Title: FIRMS IN COMPETITIVE MARKETS
1FIRMS IN COMPETITIVE MARKETS
2The Meaning of Competition
- A perfectly competitive market has the following
characteristics - ä There are many buyers and sellers in the
market. - ä The goods offered by the various sellers are
largely the same. - ä Firms can freely enter or exit the market.
3The Meaning of Competition
- A perfectly competitive market has the following
outcomes - ä The individual firm produces a small portion
of total market output. - ä The firm cannot have any influence over the
price it charges.
4The Meaning of Competition
- The individual firm in a perfectly competitive
market is a price taker. - ä It takes the price determined by the market
as the price that it will receive for its output.
5Revenue of a Competitive Firm
- Total revenue for a firm is the selling price
times the quantity sold. - TR (P X Q)
6Revenue of a Competitive Firm
- Total revenue is proportional to the amount of
output.
7Revenue of a Competitive Firm
- Average revenue tells us how much revenue a firm
receives for the typical unit sold.
8Revenue of a Competitive Firm
- In perfect competition, average revenue equals
the price of the good.
9Revenue of a Competitive Firm
- In perfect competition, average revenue equals
the price of the good.
10Revenue of a Competitive Firm
- Marginal revenue is the change in total revenue
from an additional unit sold. - MR DTR/DQ
11Revenue of a Competitive Firm
- For competitive firms, marginal revenue equals
the price of the good.
12Quick Quiz!
- When a competitive firm doubles the amount it
sells, what happens to the price of its output
and its total revenue?
13Profit Maximization for the Competitive Firm
- The goal of a competitive firm is to maximize
profit. - ä This means that the firm will want to
produce the quantity that maximizes the
difference between total revenue and total
cost.
14Profit Maximization for the Competitive Firm
- Profit maximization occurs at the quantity where
marginal revenue equals marginal cost. - If MR gt MC, increase Q to increase profit.
- If MR lt MC, decrease Q to increase profit.
- If MR MC, profit is maximized.
15Profit Maximization for the Competitive Firm
0
Quantity
16Profit Maximization for the Competitive Firm
ATC
AVC
0
Quantity
17Profit Maximization for the Competitive Firm
MC
ATC
AVC
0
Quantity
18Profit Maximization for the Competitive Firm
MC
ATC
P
P AR MR
AVC
0
Quantity
19Profit Maximization for the Competitive Firm
The firm maximizes profit by producing the
quantity at which marginal cost equals marginal
revenue.
MC
ATC
P
P AR MR
AVC
0
QMAX
Quantity
20Profit Maximization for the Competitive Firm
- A competitive firm will adjust its production
level until quantity reaches QMAX where profit is
maximized.
21Profit Maximization for the Competitive Firm
MC
ATC
P
P AR MR
AVC
0
QMAX
Quantity
22Profit Maximization for the Competitive Firm
MC
ATC
P MR1
P AR MR
AVC
MC1
0
Q1
QMAX
Quantity
23Profit Maximization for the Competitive Firm
MC
ATC
P MR1
P AR MR
AVC
MC1
MR gt MC, increase Q
0
Q1
QMAX
Quantity
24Profit Maximization for the Competitive Firm
MC
MC2
ATC
P MR2
P AR MR
AVC
0
Q2
QMAX
Quantity
25Profit Maximization for the Competitive Firm
MC
MC2
ATC
P MR2
P AR MR
AVC
MR lt MC, decrease Q
0
Q2
QMAX
Quantity
26The Firms Decision to Shut Down
- A shutdown refers to a short-run decision not to
produce anything during a specific period of
time. - Exit refers to a long-run decision to leave the
market.
27The Firms Decision to Shut Down
- The firm considers its sunk costs when deciding
to exit, but ignores them when deciding whether
to shut down. - ä Sunk costs are costs that have already been
committed and cannot be recovered.
28The Firms Decision to Shut Down
- The firm shuts down if the revenue it gets from
producing is less than the variable cost of
production. - Shut down if TR lt VC
- Shut down if TR/Q lt VC/Q
- Shut down if P lt AVC
29The Firms Decision to Shut Down
Costs
Quantity
0
30The Firms Decision to Shut Down
Costs
MC
ATC
AVC
Quantity
0
31The Firms Decision to Shut Down
Costs
If P gt ATC, keep producing at a profit.
MC
ATC
AVC
Quantity
0
32The Firms Decision to Shut Down
Costs
If P gt ATC, keep producing at a profit.
MC
ATC
If P gt AVC, keep producing in the short run.
AVC
Quantity
0
33The Firms Decision to Shut Down
Costs
If P gt ATC, keep producing at a profit.
MC
ATC
If P gt AVC, keep producing in the short run.
AVC
If P lt AVC, shut down.
Quantity
0
34The Firms Decision to Shut Down
- The portion of the marginal-cost curve that lies
above average variable cost is the competitive
firms short-run supply curve.
