chapter 14 firms in competitive markets. objectives 2.) understand how competitive firms decide how...

Chapter 14

Firms in

Competitive Markets

Objectives

2.) Understand how competitive firms decide how much to produce

3.) Know when competitive firms shut down temporarily

4.) Learn what causes competitive firms to enterand leave a market

5.) Understand the determination of the market’s short-run and long-run supply curves

1.) Know the characteristics of a competitive market

PREFECT COMPETITIVE

Market structure is a market characterize by

Many, many firms Homogenous product No control over price(price taker) Easy entrance and exit to and from the

market

A Perfectly Competitive Market (Chapter 4)

A Market in which:-There are a large

number of buyers and sellers

-The goods offered are functionally identical products.

-There is freedom of market entry & exit.

A Perfectly Competitive Market (Chapter 4)

Results in a Market:-not controlled by any

one person or firm.

-with a narrow “range of prices.”

– where Buyers and Sellers are Price Takers.

Perfect Competition - Price Takers

The individual firm produces such a small portion of the total market output that it cannot influence the price it charges for the product it sells.

The firm is a Price Taker in that it takes the market determined price as the price it will receive for its output.

The Revenue of a Competitive Firm

Total Revenue for a firm is the market selling price times the quantity sold.

TR = (P x Q) Total revenue is proportional to the

amount of output. (Table 14-1)

Graphically: Total revenue increases at a constant rate, as each unit sold sells for a constant price.

Total Revenue Firm In Perfect Competition

$25

$20

$15

$10

$ 5

$

Quantity

Total Revenue

1 2 3 4 5


$25

$20

$15

$10

$ 5

$

Quantity

Total Revenue

1 2 3 4 5

At a market price of $5, total revenueis ($5x1) = $5!

Alternative Measurements of Revenue

Average Revenue:– Tells us how much revenue a firm

receives for the typical unit sold.

AR = TR ÷ Q– Average Revenue equals the price of the

good, in perfect competition.

Alternative Measurements of Revenue

Marginal Revenue:– Tells us how much revenue a firm

receives for one additional unit of output.

MR = TR ÷ Q– Marginal Revenue equals the price of the

good, in perfect competition. Graphically: Each unit sold will add

the same amount to total revenue, $5!

Quality Price TotalRevenue

AverageRevenue

Marginal Revenue

12345678

Total, Average, and Marginal Revenue for a Competitive Firm

Q P (TR=P*Q) (AR=TR/Q)

$66666666

$612182430364248

$66666666

$66666666

gallon

(MR= TR / Q)

Quality TotalRevenue

TotalCost

Profit MarginalRevenue

Marginal cost

0

1

2

3

4

5

6

7

8

$ 0

6

12

18

24

30

36

42

48

$ 3

5

8

12

17

23

30

38

47

-$3

1

4

6

7

7

6

4

1

$ 6

6

6

6

6

6

6

6

$2

3

4

5

6

7

8

9

(Q) (TR) (TC) (TR - TC) (MR = TR / Q) (MC = TC / Q)

Profit Maximization for the Competitive Firm

The goal of a competitive firm is to maximize profit.

This means that the firm will want to produce the quantity that maximizes the difference between total revenue and total cost.


$25

$20

$15

$10

$ 5

$

Quantity

Total Revenue

1 2 3 4 5

MarginalRevenue

Quick Quiz!

When a competitive firm doubles the amount it sells, what happens to the price of its output and its total revenue?

Profit Maximization

The goal of a competitive firm is to maximize profit.

Profit = TR -TC Graphically: Combine

graphs from Chapter 13 with Chapter 14

Profit Maximization

$25

$20

$15

$10

$ 5

$

Quantity1 2 3 4 5

Total Cost

Profit Maximization

$25

$20

$15

$10

$ 5

$

Quantity

Total Revenue

1 2 3 4 5

Total Cost

Profit Maximization

$25

$20

$15

$10

$ 5

$

Quantity

Total Revenue

1 2 3 4 5

Total Cost

Profit Maximizationat Q = 3 units!

Profit Maximization

$25

$20

$15

$10

$ 5

$

Quantity

Total Revenue

1 2 3 4 5

Total Cost

Profit Maximizationat Q = 3 units!}

Profit Maximization

Maximum profits occur at a quantity that maximizes the difference (distance) between revenue and costs.

The Competitive Firm’s Cost Curves Chapter 13 revisit of average cost

curves:

– The marginal-cost curve (MC) is upward sloping.

– The average-total-cost curve (ATC) is U-shaped.

– Marginal Cost crosses the Average-Total-Cost at the minimum ATC.

