Class 12 Economics Notes
Chapter 4: The Theory of the Firm under Perfect Competition
1. Perfect Competition
Meaning
Perfect competition is a market where many buyers and sellers trade an identical product, and no individual buyer or seller can influence the market price.
Features
- Large number of buyers and sellers
- Homogeneous (identical) product
- Free entry and exit of firms
- Perfect information
- Firms are price takers
Remember:
Firm accepts the market price.
It cannot charge a higher or lower price.
2. Price Taker
A price-taking firm has no control over price.
If it charges:
- Higher price → No customers
- Lower price → Unnecessary loss
Therefore,
Selling Price = Market Price
3. Revenue
Revenue means money earned from selling goods.
(A) Total Revenue (TR)
Formula
TR = Price × Quantity
Example
Price = ₹20
Quantity = 5
TR = 20 × 5 = ₹100
(B) Average Revenue (AR)
Revenue earned per unit.
Formula
AR = TR ÷ Quantity
Under perfect competition
AR = Price
(C) Marginal Revenue (MR)
Extra revenue earned by selling one additional unit.
Formula
MR = Change in TR ÷ Change in Output
Under perfect competition
MR = AR = Price
Important Relationship
Under Perfect Competition
Price = AR = MR
This is one of the most important board exam points.
4. Demand Curve of a Firm
The demand curve facing a firm is:
- Horizontal
- Perfectly elastic
Reason:
The firm can sell any quantity at the market price.
5. Profit
Profit means earnings after deducting total cost.
Formula
Profit = TR − TC
Where
TR = Total Revenue
TC = Total Cost
6. Profit Maximisation
A firm’s main objective is to earn maximum profit.
A firm produces that level of output where profit is highest.
Conditions for Profit Maximisation
Condition 1
Price = Marginal Cost
or
P = MC
Condition 2
MC should be rising.
The MC curve should cut the price line from below.
Condition 3
Short Run
Price ≥ AVC
Long Run
Price ≥ AC
Board Exam Shortcut
Profit Maximisation
✔ P = MC
✔ MC rising
✔ P ≥ AVC (Short Run)
✔ P ≥ AC (Long Run)
7. Short Run Decision
The firm continues production if
Price ≥ AVC
Otherwise,
Production stops.
8. Long Run Decision
The firm continues production only if
Price ≥ AC
If Price < AC
The firm exits the industry.
9. Supply
Supply means the quantity a firm is willing to sell at different prices.
10. Supply Schedule
A table showing different quantities supplied at different prices.
11. Supply Curve
A graph showing the relationship between:
Price (Y-axis)
Quantity Supplied (X-axis)
Supply curve slopes upward.
12. Short Run Supply Curve
Short-run supply curve is:
The rising portion of the MC curve above AVC.
If
Price < AVC
Supply = 0
13. Long Run Supply Curve
Long-run supply curve is:
The rising portion of the MC curve above AC.
If
Price < AC
Supply = 0
14. Shut Down Point
The minimum point of AVC.
Below this point
The firm stops production in the short run.
15. Break-even Point
Point where
Total Revenue = Total Cost
or
Profit = Zero
The firm earns only normal profit.
16. Normal Profit
Minimum profit required to continue business.
It is included in cost.
17. Super Normal Profit
Profit earned above normal profit.
Formula
Super Normal Profit = Total Profit − Normal Profit
18. Factors Affecting Supply
(A) Technological Improvement
Better technology
↓
Lower cost
↓
Higher supply
Supply curve shifts Right
(B) Increase in Input Prices
Higher wages or raw material cost
↓
Higher production cost
↓
Lower supply
Supply curve shifts Left
(C) Unit Tax
Tax per unit increases production cost.
Result
Supply decreases.
Supply curve shifts Left.
19. Market Supply
Market Supply = Sum of supplies of all firms.
Example
Firm A = 50 units
Firm B = 70 units
Market Supply
= 50 + 70
= 120 units
20. Market Supply Curve
Obtained by
Horizontal addition of individual firms’ supply curves.
21. Price Elasticity of Supply (Es)
Measures how much supply changes when price changes.
Formula
Es = % Change in Quantity Supplied ÷ % Change in Price
Interpretation
Es > 1
Supply is elastic.
Es = 1
Unitary elastic supply.
Es < 1
Supply is inelastic.
Es = 0
Perfectly inelastic supply.
Vertical supply curve.
Important Formula Sheet
TR = P × Q
AR = TR ÷ Q
MR = ΔTR ÷ ΔQ
Profit = TR − TC
P = MR = AR
Profit Maximisation
P = MC
Es = %ΔQ ÷ %ΔP
Important Graphs to Practice
✔ Total Revenue Curve
✔ Price Line (AR = MR)
✔ Profit Maximisation
✔ Short Run Supply Curve
✔ Long Run Supply Curve
✔ Market Supply Curve
✔ Elasticity of Supply
Most Important Board Questions
1 Mark
- Define Perfect Competition.
- Define Price Taker.
- Define Total Revenue.
- Define Average Revenue.
- Define Marginal Revenue.
- Define Normal Profit.
- Define Break-even Point.
- Define Shut Down Point.
3 Marks
- Explain features of perfect competition.
- Explain the relationship between Price, AR and MR.
- Explain profit maximisation conditions.
- Explain short-run supply curve.
- Explain long-run supply curve.
4–6 Marks
- Explain profit maximisation with conditions.
- Explain the derivation of the firm’s supply curve.
- Explain determinants of supply.
- Explain market supply.
- Explain price elasticity of supply with formula and examples.
One-Page Revision
- Perfect Competition → Many buyers & sellers, identical products, free entry/exit.
- Firm is a Price Taker.