35The Firms Decision to Shut Down
Costs
If P gt ATC, keep producing at a profit.
MC
ATC
If P gt AVC, keep producing in the short run.
AVC
If P lt AVC, shut down.
Quantity
0
36The Firms Decision to Shut Down
Costs
MC
ATC
AVC
Quantity
0
37The Long-Run Decision to Exit an Industry
- In the long-run, the firm exits if the revenue it
would get from producing is less than its total
cost. - Exit if TR lt TC
- Exit if TR/Q lt TC/Q
- Exit if P lt ATC
38The Long-Run Decision to Enter an Industry
- A firm will enter the industry if such an action
would be profitable. - Enter if TR gt TC
- Enter if TR/Q gt TC/Q
- Enter if P gt ATC
39The Competitive Firms Long-Run Supply Curve
40The Competitive Firms Long-Run Supply Curve
Costs
Quantity
0
41The Competitive Firms Long-Run Supply Curve
Costs
MC
ATC
AVC
Quantity
0
42The Competitive Firms Long-Run Supply Curve
Costs
MC
Firm enters if P gt ATC
ATC
AVC
Quantity
0
43The Competitive Firms Long-Run Supply Curve
44The Competitive Firms Long-Run Supply Curve
- The competitive firms long-run supply curve is
the portion of its marginal-cost curve that lies
above average total cost.
45The Competitive Firms Long-Run Supply Curve
46The Competitive Firms Long-Run Supply Curve
Costs
MC
ATC
AVC
Quantity
0
47The Firms Short-Run and Long-Run Supply Curves
- Short-Run Supply Curve
- ä The portion of its marginal cost curve that
lies above average variable cost. - Long-Run Supply Curve
- ä The marginal cost curve above the minimum
point of its average total cost curve.
48Profit as the Area Between Price and Average
Total Cost
49Profit as the Area Between Price and Average
Total Cost
Price
Quantity
0
50Profit as the Area Between Price and Average
Total Cost
Price
ATC
MC
Quantity
0
51Profit as the Area Between Price and Average
Total Cost
Price
ATC
MC
P
P AR MR
Quantity
0
52Profit as the Area Between Price and Average
Total Cost
Price
ATC
MC
P
P AR MR
ATC
Profit-maximizing quantity
Quantity
0
Q
53Profit as the Area Between Price and Average
Total Cost
Price
ATC
MC
Profit
P
P AR MR
ATC
Profit-maximizing quantity
Quantity
0
Q
54Loss as the Area Between Price and Average Total
Cost
55Loss as the Area Between Price and Average Total
Cost
Price
ATC
MC
Quantity
0
56Loss as the Area Between Price and Average Total
Cost
Price
ATC
MC
P
P AR MR
Quantity
0
57Loss as the Area Between Price and Average Total
Cost
Price
ATC
MC
ATC
P
P AR MR
Loss-minimizing quantity
Quantity
0
Q
58Loss as the Area Between Price and Average Total
Cost
Price
ATC
MC
ATC
P
P AR MR
Loss
Loss-minimizing quantity
Quantity
0
Q
59Quick Quiz!
- How does the price faced by a profit-maximizing
competitive firm compare to its marginal cost?
60Quick Quiz!
- When will a profit-maximizing firm decide to shut
down?
61Supply in a Competitive Market
- Market supply equals the sum of the quantities
supplied by the individual firms in the market.
62Supply in a Competitive Market
- Market Supply with a Fixed Number of Firms
- ä For any given price, each firm supplies a
quantity of output so that price equals its
marginal cost. - ä The market supply curve reflects the
individual firms marginal cost curves.
63Supply in a Competitive Market
- Market Supply with Entry and Exit
- ä Firms will enter or exit the market until
profit is driven to zero. - ä In the long-run, price equals the minimum
of average total cost. - ä The long-run market supply curve is
horizontal at this price.
64The Supply Curve in a Competitive Market
(a) Firms Zero-Profit Condition
(b) Market Supply
Price
Price
MC
ATC
P minimum ATC
Supply
Quantity (firm)
0
Quantity (market)
0
65Increase in Demand in the Short Run
- An increase in demand raises price and quantity
in the short run. - Firms earn profits because price now exceeds
average total cost.
66Initial Condition
Market
Firm
Price
Price
Quantity (firm)
0
Quantity (market)
0
67Initial Condition
Market
Firm
Price
Price
ATC
S
MC
1
A
Long-run supply
P1
P1
D1
Quantity (firm)
0
Quantity (market)
0
Q1
68Short-Run Response
Market
Firm
Price
Price
B
S
ATC
MC
1
A
Long-run supply
P1
P1
P1
D
2
D
1
Quantity (firm)
0
Quantity (market)
0
Q1
69Short-Run Response
Market
Firm
Price
Price
ATC
S
MC
B
1
P2
P2
A
Long-run supply
P1
P1
D
2
D
1
Quantity (firm)
0
Quantity (market)
0
Q1
Q2
70Short-Run Response
Market
Firm
Price
Price
Profit
ATC
S
MC
B
1
P2
P2
A
Long-run supply
P1
P1
D
2
D
1
Quantity (firm)
0
Quantity (market)
0
Q1
Q2
71Increase in Demand in the Long Run
- Over time, the short-run supply curve shifts as
profits encourage new firms to enter the market.
