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8/12/2019 Firms Competitive Ch-14
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Firms in CompetitiveMarkets
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WHAT IS A COMPETITIVEMARKET?
A perfectly competitive market has the
following characteristics:
There are many buyers and sellers in the market.
The goods offered by the various sellers are largelythe same.
Firms can freely enter or exit the market.
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WHAT IS A COMPETITIVEMARKET?
As a result of its characteristics, the perfectly
competitive market has the following outcomes:
The actions of any single buyer or seller in the
market have a negligible impact on the marketprice.
Each buyer and seller takes the market price as
given.
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WHAT IS A COMPETITIVEMARKET?
A competitive market has many buyers and
sellers trading identical products so that each
buyer and seller is a price taker.
Buyers and sellers must accept the price determinedby the market.
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The Revenue of a Competitive Firm Total revenue for a firm is theselling price
times the quantity sold.
TR = (P Q)
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The Revenue of a Competitive Firm Total revenue is proportional to the amount of
output.
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The Revenue of a Competitive Firm Average revenue tells us how much revenue a
firm receives for the typical unit sold.
Average revenue is total revenue divided by the
quantity sold.
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The Revenue of a Competitive Firm In perfect competition,average revenue equals
the price of the good.
Average Revenue =
Total revenue
Quantity
Price Quantity
Quantity
Price
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The Revenue of a Competitive Firm Marginal revenue is the change in total revenue
from an additional unit sold.
MR =TR/ Q
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The Revenue of a Competitive Firm For competitive firms, marginal revenue equals
the price of the good.
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Table 1 Total, Average, and Marginal Revenue fora Competitive Firm
Copyright2004 South-Western
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PROFIT MAXIMIZATION AND THECOMPETITIVE FIRMS SUPPLY CURVE
The goal of a competitive firm is to maximize
profit.
This means that the firm will want to produce
the quantity that maximizes the differencebetween total revenue and total cost.
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Table 2 Profit Maximization: A Numerical Example
Copyright2004 South-Western
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Figure 1 Profit Maximization for a Competitive Firm
Quantity0
Costs
andRevenue
MC
ATC
AVC
MC1
Q1
MC2
Q2
The firm maximizesprofit by producingthe quantity at whichmarginal cost equalsmarginal revenue.
QMAX
P = MR1 = MR2 P =AR = MR
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PROFIT MAXIMIZATION AND THECOMPETITIVE FIRMS SUPPLY CURVE
Profit maximization occurs at the quantitywhere marginal revenue equals marginal cost.
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PROFIT MAXIMIZATION AND THECOMPETITIVE FIRMS SUPPLY CURVE
WhenMR > MC increaseQ
WhenMR < MC decreaseQ
WhenMR = MC Profit is maximized.
Fi 2 M i l C t th C titi Fi S l
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Figure 2 Marginal Cost as the Competitive Firms SupplyCurve
Copyright 2004 South-Western
Quantity0
Price
MC
ATC
AVC
P1
Q1
P2
Q2
This section of thefirms MCcurve isalso the firms supplycurve.
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The Firms Short-Run Decision to Shut Down Ashutdownrefers to a short-run decision not to
produce anything during a specific period of
time because of current market conditions.
Exitrefers to a long-run decision to leave themarket.
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The Firms Short-Run Decision to Shut Down The firm considers itssunk costs when deciding
to exit, but ignores them when deciding
whether to shut down.
Sunk costs are costs that have already beencommitted and cannot be recovered.
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The Firms Short-Run 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 ifTR < VC Shut down ifTR/Q < VC/Q
Shut down ifP < AVC
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Figure 3 The Competitive Firms Short Run Supply Curve
Copyright 2004 South-Western
MC
Quantity
ATC
AVC
0
Costs
Firm
shuts
down if
PAVC,firm willcontinue to producein the short run.
If P>ATC, the firmwill continue toproduce at a profit.
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The Firms Short-Run Decision to Shut Down The portion of the marginal-cost curve that lies
above average variable cost is the competitive
firmsshort-run supply curve.
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The Firms Long-Run Decision to Exit orEnter a Market In the long run, the firm exits if the revenue it
would get from producing is less than its total
cost.
Exit ifTR < TC Exit ifTR/Q < TC/Q
Exit ifP < ATC
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The Firms Long-Run Decision to Exit orEnter a Market A firm will enter the industry if such an action
would be profitable.
Enter ifTR > TC
Enter ifTR/Q > TC/Q
Enter ifP > ATC
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Figure 4 The Competitive Firms Long-Run Supply Curve
Copyright 2004 South-Western
MC = long-run S
Firm
exits ifP ATC
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THE SUPPLY CURVE IN ACOMPETITIVE MARKET
The competitive firms long-run supply curve isthe portion of its marginal-cost curve that lies
above average total cost.
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Figure 4 The Competitive Firms Long-Run Supply Curve
Copyright 2004 South-Western
MC
Quantity
ATC
0
Costs
Firms long-runsupply curve
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THE SUPPLY CURVE IN ACOMPETITIVE MARKET
Short-Run Supply Curve
The portion of its marginal cost curve that lies
above average variable cost.
