Marginal revenue - price curve. Always below demand curve.

Demand is negatively sloped → elasticity will be negative → marginal revenue - price curve will be below demand curve.

Perfect competition

• Large number of buyers and sellers in the market.

• Sellers sell homogenous products. The products from two sellers are not distinguishable, and perfectly substitute each other.

• No entry or exit barrrier for buyers and sellers.

These features results in firms having no power to define market price. That is, the firms become price takers. The firms can sell as much as they want at that price.

Let $P$ be the market price. If the firms are price takers, then the demand curve ($P-Q$ graph) will be horizontal. It will also be exactly equal to the marginal revenue curve. (see this as $\text{MR}=\frac{d(\text{PQ})}{dQ}=P$).

Profit is maximised when $\text{MR}=\text{MC}$. But there are two intersection points of $\text{MR}$ and $\text{MC}$.

For the left equality (say at A, with price $Q_A$), it is not sensible to produce less than $Q_A$ because for each good produced before, the marginal cost is higher than the marginal revenue.

Total revenue is given by $P\times Q$, while total cost is given by $\text{AC}\cdot Q$.

We can see that the right equality is more profitable than the left equality (which incurs a loss), following the above calculation.

In this case, the firm earns extra profit. This causes an entry of new firms into the market. (If return to capital is $r$ and profit it $p$, then the extra profit is $p-r$).

If a firm incurs loss, they will exit the market. This happens if the average cost does not come below the price.

If the price, MC and AC intesects at the same point, then there is no extra profit (but there is the profit initially calculated). This situation is a true equilibrium, and the firm will not leave the market.

If the price is below the minimum of the average cost curve, the firm incurs loss and moves out of the market.

Supply curve is the marginal cost curve above the average cost curve.

For several firms we can take the summation of the supply curves for each firm, to get the market supply curve.