Takeaway

We have now answered the three questions with which we opened the chapter. What price to set? Answer: A firm in a competitive industry sets its price at the market price. What quantity to produce? Answer: To maximize profit, a competitive firm should produce the quantity that makes P = MC. When to exit and enter an industry? Answer: In the short run, the firm should shut down only if price is less than average variable cost. In the long run, the firm should enter if P > AC and exit if P < AC.

A competitive industry is one where the product being sold is similar across sellers; there are many buyers and sellers, each small relative to the total market; and/or there are many potential sellers.

We have also shown how profit maximization and entry and exit decisions are the foundation of supply curves. In an increasing cost industry, costs rise as more firms enter so supply curves are upward-sloping. In a constant cost industry, costs remain the same as firms enter so the long-run supply curve is flat. And in the rare case of a decreasing cost industry, costs fall as firms enter so supply curves are downward-sloping.