Things to know about all market systems

1. Things to know about all market systems 1. An equilibrium is where no one has an incentive to change their production. • In market systems: • if a firm can increase their profit by changing the price or quantity of their goods, they will. • They will stop changing these factors when they have reached the maximum amount of profit they possibly can achieve, given the current conditions of the market. • This profit maximizing output and price is the equilibrium.

2. Things to know about all market systems 2. Firms will produce where MC=MR • Recall, Marginal Cost (MC) is the additional cost of producing one more unit of output. • Marginal Revenue (MR) is the additional revenue acquired by producing (and as we assume selling) one more unit of output. • MR= TR/ Q = (TR1-TR2)/(Q1-Q2) • MR=P in a competitive market (we will talk about this more later) • MR<P in a monopoly (we will talk about this more later)

3. Things to know about all market systems 2. Firms will produce where MR=MC: we prove this by eliminating all other possibilities • If MC<MR, a firm can make a higher profit by increasing their output. • The additional revenue from selling one more unit is more than the extra cost to produce that unit. • So, a firm’s profit will increase if output increases, therefore the firm producing where MC<MR has an incentive to change their price and/or output. • If MC>MR, a firm can make a higher profit by decreasing their output. • The additional revenue from selling one more unit is less that the extra cost to produce that unit. • So, a firm’s profit will increase if output decreases, therefore the firm producing where MC>MR has an incentive to change their price and/or output. • If MC=MR, a firm is making the highest profit possible. • At this point, each firm does not have a way to increase profit more, so they have no incentive to change their price and/or output.

4. Competitive Markets

5. By the end of this Section, You should be able to: • Define Competitive Market and describe its properties • Know and use the properties of a competitive firm’s profit maximizing quantity and price • Determine LR and SR choice to enter or exit the market • Display the competitive markets in SR and LR

6. Perfectly Competitive Markets • A perfect competition is a market structure in which the decisions of individual buyers and sellers has no effect on the market. • Each firm and consumer is such a small part of the market, a change in one firm or one consumer’s behavior won’t effect the price • Price is set by market forces (invisible hand)

7. Perfectly Competitive Market Assumptions • A competitive firm takes the price as given or they are a price taker. • Products sold by the firms in a competitive industry homogenous (the same). They are perfect substitutes. • Any firm can enter/exit the market without serious impediments. • Both Buyers and Sellers have equal access to information.

8. Perfectly Competitive Firms Maximize Profits in the SR • Note, because the firm is a price taker, a Competitive Firm maximizes profits by choosing the optimal amount to produce. • The Profit Maximizing Quantity is determined by using one of two strategies: • 1. TR>TC • Profit maximizing output is where TR exceeds TC the most. • 2. MC=MR=P

9. Applying MR=MC Rule Graphically Economic Profit = BH = (Q*)(P-ATC) Price/Costs MR = MC MC P MR = P Economic Profit ATC ATC Q* Quantity LO: 7-3

10. Entering and Exiting the Market in the Short Run • In the short run, • A firm enters the market by providing output to sell • a firm can not exit the industry as a whole but can shut down, or not manufacture the good for a period of time • If the firm enters the market in the short run: • Profit = TR – VC – FC • In the short run, a firm will ALWAYS incur fixed costs. • Fixed costs in this case are called sunk costs. Sunk costs are costs already committed to. • If a firm shuts down (exits the market) in the SR: • Profit = 0 – 0 – FC • They produces 0 output and incurs a loss equal to its fixed costs. • Shutting down prevents them from losing any more profit.

11. LR Competitive Equilibrium • The long run competitive equilibrium is where economic profit = 0. • Called the Zero Profit Condition • Note this is economic profit.

12. LR Competitive Equilibrium Graphically LR Competitive Equilibrium is where “everything is equal”. Price Notice, where the set market price (or MR) crosses the MC where the SRAC and the LRAC are at their minimum. This also follows MC=MR=P. MC SRAC LRAC P* MR Q* Quantity

13. Entering and Exiting the Market in the Long Run • In the long run, • A firm enters the market by choosing to provide the good to sell. • A firm will enter the market as long as the current firms are making a positive profit. • A firm exits the industry by choosing to not produce a good to sell any more. • Once firms stop making a positive profit, firms will no longer choose to enter the market. • If firms are making a negative profit, firms will exit the market. • They will exit the market until LR profits = 0.