Graphically. . . (Figure 14.1)

The Shape of Typical Cost CurvesC

ost

($’

s)

Quantity

MCATC

AVC

The Competitive Firm’s Profit Maximizing Output

Adding a line for the market price which is the same as the firm’s average revenue (AR) and its marginal revenue (MR).

Identify the level of output that maximizes profit.


Quantity

MCATC

AVC

P=MR=AR

Price


Quantity

MCATC

AVC

P=MR=AR

QMax

Price


Quantity

MCATC

AVC

P=MR=AR

QMax

MaximumProfits!

Price


Profit is maximized when

MR = MC A competitive firm will

adjust its level of production until the quantity reaches QMax where profit is maximized.

The Marginal-Cost Curve and the Firm’s Supply Decision...

Quantity0

Costsand

RevenueMC

ATC

AVC

Copyright © 2001 by Harcourt, Inc. All rights reserved

Q1

P1

P2

Q2

This section of the firm’s MC curve is also the firm’s supply curve.

The Competitive Firm’s Shut-Down Decision

Alternative levels of output produced because the firm is a price taker.

If the selling price is below the minimum average variable cost, the firm should shut down!

Shut Down! Costs are greater than market price

Quantity

MCATC

AVC

P=MR=AR

Q Don’t Produce!

Price

Shut Down! Costs are greater than market price

Quantity

MCATC

AVC

P=MR=AR

Loss!Q Don’t Produce!

Price

The Competitive Firm’s Shut Down Decision


If the selling price is above the minimum average variable cost but below average total cost, the firm should produce in the short-run a quantity that corresponds with MR = MC.

Incurs economic losses, but minimized.

Short-Run Production Minimize Losses when MR = MC

Quantity

MCATC

AVC

P=MR=AR

Qshort-run

Price

The Competitive Firm’s Output Decision


If the selling price is above the minimum average total cost the firm should produce a quantity that corresponds with MR = MC.

Incurs economic profits

The Competitive Firm’s Output Decision

Quantity

MCATC

AVC

P=MR=AR

QMax

Price

The Competitive Firm’s Supply Curve

Short-Run Supply:

–Is the portion of its marginal cost curve that lies above average variable cost.

Long-Run Supply:

–Is the marginal cost curve above the minimum point of its average total cost curve.


Quantity

MCATC

AVC

P=MR=AR

Q1

P1

Price


Quantity

MCATC

AVC

P=MR=AR

Q1 Q2

P1

P2

Price


Quantity

MCATC

AVC

P=MR=AR

Q3Q1 Q2

P1

P2

P3

Price


QuantityQ3Q1 Q2

P1

P2

P3

Price

Firms ShortRun Supply

Curve

}

The Firm’s Profit

Profit equals total revenue (TR) minus total costs (TC)– Profit = TR - TC

– Profit = ([TR ÷ Q] - [TC ÷ Q]) x Q

– Profit = (P - ATC) x Q

The Competitive Firm’s Decision To Produce, Shut Down or Exit

In the short-run, a firm will choose to shut down temporarily if the price of the good is less than the average variable cost.

In the long-run when the firm can recover both fixed and variablecosts, the firm will choose toremain in business.

The Firm’s Short-Run Decision to Shut Down

A shutdown refers to a short-run decision not to produce anything during a specific period of time because of current market conditions.

Exit refers to a long-run decision to leave the market.

The Firm’s Short-Run Decision to Shut Down

The firm considers its sunk costs when deciding to exit, but ignores them when deciding whether to shut down.

Sunk costs are costs that have already been committed and cannot be recovered.

Quick Quiz! How does the price

faced by a profit-maximizing competitive firm compare to its marginal cost?

When will a profit-maximizing firm decide to shut down?

The Market Supply Curve

For any give price, each firm supplies a quantity of output so that price equals its marginal cost.

The quantity of output supplied to the market equals the sum of the quantities supplied by the individual firms.

The Market Supply Curve

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. (Figure 14-7)

Because firms can enter and exit more easily in the long run than in the short-run, the long-run supply curve is more elastic than the short-run supply curve.

Market Supply with Entry and Exit(Figure 14-7)

MC

ATC

Quantity (firm)

P=minimumATC

Price

0 Quantity (market)

Price

0

Supply

(a) Firm’s Zero-Profit Condition (b) Market Supply

Summary/Conclusion

If business firms are competitive and profit-maximizing, the price of a good equals the marginal cost of making that good.

If firms can freely enter and exit the market, the price also equals the lowest possible average total cost of production.

chapter 14 firms in competitive markets. objectives 2.) understand how competitive firms decide how...

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