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Supply in a Competitive Market 8

Raising chickens in urban areas is a new trend among fans of locally produced food. Suppose Ty is an aspiring urban farmer and has to decide how many chickens to raise in his backyard. He might eat a few of the eggs and an occasional chicken himself, but he plans to sell most of his production at local markets. In essence, Ty is starting a firm, and he is facing the same production decisions any firm faces. How many chickens Ty raises isn’t going to noticeably affect the total supply of eggs or chicken in the market. Not only do tens of thousands of people raise chickens in their backyards, but there are also large farms that supply chickens to the market. How many chickens Ty raises is going to affect his profits, however. So, how should Ty—or any firm—make production decisions?

In Chapter 6 and Chapter 7, we learned how a firm chooses an input mix to minimize the cost of producing a particular amount of output and how this minimum cost changes with the output level. In this chapter, we start exploring how a firm chooses how much output to produce. In doing this, we move from talking about a firm’s cost-minimizing behavior to a discussion of how a firm chooses an output level to maximize its profits. This choice gives us the supply curves we learned about in Chapter 2 and Chapter 3.

Although all firms use knowledge of marginal revenue, marginal costs, and prices to guide their actions, profit-maximizing behavior is different for different types of firms. We begin the chapter by explaining the different types of market structures within which firms operate and what competition truly means. Most of this chapter focuses on perfect competition, a market (or industry) with many firms producing an identical product and no barriers to entry, and explores how firms behave in a perfectly competitive industry to maximize their profits.