1. Supply Curves and Marginal
Revenue
How perfectly-competitive firms
would set output.
If there are such firms.

2. The BIG ideas
• Perfectly competitive firms produce until
MU=MC.
• This is irrelevant because there are no perfectly
competitive firms. Monopolies produce where
MC=Marginal Revenue.
• At MU=MC, firms lose money on some output
because are not accounting for fixed inputs.
• Rational firms establish monopolies to raise
prices, reducing production until MC=MR.

3. Orthodox bottom line:
Supply Curves slope up and firms produce
where MU=MC
The punch line and the real story: It ain’t
necessarily so.
Price
Monopoly P
and Q
Perfect Competitive P
and Q
Output

4. Perfectly competitive firms ignore
their effect on market prices and
think only of marginal costs

5. Why do marginal costs rise?
1. Because of diminishing marginal productivity.
2. Because variable inputs have less and less
with which to work.
3. Because the MPL declines with additional
workers.
4. All of the above.

6. Perfectly competitive firms produce if
Price > or = Marginal Cost
they think they profit if produce at a marginal
cost less than the selling price.

7. At the PC Equilibrium:
1. Independence: market supply is the sum of
each individual firm’s output. Add it up.
2. Price leads firms to produce what consumers
want at that price.
3. More output comes with a higher price
(moving up the MC or PC Supply Curve).
4. Less output at lower price if consumer
demand declines (moving down the MC or
PC Supply Curve).

8. Output increases with higher prices along the
Supply Curve because at higher prices firms can
profit at higher MC

9. Firms profit on inframarginal output
Don’t produce!

10. In perfect competition, excessive profits
attracts new entrants to drive down prices
and profits

11. Perfect Competition is Impossible
1. Perfect competitors ignore “sunk costs”
2. They ignore the effect that increasing
production and sales has on the market price.
Perfectly competitive firms go bankrupt.

12. Compare Marginal Costs with Average
Total Costs
MC and Supply Curve:
Perfect Competition Loss
$8.00 between
ATC
P
$6.00 and
r Price
i $4.00
c
e
$2.00
$0.00
1 2 3 4 5 6 7 8 9 10
Quantity
MC Demand Pri ce Average total costs

13. To stay in business, firms must cover
marginal costs and fixed costs
They cannot do this if they are perfectly
competitive and sell at MC!
Our capitalist economy can only function
if firms are monopolies.
Right again

14. How would you price airline tickets?
How much do you think it costs an airline to fly
one more passenger from Boston to Paris?
1.Marginal cost (about $50)
2.Average cost (about $330)
3.$500 (about the price of a ticket)

15. A Boeing 747-400er

16. Perfectly competitive firms are myopic.
And dumb.
They ignore the effect that Firms sell their increased
increasing output has output by lowering
on the market price prices. Duh.
So the extra revenue they
get from selling more
must be discounted by
the lower prices they
now charge everyone
else.

17. Algebra
MR= P – Q * Δ P
Marginal revenue is the price you get for the
new sale minus the discount you give on all
your earlier sales.
Isn’t math fun?

18. Why MR < Price
Sales Demand TR Discount MR $30.00
1 $25.00 $25.00 $-00 $25.00
$25.00
2 $23.75 $47.50 $(1.25) $22.50
3 $22.56 $67.69 $(2.38) $20.19 $20.00
4 $21.43 $85.74 $(3.38) $18.05 $15.00
5 $20.36 $101.81 $(4.29) $16.08 Demand
$10.00
6 $19.34 $116.07 $(5.09) $14.25 MR
7 $18.38 $128.64 $(5.80) $12.57 $5.00
Discount
8 $17.46 $139.67 $(6.43) $11.03 $-00
9 $16.59 $149.27 $(6.98) $9.60 $(5.00)
1 3 5 7 9 11 13 15 17 19 21 23 25 27
10 $15.76 $157.56 $(7.46) $8.29
$(10.00)
11 $14.97 $164.65 $(7.88) $7.09
12 $14.22 $170.64 $(8.23) $5.99 $(15.00)
13 $13.51 $175.62 $(8.53) $4.98
14 $12.83 $179.67 $(8.78) $4.05 Selling more produces additional
15 $12.19 $182.88 $(8.98) $3.21
16 $11.58 $185.32 $(9.14) $2.44 revenue equal to the price. But
17 $11.00 $187.05 $(9.27) $1.74 from this additional revenue must
18 $10.45 $188.15 $(9.35) $1.10 be deducted the discount given to
19 $9.93 $188.68 $(9.41) $0.52
20 $9.43 $188.68 $(9.43) $-00
previous (inframarginal) buyers.
Marginal revenue is less than the
price of output by this discount.

19. That is why Marginal Revenue is less
than the selling price

20. If you sell on the demand curve, rather
than the MR curve, you lose profit
Monopoly and Perfect Competition
$8.00
$6.00
Mono P Perfect
r
poly i $4.00 competi
profit c tive loss
e
$2.00
$0.00
1 2 3 4 5 6 7 8 9 10
Quantity
MC Demand Average total costs MR

21. Smart businesses do not act like
perfect competitors
1. They collude and form monopolies.
2. They try to establish themselves as little
monopolies by differentiating their products.
3. Brand names, frequent-buyer
programs, credit arrangements, technical
restrictions are ways that firms lock you in as
customers.

22. Only monopolies can survive
Sell on the demand curve and price
at MC and you do not recoup your
fixed costs.
You lose money.
Unless you form a monopoly or cartel
to control prices.

23. Take-away points
• Perfectly competitive firms produce until
MU=MC.
• Competitive firms lose money on some of their
output because they have driven down prices.
• Competitive firms go bankrupt because they do
not cover their fixed costs.
• Rational firms form monopolies to raise prices
by reducing production until MC=MR.