Holt 7525-9 S15_IT

cost. The shutdown point occurs if price falls below average variable cost. By shutting down, a
firm limits its loss to its fixed costs.
The supply curve for a perfect competitor is the portion of the firm’s marginal cost curve that lies
above the shutdown point.
In the long run, economic profits or losses are eliminated (by firms entering or exiting the industry)
and price will be equal to minimum average total cost. If economic profits are available, new firms
will be attracted to the market. As new firms enter the market, market supply increases, and the
market price decreases. As long as the market price is above average total cost, economic profits
will be earned and new firms will continue to enter the market. If economic losses are occurring,
existing firms will be motivated to leave the market. As firms exit the market, market supply
decreases, and the market price increases. As long as the market price is below average total
cost, economic losses will occur and existing firms will continue to exit the market.
The economic efficiency rule is to produce the quantity of output where marginal social benefit
equals marginal social cost. Marginal social benefit is the benefit to society of the marginal unit of
output, and is generally measured by market price. Marginal social cost is the cost to society of
producing the marginal unit of output, and is generally measured by marginal cost.
Perfect competition is the ideal (most efficient) market structure because it results in the quantity
of output where price equals marginal cost and thus (assuming no externalities) where marginal
social benefit equals marginal social cost. By a happy coincidence, for a perfect competitor the
profit-maximizing quantity of output (where marginal revenue equals marginal cost) is also the
economically efficient quantity of output (where marginal social benefit equals marginal social
cost). This is why perfect competition is the ideal market structure.
Another advantage of perfect competition is that production and distribution decisions can be
made by individuals, not by central authority, since the goal of the firm (profit-maximization) and
the goal of society (economic efficiency) are both reached at the same quantity of output. This
maximizes individual freedom.
Questions for Chapter 21
Fill-in-the-blanks:
1. ______________________ ______________________ is the ability of a seller or a buyer to
affect market price.
2. ______________________ ______________________ is many sellers of identical
products.
3. ______________________ ______________________ is the ideal market structure.
4. A perfect competitor will face a demand curve for its product that is ____________________
at the market price.
5. ______________________ ______________________ is the change in total revenue from
selling one additional unit of output.
6. The shutdown point occurs if price falls below ______________________
______________________ cost.
7. The ______________________ ______________________ rule says produce the quantity
of output where marginal social benefit equals marginal social cost.
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Perfect Competition 21 - 10