1 Why does a firm in perfect competition produce the quantity at which marginal cost equals price? A perfectly competitive firm’s supply curve shows how its profit-maximising output varies as the market price varies, other things remaining the same. The supply curve is derived from the firm’s marginal cost curve and average variable cost curves. Figure 11.5 illustrates the derivation of the supply curve.

When the price exceeds minimum average variable cost (more than £17), the firm maximises profit by producing the output at which marginal cost equals price. If the price rises, the firm increases its output – it moves up along its marginal cost curve.

When the price is less than minimum average variable cost (less than £17 a jumper), the firm maximises profit by temporarily shutting down and producing no output.

The firm produces zero output at all prices below minimum average variable cost.