Post on 19-Dec-2015
Firms in Competitive Markets
Chapter 14
Competitive MarketLots of buyers and sellers dealing in identical goods.
Sellers can freely enter or leave.
Firms in a competitive market …
… are price takers. They take the price as given because nothing they do can affect it.
For a firm in a competitive market, the price is the marginal revenue.
Profit maximization assumption
Firms act to maximize profit (Π ).Profit = total revenue – total cost
= PQ – FC – VC
Profit maximization example
Q TR TC Π MR MC ΔΠ
0 0 3 (3) 6
1 6 5 1 6 2 4
2 12 8 4 6 3 3
3 18 12 6 6 4 2
4 24 17 7 6 5 1
5 30 23 7 6 6 0
6 36 30 6 6 7 (1)
7 42 38 4 6 8 (2)
8 48 47 1 6 9 (3)
Rule for profit maximization
If MC is rising, produce up to the point at which MC = MR.
Figure 1 Profit Maximization for a Competitive Firm
Copyright © 2004 South-Western
Quantity0
Costsand
Revenue
MC
ATC
AVC
MC1
Q1
MC2
Q2
The firm maximizesprofit by producing the quantity at whichmarginal cost equalsmarginal revenue.
QMAX
P = MR1 = MR2 P = AR = MR
Figure 2 Marginal Cost as the Competitive Firm’s Supply Curve
Copyright © 2004 South-Western
Quantity0
Price
MC
ATC
AVC
P1
Q1
P2
Q2
This section of thefirm’s MC curve isalso the firm’s supplycurve.
Figure 3 The Competitive Firm’s Short Run Supply Curve
Copyright © 2004 South-Western
MC
Quantity
ATC
AVC
0
Costs
Firmshutsdown ifP< AVC
Firm’s short-runsupply curve
If P > AVC, firm will continue to produce in the short run.
If P > ATC, the firm will continue to produce at a profit.
Shutdown vs. Exit
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.
Figure 4 The Competitive Firm’s Long-Run Supply Curve
Copyright © 2004 South-Western
MC = long-run S
Firmexits ifP < ATC
Quantity
ATC
0
CostsFirm’s long-runsupply curve
Firmenters ifP > ATC
Figure 5 Profit as the Area between Price and Average Total 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 Total Cost
Copyright © 2004 South-Western
(b) A Firm with Losses
Quantity0
Price
ATCMC
(loss-minimizing quantity)
P = AR = MRP
ATC
Q
Loss
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
Figure 7 Market Supply with Entry and Exit
Copyright © 2004 South-Western
(a) Firm’s Zero-Profit Condition
Quantity (firm)0
Price
(b) Market Supply
Quantity (market)
Price
0
P = minimumATC
Supply
MC
ATC
Figure 8 An Increase in Demand in the Short Run and Long Run
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 Run
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
P2
B
Figure 8 An Increase in Demand in the Short Run and Long Run
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