if price covers average variable cost, since fixed costs are paid either way. Below that threshold every unit produced deepens the loss beyond the unavoidable fixed component.
Short-run firm supply curve
The rising portion of marginal cost lying above average variable cost, with zero output below the shutdown price. It answers how much the firm offers at each conceivable price.
Exit rule in the long run
Leave the industry if price falls short of long-run average cost, because in the long run every input is variable and no cost is unavoidable.
Short-run market supply
The horizontal sum of the supply curves of a fixed number of firms. Its slope reflects rising marginal cost, since the number of producers cannot change.
Long-run market supply
The relationship between price and quantity once entry and exit have run their course. With identical firms and free entry it is horizontal at minimum long-run average cost.
Zero economic profit condition
Free entry drives price down to minimum average cost, so surviving firms earn only the normal return that keeps resources in the industry. Accounting profit may still be positive.
Economic profit versus accounting profit
Economic profit deducts the opportunity cost of owner-supplied capital and labour as well as explicit outlays. Zero economic profit therefore means a perfectly adequate return, not failure.
Entry and the profit signal
Positive economic profit attracts new firms, expanding supply and lowering price until profit vanishes. Losses trigger the reverse process, which is how the market reallocates resources.
Constant cost industry
An industry whose input prices do not change as it expands, giving a horizontal long-run supply curve. Entry replicates existing firms without bidding up factor costs.
Increasing cost industry
One where expansion raises input prices, perhaps through a scarce specialised factor, producing an upward-sloping long-run supply curve even with free entry.
Economic rent
Payment to a factor above the minimum needed to keep it in its current use. It arises when a factor is in fixed supply and is absorbed into land values or licence prices.
Producer surplus
The area between price and the marginal cost curve up to the quantity supplied, equal to revenue minus variable cost. It measures the short-run gain from trade accruing to sellers.
Competitive market equilibrium
The price at which quantity demanded equals quantity supplied, so no participant has an incentive to change behaviour given the price. It is a rest point, not necessarily a fair outcome.
Allocative efficiency of competition
In equilibrium price equals marginal cost, so the value buyers place on the last unit equals its resource cost. No reallocation could raise total surplus.
Comparative statics of a demand shift
An outward shift of demand raises price and quantity in the short run, then attracts entry that lowers price back toward minimum average cost in a constant cost industry.
Incidence of a per-unit tax
The division of a tax burden between buyers and sellers, determined by relative elasticities. The more inelastic side absorbs more, since it has fewer alternatives to escape to.
Elasticity and tax burden
If supply is perfectly elastic buyers bear the whole tax, and if demand is perfectly inelastic buyers again bear it all. Legal liability for remitting the tax is irrelevant to who really pays.
Price ceiling effects
A binding maximum price below equilibrium creates excess demand, rationing by queue or favouritism, and destroys surplus on the trades that no longer occur.