- TR = P × Q
- AR = Price
- MR = Price
- Profit = TR − TC
- Profit maximisation: P = MC, MC rising.
- Short Run: Produce if P ≥ AVC.
- Long Run: Produce if P ≥ AC.
- Shut Down Point = Minimum AVC.
- Break-even Point = Normal Profit.
- Technology ↑ → Supply ↑.
- Input Prices ↑ → Supply ↓.
- Unit Tax ↑ → Supply ↓.
- Market Supply = Sum of Individual Supplies.
- Es = %ΔQ ÷ %ΔP.
🧠 SECTION A: MCQs (1 mark each)
1. Perfect Competition is a market structure with:
A. One seller
B. Few sellers
C. Many buyers and sellers
D. Government control
Ans: C
2. In perfect competition, firms are:
A. Price makers
B. Price takers
C. Monopoly holders
D. Cartel members
Ans: B
3. Total Revenue is equal to:
A. P + Q
B. P − Q
C. P × Q
D. Q ÷ P
Ans: C
4. Under perfect competition, AR is equal to:
A. MC
B. TC
C. Price
D. Profit
Ans: C
5. MR under perfect competition is:
A. Zero
B. Equal to Price
C. Greater than Price
D. Less than Price
Ans: B
6. Profit maximisation condition is:
A. MR > MC
B. MR < MC
C. MR = MC
D. AR = AC
Ans: C
7. The supply curve of a firm in short run is:
A. MC below AVC
B. Rising part of MC above AVC
C. Falling MC
D. Horizontal line
Ans: B
8. Shut down point is:
A. Maximum AC
B. Minimum AVC
C. Maximum profit
D. Minimum MC
Ans: B
9. In long run, firm produces only if:
A. P < AC
B. P ≥ AC
C. P < AVC
D. P = 0
Ans: B
10. Market supply curve is obtained by:
A. Vertical addition
B. Average addition
C. Horizontal summation
D. Subtraction
Ans: C
✍️ SECTION B: Fill in the blanks
1. In perfect competition, firms are __________ takers.
👉 Price
2. TR = Price × __________.
👉 Quantity
3. AR is equal to __________ under perfect competition.
👉 Price
4. MR = __________ in perfect competition.
👉 Price
5. Profit = TR − __________.
👉 TC
6. Profit maximisation occurs when MR = __________.
👉 MC
7. Short run supply curve is the rising part of __________ curve.
👉 MC (SMC)
8. Shut down point is minimum of __________.
👉 AVC
9. Long run supply curve is based on __________ cost.
👉 Long run marginal
10. Market supply is sum of __________ supplies.
👉 Individual firm’s
✔️ SECTION C: True / False
1. Firms in perfect competition can set their own price.
❌ False
2. AR = MR = Price in perfect competition.
✔ True
3. Supply curve slopes downward in perfect competition.
❌ False
4. Profit maximisation occurs at MR = MC.
✔ True
5. If price < AVC, firm produces in short run.
❌ False
6. Market supply is horizontal summation of individual supply.
✔ True
7. Technological improvement shifts supply curve leftward.
❌ False (it shifts rightward)
8. Unit tax reduces supply.
✔ True
9. Long run shut down point is minimum LRAC.
✔ True
10. MR is always equal to MC at equilibrium.
✔ True
📌 SECTION D: Very Short Answer (1–2 marks)
1. What is perfect competition?
A market with many buyers and sellers, identical products, free entry/exit, and price-taking behaviour.
2. Define price taker.
A firm that accepts the market price as given and cannot influence it.
3. Define total revenue.
Money earned by selling output: TR = P × Q.
4. What is marginal revenue?
Extra revenue from selling one additional unit of output.
5. Define shut down point.
The point where price equals minimum AVC; below this firm stops production.
6. What is break-even point?
Point where TR = TC and firm earns normal profit.
7. What is market supply?
Total supply of all firms in the market at a given price.
📊 SECTION E: Short Answer (3–4 marks)
1. Explain features of perfect competition.
- Large number of buyers and sellers
- Homogeneous product
- Free entry and exit
- Perfect information
- Firms are price takers
2. Why AR = MR = Price?
Because firms can sell any quantity at a fixed market price, so revenue per unit and extra revenue both equal price.
3. Explain profit maximisation condition.
A firm maximises profit where:
- MR = MC
- MC is rising
- Price ≥ AVC (short run)
- Price ≥ AC (long run)
4. What happens if price < AVC?
Firm shuts down in short run because it cannot even cover variable costs.
5. What is supply curve of a firm?
It shows quantity supplied at different prices; in short run it is rising part of MC above AVC.
📈 SECTION F: Case-Based Questions
Case 1
A firm produces 10 units when price is ₹20 and MR = MC.
Questions:
- What is MR equal to?
👉 ₹20 - What is profit condition?
👉 MR = MC - What type of market?
👉 Perfect competition
Case 2
At price ₹15, AVC is ₹18.
Questions:
- Will firm produce?
👉 No - Why?
👉 Price < AVC → shutdown
Case 3
Price increases from ₹10 to ₹30 and output rises.
Questions:
- What happens to supply?
👉 Increases - What is elasticity sign?
👉 Positive
🔥 SECTION G: Numericals (Board level idea)
1.
TR = ₹200, Q = 20
Find price.
👉 P = TR/Q = 200/20 = ₹10
2.
Q increases from 100 to 150 when price rises from 10 to 20.
Find elasticity.
👉 %ΔQ = 50%
👉 %ΔP = 100%
👉 Es = 0.5
📌 MOST IMPORTANT REVISION POINTS
- P = MR = AR
- Profit max → MR = MC
- Short run supply → MC above AVC
- Long run supply → MC above AC
- Market supply = horizontal sum
- Elasticity measures responsiveness