If you're seeing this message, it means we're having trouble loading external resources on our website.

If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked.

Main content
Current time:0:00Total duration:8:14
AP.MICRO:
PRD‑3 (EU)
,
PRD‑3.A (LO)
,
PRD‑3.A.1 (EK)
,
PRD‑3.A.3 (EK)
,
PRD‑3.A.4 (EK)

Video transcript

in this video we're going to dig a little bit deeper into the notion of perfectly competitive market so we're think about under what scenarios a firm would make an economic profit or an economic loss in them now as a reminder these perfectly competitive markets are something of a theoretical ideal there's a few markets in the real world that are truly perfectly competitive some might get close but most markets are someplace in a spectrum between perfectly competitive and at the other extreme say something like a monopoly but here we're talking about perfect competition and perfect competition the firm's products aren't differentiated there's no barriers to entry or exit and so in that situation the market supply and demand curves are going to define the price in the market which are also reading to find the marginal revenue for these firms they're all going to be price takers they're gonna be passive in terms of price whatever the market price is that's the price that they are going to sell their products for and their decision is really what quantity does to produce and sell and whether to enter or exit the market so let's look at that a little bit so these are just your classic and supply demand curve supply and demand curves you might see for a market the first few units in the market there's a huge marginal benefit so people are willing to pay a lot but then each incremental unit the marginal benefits a little bit lower and lower and lower and lower and that's what we have those that downward sloping demand curve and then on the supply curve the first unit in the market might be fairly inexpensive to produce but then the marginal cost gets higher and higher and higher and where they meet where the supply and demand meet that tells us the equilibrium price in equilibrium quantity in the market and we can show that with that line and let's just say that equilibrium price is $10 and as I just mentioned that's going to have to be the price that all of the firm's and these might not be all of the firm's in the market but all of the firms in the market if we're talking about a perfectly competitive market would just have to take that price so given that what what quantity what firms a B and C produce and which which of these firms would be profitable or not I encourage you to pause the video and think about those two questions if you could just which of these firms would be profitable or not and we're talking about economic profit in this context all right well let's look at firm a first well firm a for any of them it is not rational to produce a quantity where the marginal cost is higher than the marginal revenue that the firm's getting and remember this line right over here this line right here which is the price line that's also that is price which is equal to marginal revenue and so for that extra unit if you're if you can't sell it for more than you're producing then you wouldn't you wouldn't produce an extra unit so it's rational for them to produce more and more and more the marginal cost goes higher and higher until right at the point that marginal cost is equal to marginal revenue which is equal to price the market price which they're just going to take so it's rational for this firm to produce this quantity right over here so I'll just go to quantity I'll say quantity for that firm now is this firm I'm going to be profitable or not well this quantity what's its average total cost well its average total cost is right over there and so for every unit it's going to make this difference between the price or the marginal revenue it's getting and it's average total cost and so one way to think about the profit of this firm is and we're talking with economic profit it's going to be the area of this rectangle right over here so let's say if the average total cost at that quantity is let's say that this is $8 then this height of the rectangle is 10 minus 8 the height right over here let me do this in a different color this height right over here is $2 and then the width is going to be the quantity of that firm and so let's say the quantity of that firm let's say it's 10,000 units a year 10,000 10,000 units per year and so the area right over here would be $2 times 10,000 it would be $20,000 $20,000 per time unit for time unit if we're talking all of this to say per year now let's go to firm be using that same analysis is firm be making an economic profit or is it not making an economic profit well firm B is once again going to be a price taker and so the price right over here the equilibrium price in the market is going to be equal to the price that that firm has to take which is going to be its marginal revenue curve and that's why it's a flat marginal revenue curve because no matter what quantity they produce they're gonna get that same price and it wouldn't be rational for them to produce a quantity where marginal cost is higher than marginal revenue and so they would produce right over there now what is their economic profit at this quantity so this is quantity of the first second firm firm B all right like that maybe that is firm a and maybe this is also it looks about the same I'll make them a little bit different let's say that's the nine thousand five hundred units per time period well here the average total cost at that quantity is equal to the marginal cost so which is equal to the marginal revenue so at that quantity whatever that ten dollars are getting per unit they're also spending on average ten dollars per unit another way to think about the area of that rectangle is going to be zero because it has no height so this this situation right over here the firm has zero zero economic all right zero dollars of economic profit and then last but not least let's think about firm C pause this video and think about what its economic profit would be well like we've seen it would be rational for it to produce the quantity where marginal cost is equal to marginal revenue which is equal to the market price so it would produce this quantity right over here and let's say that that quantity is nine thousand units and what's its average total cost then so at nine thousand units its average total cost let's say that that is $12 right over there so what's its economic profit so for every unit its selling its ten dollars and it's costing 12 dollars on average to produce it so it's taking an economic loss of two dollars per unit so two dollars per unit so this height right over here is two dollars times the units times 9000 you're going to have two times 9000 you're going to have an $18,000 not economic profit but economic economic loss now one thing to think about is why would any firm be in this situation well it's important to think about things in the short run versus the long run in the short run we've talked about this analysis right over here where a firm can decide what quantity it would produce that is rational it's fixed costs are fixed in the short-run we've done that study that in multiple videos but in the long run it's fixed costs aren't fixed and so the firm could decide to enter or exit the market and so so for our MC while they've already put in those fixed costs it is actually rational for them to do it because they're actually able to make their the the marginal revenue they get up to that quantity it's at least they're able to more than cover their marginal costs and then they're able to eat up or I guess you could say take care of some of their fixed costs but they're still not able to run an economic profit so in the long run it wouldn't be rational for this firm to stay in the market they would likely exit the market
AP® is a registered trademark of the College Board, which has not reviewed this resource.