Question

Millions of “apps” have been created for smartphones and tablets. Most of these
apps are the work of individuals in intense competition with each other. No single
app writer can influence the price of an app, but each can and must decide how
much to work and how many apps to produce.
Examine how a firm (an app’s creator) maximizes profit in a perfect competition
market.

Answer 1

In perfect competition, each firm is too small to influence market price. So, they are price takers and accept the market-determined price as their relevant price. Each firm maximizes profit (or minimizes loss) by equating price with its marginal cost (MC).

For price taker firms, demand curve is horizontal and price equals marginal revenue (MR). Therefore, profit is maximized (loss is minimized) when

P = MR = MC.

If P > MC, the firm makes a marginal profit (= P - MC) which can be increased and maximized by increasing output until P = MC. If P < MC, the firm makes a marginal loss (= MC - P) which can be decreased and minimized by decreasing output until P = MC. If, at the point where P = MR = MC, the firm's ATC is lower that its price, firm earns positive economic profit. If, at the point where P = MR = MC, the firm's ATC is higher that its price, firm incurs negative economic profit (loss). If, at the point where P = MR = MC, the firm's ATC is equal to its price, firm earns zero economic profit.