Long-Run Supply Curve The marginal cost curve above the minimum point
of its average total cost curve.
Figure 5 Profit as the Area between Price and Average
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Figure 5 Profit as the Area between Price and AverageTotal Cost
Copyright 2004 South-Western
(a) A Firm with Profits
Quantity0
Price
P =AR =MR
ATCMC
P
ATC
Q
(profit-maximizing quantity)
Profit
Figure 5 Profit as the Area between Price and Average
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Figure 5 Profit as the Area between Price and AverageTotal Cost
Copyright 2004 South-Western
(b) A Firm with Losses
Quantity0
Price
ATCMC
(loss-minimizing quantity)
P =AR =MRP
ATC
Q
Loss
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THE SUPPLY CURVE IN ACOMPETITIVE MARKET
Market supply equals the sum of the quantitiessupplied by the individual firms in the market.
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The Short Run: Market Supply with a FixedNumber of Firms For any given price, each firm supplies a
quantity of output so that its marginal cost
equals price.
The market supply curve reflects the individualfirms marginal cost curves.
Fi 6 M k t S l ith Fi d N b f Fi
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Figure 6 Market Supply with a Fixed Number of Firms
Copyright 2004 South-Western
(a) Individual Firm Supply
Quantity (firm)0
Price
MC
1.00
100
$2.00
200
(b) Market Supply
Quantity (market)0
Price
Supply
1.00
100,000
$2.00
200,000
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The Long Run: Market Supply with Entry andExit Firms will enter or exit the market until profit is
driven to zero.
In the long run, price equals the minimum of
average total cost.
The long-run market supply curve is horizontal
at this price.
Fi 7 M k t S l ith E t d E it
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Figure 7 Market Supply with Entry and Exit
Copyright 2004 South-Western
(a) Firms Zero-Profit Condition
Quantity (firm)0
Price
(b) Market Supply
Quantity (market)
Price
0
P= minimumATC
Supply
MC
ATC
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The Long Run: Market Supply with Entry andExit At the end of the process of entry and exit,
firms that remain must be making zero
economic profit.
The process of entry and exit ends only whenprice and average total cost are driven to
equality.
Long-run equilibrium must have firmsoperating at their efficient scale.
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Why Do Competitive Firms Stay in BusinessIf They Make Zero Profit? Profit equals total revenue minus total cost.
Total cost includes all the opportunity costs of
the firm.
In the zero-profit equilibrium, the firms
revenue compensates the owners for the time
and money they expend to keep the business
going.
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A Shift in Demand in the Short Run andLong Run An increase in demand raises price and quantity
in the short run.
Firms earn profits because price now exceeds
average total cost.
Figure 8 An Increase in Demand in the Short Run and Long
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Figure 8 An Increase in Demand in the Short Run and LongRun
Firm
(a) Initial Condition
Quantity (firm)0
Price
Market
Quantity (market)
Price
0
DDemand, 1
SShort-run supply, 1
P1
ATC
Long-runsupply
P1
1Q
A
MC
Figure 8 An Increase in Demand in the Short Run and Long
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Figure 8 An Increase in Demand in the Short Run and LongRun
Copyright 2004 South-Western
MarketFirm
(b) Short-Run Response
Quantity (firm)0
Price
MC ATCProfit
P1
Quantity (market)
Long-runsupply
Price
0
D1
D2
P1
S1
P2
Q1
A
Q2
P2B
Figure 8 An Increase in Demand in the Short Run and Long
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g gRun
Copyright 2004 South-Western
P1
Firm
(c) Long-Run Response
Quantity (firm)0
Price
MC ATC
Market
Quantity (market)
Price
0
P1
P2
Q1 Q2
Long-runsupply
B
D1
D2
S1
A
S2
Q3
C
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Why the Long-Run Supply Curve Might SlopeUpward Some resources used in production may be
available only in limited quantities.
Firms may have different costs.
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Why the Long-Run Supply Curve Might SlopeUpward
Marginal Firm The marginal firmis the firm that would exit the
market if the price were any lower.
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Summary 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 firmsaverage revenue and its marginal revenue.
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Summary To maximize profit, a firm chooses the quantity
of output such that marginal revenue equals
marginal cost.
This is also the quantity at which price equalsmarginal cost.
Therefore, the firms marginal cost curve is its
supply curve.
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Summary In the short run, when a firm cannot recover its
fixed costs, the firm will choose to shut down
temporarily if the price of the good is less than
average variable cost. In the long run, when the firm can recover both
fixed and variable costs, it will choose to exit if
the price is less than average total cost.
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Summary In a market with free entry and exit, profits are
driven to zero in the long run and all firms
produce at the efficient scale.
Changes in demand have different effects overdifferent time horizons.
In the long run, the number of firms adjusts to
drive the market back to the zero-profitequilibrium.