C.  Profit Maximization and Competitive Supply

1.  Perfectly competitive markets

• Assumptions:

a.  Price taking

• Firms take the market price as given

• Large number of firms => each firm has a small share of the market => no control over the price

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b.  Product homogeneity

• Products produced by firms are identical or near identical

• Products are perfectly substitutable

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c. Free entry and exit

• No special costs to enter or exit the market

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2.  Profit maximization

• Assume goal of firm is to maximize profits

• Other possibilities are to maximize revenue, achieve revenue growth, or pay dividends to shareholders

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a.  Marginal analysis

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b.  Demand for a competitive firm

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• Profit maximizing condition for perfect competition

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3.  Perfect competition in the short run

a.  Profit maximization by a competitive firm

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b.  Shut down condition

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c.  Firm's short-run supply curve

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d.  Short-run market supply curve

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e.  Producer surplus in the short-run

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4.  Perfect competition in the long run

a.  Long run competitive equilibrium

• If there are short run profits or losses, firms will enter or exit the industry

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b.  Industry's long run supply curve

• How will the industry's supply be affected as the industry increases or decreases in size?

• Depends on the impact on input prices

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(1)  Constant-cost industry

• Costs do not change as the size of the industry increases

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(2)  Increasing-cost industry

• Costs increase as the size of the industry increases

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(3)  Decreasing-cost industry

• Costs decrease as the size of the industry decreases

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