72Increase in Demand in the Long Run
- Price falls as new firms enter the market.
73Increase in Demand in the Long Run
- In the new long-run equilibrium profits return to
zero and price returns to minimum average total
cost.
74Increase in Demand in the Long Run
- The market has more firms to satisfy the greater
demand.
75Long-Run Response
Market
Firm
Price
Price
Profit
ATC
S
MC
B
1
P2
P2
A
Long-run supply
P1
P1
D
2
D
1
Quantity (firm)
0
Quantity (market)
0
Q1
Q2
76Long-Run Response
Market
Firm
Price
Price
Profit
ATC
S1
MC
B
P2
P2
S2
A
Long-run supply
P1
P1
D2
D1
Quantity (firm)
0
Quantity (market)
0
Q1
Q2
77Long-Run Response
Market
Firm
Price
Price
ATC
S1
MC
B
P2
S2
A
Long-run supply
P1
P1
D2
D1
Quantity (firm)
0
Quantity (market)
0
Q1
Q2
78Increase in Demand in the Short and Long Run
Market
Firm
Price
Price
ATC
S1
MC
B
S2
A
C
Long-run supply
P1
P1
D2
D1
Quantity (firm)
0
Quantity (market)
0
Q1
Q2
Q3
79Why the Long-Run Supply Curve Might Slope Upward
- Some resources used in production may be
available only in limited quantities. - Firms may have different costs.
80Conclusion
- Because a competitive firm is a price taker, its
revenue is proportional to the amount of output
it produces. - The price of the good equals both the firms
average revenue and its marginal revenue
81Conclusion
- To maximize profit a firm chooses the quantity of
output where marginal revenue equals marginal
cost. - This is also the quantity at which price equals
marginal cost.
82Conclusion
- In the short run, the firm will choose to shut
down temporarily if the price of the good is less
than average variable cost. - In the long run, it will choose to exit if the
price is less than average total cost.
83Conclusion
- If firms can freely enter and exit the market,
the price also equals the lowest possible average
total cost of production in the long run. - The number of firms adjusts to drive the market
back to the zero-profit equilibrium.
84Conclusion
- Because firms can enter and exit more easily in
the long run than the short run, the long-run
supply curve is typically more elastic than the
short-run supply curve.
85FIRMS IN COMPETITIVE MARKETS
86(No Transcript)
87Figure 14-1
88Price
MC
P2
ATC
P1
AVC
Q1
Q2
Quantity
0
Figure 14-2
89Figure 14-3
90Figure 14-4
91(a) A Firm with Profits
Figure 14-5a
92(b) A Firm with Losses
Figure 14-5b
93(a) Individual Firm Supply
(b) Market Supply
Price
Price
MC
Supply
2.00
2.00
1.00
1.00
Quantity (firm)
0
100
200
Quantity (market)
0
100,000
200,000
Figure 14-6
94(a) Firm
s Zero-Profit Condition
(b) Market Supply
Price
Price
MC
ATC
P
P minimum
Supply
ATC
Quantity (firm)
0
Quantity (market)
0
Figure 14-7
95(a) Initial Condition
Market
Firm
Price
Price
MC
ATC
Short-run supply
A
Long-run
P
P
P
P
1
1
supply
Demand
Quantity (firm)
0
Quantity (market)
0
Q
1
(b) Short-Run Response
Market
Firm
Price
Price
Profit
B
MC
ATC
S
1
P
P
2
2
A
P
Long-run
P
1
supply
1
D
2
D
1
Quantity (firm)
0
Quantity (market)
0
Q
Q
1
2
(c) Long-Run Response
Firm
Market
Price
Price
S
MC
1
ATC
B
S
P
2
2
C
A
P
Long-run
P
1
1
supply
D
2
D
1
Quantity (firm)
0
Q
Q
Quantity (market)
0
Q
1
2
3
Figure 14-8
96(a) Initial Condition
Market
Firm
Price
Price
MC
ATC
Short-run supply, S1
A
Long-run supply
P1
P
P1
P
Demand, D1
0
0
Q1
Quantity (market)
Quantity (firm)
Figure 14-8a
97(b) Short-Run Response
Figure 14-8b
98(c) Long-Run Response
Firm
Market
Price
Price
MC
S1
B
ATC
S2
P2
C
A
P1
P1
Long-run
supply
D2
D1
0
Q1
Q2
0
Q3
Quantity (firm)
Quantity (market)
Figure 14-8c