The Graphs

Short-run Behavior of the Representative Firm

We can now look at the graphical treatment of optimal output choice for the perfectly competitive firm. We will examine the situation using both the total and marginal approaches. 

Short-run: Total Relationships

What is distinctive about the graphical representation of the firm in a perfectly competitive environment is the Total Revenue line. The Total Cost line is the same as we saw earlier, but the Total Revenue line is linear. The straight line is the visual representation of the assumption that price will be unaffected by the level of output. Every time the seller increase output by one unit, revenue increases by the price which does not change.

Short-run: Average and Marginal Relationships

We can also look at the situation using the average and marginal curves. The distinctive feature here is the horizontal marginal revenue (MR) curve is the same as the average revenue (AR) curve, which is also equal to the price. The optimal choice of the firm is the level of output where MR = MC which occurs at the intersection of the MC and MR lines. This firm, if it were attempting to maximize profit, would operate at an output level of something above 40 points.

Long-run Behavior of the Representative Firm

At the optimal level of output in the short-run, we find P > AC ($1 > $.5) which means there is a profit being made by the firms in the industry. What happen next in a competitive industry is that new firms move in which increases supply and lowers price. This entry will continue until the price is driven down to the point that economic profit disappears. We can see that in the following diagrams.  

Long-run: Total Relationships

The Total Cost line is the same as we saw earlier, but the Total Revenue line remains linear with a lower slope. The straight line is the visual representation of the assumption that price will be unaffected by the level of output. Every time the seller increase output by one unit, revenue increases by the price which does not change. Here, however, the price is lower so the increase in revenue from selling one more unit of output will be lower.  Because MR is just the slope of the TR curve and because MR equals the price which is now lower, then the slope has fallen.  What we see here is that the only time where costs do not exceed revenues are where the two curves touch each other.

Long-run: Average and Marginal Relationships

We can also look at the situation using the average and marginal curves. Once again the distinctive feature here is the horizontal marginal revenue (MR) curve that is the same as the average revenue (AR) curve and is also equal to the price. The optimal choice of the firm is the level of output where MR = MC which occurs at the intersection of the MC and MR lines. This firm, if it were attempting to maximize profit, would operate at an output level of something above 40 points. 

The difference between the short- and long-run solutions is that in the long-run the MR = P line has been lowered to reflect the impact of additional suppliers on the market price.  The intersection of the MR and the MC curves occurs at the minimum point of the AC curve.  This gives us the additional equilibrium condition of P = AC so that profit is zero.  You see this in the profit diagram below.  At each level of output profit is higher in the short-run and in the long-run maximum profit occurs when profit is zero.

Profit: The Short and Long Run