Economics%20103

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Economics 103

• Lecture 11
• The Competitive Firm

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The last step in completing our model is to
specify a type of market behavior on the part
of firms.
We are going to start by assuming firms are
competitive.

• The Competitive Firm
• Each firm takes the price as given.
• Each firm ignores the action of rival firms.
• No firm engages in strategic behavior.
• The price is set in the market.

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Does such a firm exist?
Probably true for a wheat farm.
Or for your average small firm.
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But these assumptions are not true for large
firms
Well talk about these firms later.
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When a firm is a price taker, they are soooo
small changes in their output have no impact on
the market price.
They can produce as much as they want, and the
price never changes. This means the demand
curve they face is treated as infinitely elastic.
What is MR? AR?
Why does MRAR?
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A firm wants to Maximize Profit.
Profit Total Revenue Total Costs.
A necessary condition for maximizing profits is
the following Marginal
Revenue Marginal Costs.
Why would the firm do better at producing 10,
than some other quantity?
-the profit max. rule is PMC
Is the firm making a profit at 10?
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PROFIT VS RENT
If there are no SUNK costs, then profit and rent
are the same thing.
- lets start with this assumption.
To tell if this firm is making a profit we need
to measure costs on the graph.
Method 1 The area under the MC curve measures VC.
So if there are no sunk/fixed costs, this area
would be the profit of the firm. We also call
this rent, and sellers surplus.
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PROFIT VS RENT
Method 2 Using the average cost curves.
This shaded area should equal the other shaded
area. Both areas are the total revenue minus
the total costs.
This method is easier because we are dealing with
rectangles, and we can deal with the case of
sunk costs not equaling zero.
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What happens when there are fixed costs? Suppose
the fixed costs equal 10.
Nothing happens to the AVC.
But the AC curve shift up by the AFC.
Clearly the firm earns zero profit.
What is the shaded area?
Rent Total Revenue Opportunity Costs
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There seems to be no end of confusion between
Rents and Profits.
Why would a firm ever stay in business if it
made a loss?
How could a firm stay in business if it made
zero profit?
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Can a firm ever make an economic profit in
equilibrium?
The answer is NO. - entry or exit of
firms will eliminate the profit or loss.

• if the profit is due to a special factor input,
  then the
• price of this input increases until the profit
  is
• eliminated.

In both cases the AC curve adjusts until profit
is eliminated.
Can a firm make a rent in equilibrium?
Absolutely. This is the amount that could be
taken away and the firm would still stay in
business.
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In the early 1990s the National Institute for
Health gave out fellowships for life long
support.

• after 10 years they found that only 50
• of researchers were still doing research.

-these 50 were clearly earning rents.
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Given the structure of costs, what is the firms
supply curve?
The segment above the minimum AVC curve along
the MC is the supply curve of the firm?
Why?
Because the firm maximizes profit when it sets
PMC.
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So, if we have a competitive firm, what does the
market supply look like.
This turns out to depend on how the various firms
differ.
Case 1 All firms identical, no sunk costs.
Suppose every firm was identical.
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Then we would have
The market supply curve is just flat.
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Suppose every firm was identical in everyway,
except they had different levels of fixed/sunk
costs.
The marginal firm earns zero rent.
The intra marginal firms earn zero profit, and
positive rent.
Why would a firm be intra marginal?
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What does the marginal firm look like?
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What happens if we combine the comparative
advantage ideas from before with the
diminishing marginal products of this lecture?
Each individual firm would now have different
shaped marginal costs.
The low cost firms produce first, and as price
increases higher cost firms join the market.
Once again we would have extensive and intensive
adjustments. The market supply curve would still
be upward sloping.
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The bottom line
Market supply curves are upward sloping.