Chapter

Firms in CompetitiveMarkets

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What is a Competitive Market?

• The meaning of competition• Competitive market

– Market with many buyers and sellers– Trading identical products– Each buyer and seller is a price taker– Firms can freely enter or exit the market

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What is a Competitive Market?

• The revenue of a competitive firm– Maximize profit

• Total revenue minus total cost

• Total revenue = price times quantity = P ˣ Q

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What is a Competitive Market?

• The revenue of a competitive firm• Marginal revenue

– Change in total revenue from an additional unit sold

• For competitive firms– Marginal revenue = P

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Profit Maximization& Competitive Firm’s Supply Curve

• A simple example of profit maximization• Maximize profit

– Compare marginal revenue with marginal cost• If MR > MC – increase production• If MR < MC – decrease production

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Profit Maximization& Competitive Firm’s Supply Curve

• The marginal-cost curve and the firm’s supply decision

• Three general rules for profit maximization:– If MR > MC - firm should increase output– If MC > MR - firm should decrease output– If MR = MC - profit-maximizing level of output

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Profit Maximization& Competitive Firm’s Supply Curve

• The marginal-cost curve and the firm’s supply decision

• Marginal-cost curve– Determines the quantity of the good the firm

is willing to supply at any price– Is the supply curve

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Profit Maximization& Competitive Firm’s Supply Curve

• Shutdown– Short-run decision not to produce anything

• During a specific period of time• Because of current market conditions

– Firm still has to pay fixed costs• Exit

– Long-run decision to leave the market– Firm doesn’t have to pay any costs

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Profit Maximization& Competitive Firm’s Supply Curve

• Spilt milk and other sunk costs• Sunk cost

– Has already been committed– Cannot be recovered– Ignore them when making decisions

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• Restaurant – stay open for lunch?– Fixed costs

• Not relevant• Are sunk costs in short run

– Variable costs – relevant– Shut down if revenue from lunch < variable costs– Stay open if revenue from lunch > variable costs

• Operator of a miniature-golf course– Ignore fixed costs– Stay open if revenue > variable costs

Near-empty restaurants and off-season miniature golf

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Profit Maximization& Competitive Firm’s Supply Curve

• Firm’s long-run decision to exit/enter a market • Competitive firm’s long-run supply curve

– The portion of its marginal-cost curve– That lies above average total cost

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Supply Curve in a Competitive Market

• Long run: market supply with entry and exit• Long run – firms can enter and exit the market

– If P > ATC – firms make positive profit– New firms enter the market

– If P < ATC – firms make negative profit– Firms exit the market

– Process of entry and exit ends when

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Supply Curve in a Competitive Market

• Why do competitive firms stay in business if they make zero profit? – Profit = total revenue – total cost– Total cost – includes all opportunity costs– Zero-profit equilibrium

• Economic profit is zero• Accounting profit is positive

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Monopoly

Why Monopolies Arise

• Monopoly– Firm that is the sole seller of a product

without close substitutes– Price maker– Barriers to entry

• Monopoly resources• Government regulation• The production process

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Why Monopolies Arise

• Monopoly resources– A key resource required for production is

owned by a single firm– Higher price

• Government regulation– Government gives a single firm the exclusive

right to produce some good or service– Government-created monopolies

• Patent and copyright laws• Higher prices; Higher profits

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Why Monopolies Arise

• The production process– A single firm can produce output at a lower

cost than can a larger number of producers• Natural monopoly

– Arises because a single firm can supply a good or service to an entire market• At a smaller cost than could two or more firms

– Economies of scale over the relevant range of output

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How Monopolies Make Production& Pricing Decisions

• Monopoly versus competition– Monopoly

• Price maker• Sole producer• Downward sloping demand

– Market demand curve

– Competitive firm• Price taker• One producer of many• Demand – horizontal line (Price)

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The Welfare Cost of Monopolies

• The deadweight loss• Monopoly

– Produce quantity where• MC = MR

– Produces less than the socially efficient quantity of output

– Charge P>MC– Deadweight loss

• Triangle between: demand curve and MC curve

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