• The assumed objective of the firm is to maximize its economic profit. Competitive pressures in the marketplace may render this a plausible assumption, even though it seems to impute an unrealistically high degree of purposefulness to the actions of many managers. Economic profit is the difference between total revenue and cost—both explicit and implicit—of all resources used in production. Economic profit is not to be confused with accounting profit, which is the difference between total revenue and the explicit cost of resources used.
• The economic model of perfect competition assumes a standardized product, price-taking behavior on the part of the firms, perfect mobility of resources, and perfect information on the part of buyers and firms. In this sense, it is similar to the physicist's model of motion on frictionless surfaces. Both models describe idealized conditions that are rarely if ever met in practice, and yet each generates useful predictions and explanations of events we observe in the world.
• The rule for profit maximization in the short run is to produce the level of output for which price is equal to short-run marginal cost on the rising portion of that curve. If price falls below the minimum value of average variable cost, the firm does best to produce no output in the short run. The individual firm's short-run supply curve is thus the rising portion of its short-run marginal cost curve that lies above the minimum point of its average variable cost curve.
• The short-run industry supply curve is the horizontal summation of the individual firms' supply curves. It intersects the industry demand curve to determine the short-run equilibrium price. The individual competitive firm's demand curve is a horizontal line at the equilibrium price. If that price happens to lie above the minimum value of the longrun average cost curve, each firm will earn positive economic profit. If price is less than that value, each will suffer economic losses.
• Long-run adjustments consist not only of alterations in the size of existing firms' capital stocks, but also of entry and exit of firms. Where firms have identical U-shaped LAC curves, the long-run equilibrium price will be the minimum value of that LAC curve, and each firm will produce the corresponding quantity.
• Both long-run and short-run equilibrium positions are efficient in the sense that the value of the resources used in making the last unit of output is exactly equal to the value of that output to the buyer. This means that the equilibrium position exhausts all possibilities for mutually beneficial exchange. The long-run equilibrium has two additional attractive features: (1) Output is produced at the lowest possible unit cost, and (2) the seller is paid only the cost of producing the product. No economic profit is extracted from the buyer.
• Under perfect competition with constant input prices, the long-run industry supply curve is a horizontal line, not only when LAC curves are horizontal, but also when they are U-shaped. When input prices are an increasing function of industry output, the industry supply curves in both cases will be upward sloping. When input prices decline with industry output, the competitive industry supply curve will be downward sloping.
• The effect of competition for the purchase of unusually high quality inputs is to raise the price of those inputs until they no longer enable the firm that employs them to earn an economic profit. This is an extremely important part of the long-run adjustment process, and failure to account for it lies behind the failure of many well-intended economic policies.
• Even price-taking firms must actively seek out means of reducing their costs of doing business. To the early adopters of cost-saving innovations goes a temporary stream of economic profit, while late adopters must suffer through periods of economic losses.
