Summary

1. An industry’s market structure is characterized by the number of firms in the industry, the type of product sold, and the degree of barriers to entry. Given these criteria, there are four different types of market structures in an economy: perfect competition, monopolistic competition, oligopoly, and monopoly. Perfectly competitive industries feature a large number of firms selling identical products and have no barriers to entry. As a result of such characteristics, these firms are price takers, facing horizontal demand curves equal to their marginal revenue curves. [Section 8.1]

2. A firm aims to maximize its profits, the difference between its total revenue and its total costs. A perfectly competitive firm produces its profit-maximizing output when its marginal cost equals the market price. For a perfectly competitive firm, the market price also equals its marginal revenue. [Section 8.2]

3. Because firms will operate in the short run only when price is greater than or equal to the firm’s average variable costs, a firm’s short-run supply curve is the portion of its marginal cost curve at or above the average variable cost curve. For all prices below that, the firm’s supply curve is vertical at the y-axis because quantity produced equals zero. [Section 8.3]

4. The industry supply curve is the horizontal sum of individual firms’ supply curves; that is, the industry quantity supplied at any given price equals the sum of firms’ quantities supplied at that price. Like a firm’s supply curve, the industry supply curve generally slopes upward because of two factors. First, individual firms produce more as market prices rise; second, the quantity supplied by the industry will increase as firms operating with higher costs begin supplying at higher prices. [Section 8.3]

5. A firm’s producer surplus equals its total revenue minus its variable cost, while a firm’s profit is its total revenue minus its total cost. Graphically, the firm’s and industry’s producer surplus is the area below the market price but above the firm’s or industry’s short-run supply curve. [Section 8.4]

6. When a perfectly competitive industry is in long-run competitive equilibrium, firms earn zero economic profits. This is because perfectly competitive industries have no barriers to entry: Firms have free entry and free exit into and out of the industry, and will choose to enter or exit an industry when it is profitable to do so. Over time, changes in demand or in costs will change the long-run equilibrium quantity supplied. For constant-cost industries, the long-run supply curve is horizontal, while increasing-cost industries and decreasing-cost industries have upward- and downward-sloping supply curves, respectively. [Section 8.4]

7. While a perfectly competitive firm earns zero economic profits in the long run, it can earn positive economic rents. A firm earns positive rents when its costs are lower relative to those of other firms in the industry. [Section 8.5]