A Second Look at Firm Behavior Under Perfect Competition

Abstract

Assume a profit-maximizing firm.

• 1. Assume that the firm supplies a strictly positive and finite quantity. Then, the rule “marginal revenues = marginal costs” holds in the optimum.

• 2. A firm in perfect competition always supplies according the rule “price = marginal costs” if the resulting revenues at least cover the average variable costs.

• 3. The firm will never make losses in its optimum because it can avoid these by leaving the market.

• 4. In the long-run market equilibrium with free market entry and exit, a firm’s producer surplus is always equal to zero.

Assume a profit-maximizing firm with a cost function of $C(y)=y^{2}+49$ in a market with perfect competition.

• 1. The average costs of this firm are equal to the marginal costs at the minimum of the average cost curve.

• 2. The average variable costs are $AVC(y)=2y+\frac{49}{y}$.

• 3. Assume that the firm only produces with one factor (labor), l. The wages are w = 4. That means that the production function of the firm is $y=4\cdot l^{\frac{1}{2}}$.

• 4. In the long-run market equilibrium with perfect competition and with free market entry and exit, the equilibrium price is p = 14.