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Chapter 12: Problem 2

What is the relationship between a perfectly competitive firm's marginal cost curve and its supply curve?

Short Answer

Expert verified
In a perfectly competitive market, the firm's Marginal Cost (MC) curve, above its minimum, serves as the firm's supply curve, since the firm equates the market price to its marginal cost to maximize profit. However, this holds true only when the firm operates at an optimum scale and the market is perfectly competitive.

Step by step solution

01

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Firstly, understand the concept of Marginal Cost (MC). MC is the change in total cost that arises when the quantity produced changes by one unit. Mathematically, MC could be represented as \(MC = \Delta TC / \Delta Q\), which represents the ratio of change in total cost (\(\Delta TC\)) to change in quantity (\(\Delta Q\)).
02

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Next, get familiar with the principle of perfect competition. In a perfectly competitive market, firms are price-takers, i.e., each firm takes the market price as given. Hence, it equates its own marginal cost to the market price to maximize profit.
03

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Now, identify the connection between the MC curve and the firm's supply curve. The MC curve above its minimum point is the firm’s short-run supply curve in a perfectly competitive market. The portion of the MC curve that lies above the average variable cost (AVC) curve forms the supply curve of the perfectly competitive firm since the firm won't operate where price is less than average variable cost.
04

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Remember that this connection holds true only under certain circumstances. For the MC to serve as the supply curve, two conditions must be satisfied: (1) The market must be perfectly competitive & (2) The scale of operation of the firm should be optimum, i.e., the firm must be operating in conditions of ‘Equilibrium’ (MC=MR).

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Most popular questions from this chapter

(Related to Solved Problem 12.6 on page 439) Discuss the following statement: "In a perfectly competitive market, in the long run consumers benefit from reductions in costs, but firms don't." Don't firms also benefit from cost reductions because they are able to earn larger profits?

(Related to the Don't Let This Happen fo You on page 418 ) Explain whether you agree with the following remark: According to the model of perfectly competitive markets, the demand curve for wheat should be a horizontal line. But this can't be true: When the price of wheat rises, the quantity of wheat demanded falls, and when the price of wheat falls, the quantity of wheat demanded rises. Therefore, the demand curve for wheat is not a horizontal line.

What is a price taker? When are firms likely to be price takers?

How does perfect competition lead to allocative efficiency and productive efficiency?

An article in the Wall Street Journal discusses the visual effects industry, which is made up of firms that provide visual effects for films and television programs. The article noted, "Blockbusters ... often have thousands of visual effects shots. Even dramas and comedies today can include hundreds of them." But the article also noted that the firms producing the effects have not been very profitable. Some firms have declared bankruptcy, and the former general manager of one firm was quoted as saying, "A good year for us was a \(5 \%\) return." If demand for visual effects is so strong, why is it difficult for the firms that supply them to make an economic profit?
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