Table 59.1 summarizes the perfectly competitive firm’s profitability and production
conditions. It also relates them to entry into and exit from the industry in the long run.
Now that we understand how a perfectly competitive firmmakes its decisions, we can
go on to look at the supply curve for a perfectly competitive marketand the long-run
equilibrium in perfect competition.596 section 11 Market Structures: Perfect Competition and Monopoly
Summary of the Perfectly Competitive Firm’s Profitability and Production Conditions
Profitability condition
(minimumATC=break - even price) Result
P>minimumATC Firm profitable. Entry into industry in the long run.
P=minimumATC Firm breaks even. No entry into or exit from industry in
the long run.
P<minimumATC Firm unprofitable. Exit from industry in the long run.
Production condition
(minimumAVC=shut - down price) Result
P>minimumAVC Firm produces in the short run. If P<minimumATC,
firm covers variable cost and some but not all of fixed
cost. If P>minimumATC,firm covers all variable cost
and fixed cost.
P=minimumAVC Firm indifferent between producing in the short run or
not. Just covers variable cost.
P<minimumAVC Firm shuts down in the short run. Does not cover
variable cost.table59.1
Prices Are Up... but So Are Costs
In 2005 Congress passed the Energy Policy Act,
mandating that by the year 2012, 7.5 billion
gallons of alternative fuel—mostly corn-based
ethanol—be added to the American fuel supply
with the goal of reducing gasoline consumption.
The unsurprising result of this mandate: the de-
mand for corn skyrocketed, along with its price.
In spring 2007, the price of corn was 50%
higher than it had been a year earlier.
This development caught the eye of Ameri-
can farmers like Ronnie Gerik of Aquilla, Texas,
who, in response to surging corn prices, re-
duced the size of his cotton crop and increased
his corn acreage by 40%. He was not alone;
within a year, the amount of U.S. acreage
planted in corn increased by 15%.
Although this sounds like a sure way to make
a profit, Gerik was actually taking a big gamble:
even though the price of corn increased, so did
the cost of the raw materials needed to grow
it—by 20%. Consider the cost of just two inputs:fertilizer and fuel. Corn requires more fertilizer
than other crops and, with more farmers plant-
ing corn, the increased demand for fertilizer led
to a price increase. Corn also has to be trans-
ported farther away from the farm than cotton;
at the same time that Gerik began shifting to
greater corn production, diesel fuel became very
expensive. Moreover, corn is much more sensi-
tive to the amount of rainfall than a crop like cot-
ton. So farmers who plant corn in drought-prone
places like Texas are increasing their risk of loss.
Gerik had to incorporate into his calculations his
best guess of what a dry spell would cost him.
Despite all of this, what Gerik did made com-
plete economic sense. By planting more corn,
he was moving up his individual short-run sup-
ply curve for corn production. And because his
individual supply curve is his marginal cost
curve, his costs also went up because he had to
use more inputs—inputs that had become more
expensive to obtain.fyi
So the moral of this story is that farmers will
increase their corn acreage until the marginal
cost of producing corn is approximately equal to
the market price of corn—which shouldn’t
come as a surprise because corn production
satisfies all the requirements of a perfectly
competitive industry.Courtesy of Ronnie Gerik.
Although Gerik was taking a big gamble when
he cut the size of his cotton crop to plant more
corn, his decision made good economic sense.