Perfect Competition - Price Takers

1. 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 Takerin that it takes the market-determined price as the price it will receive for its output.

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

3. Total Revenue: Competitive Firm $ Total Revenue $25 $20 At a market price of $5, total revenue is ($5x1) = $5! $15 $10 $ 5 Quantity 1 2 3 4 5

4. 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.

5. 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!

6. Total Revenue: Competitive Firm $ Total Revenue $25 $20 $15 $10 Marginal Revenue $ 5 Quantity 1 2 3 4 5

7. Profit Maximization Total Cost $ $25 $20 $15 $10 $ 5 Quantity 1 2 3 4 5

8. Profit Maximization Total Cost $ Total Revenue $25 $20 $ Maximum Profit at Q = 3 units! } $15 $10 $ 5 Quantity 1 2 3 4 5

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

10. The Competitive Firm’s Cost Curves • Revisit of average cost curves: • The marginal-cost curve (MC) eventually increases. • The average-total-cost curve (ATC) is U-shaped. • Marginal Cost crosses the Average-Total-Cost at the minimum ATC. • Graphically. . .

11. The Shape of Typical Cost Curves MC ATC AVC Cost ($’s) Quantity

12. The Competitive Firm’s Profit- Maximizing Output • Add 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.

13. The Competitive Firm’s Profit- Maximizing Output Price MC ATC P=MR=AR AVC Quantity QMax

14. The Competitive Firm’s Profit- Maximizing Output Price MC ATC P P=MR=AR AVC ATC Maximum Profit Quantity QMax

15. 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! • The minimumloss would equal to the firm’s Total Fixed Cost.

16. Shut-Down! Costs are greater than market price Price MC ATC AVC Q Don’t Produce! P=MR=AR Loss in Excess of Fixed Costs Quantity

17. Short-Run Production Minimize Losses when MR = MC Price MC ATC AVC ATC P P=MR=AR Losses are less than fixed costs Quantity Q short-run

18. Short-Run Production Maximize Profits when MR = MC Price MC ATC P P=MR=AR ATC AVC Maximum Economic Profit Quantity QMax

19. Long-Run Production Normal Profits when MR = MC • In the long-run the typical firm will operate where: • MR = MC • Normal Profit where Price = ATC • Minimum ATC • Why? • Due to Easy Entry • Due to Intense Competition

20. Long-Run Production Normal Profits when MR = MC Price ATC MC P=MR=AR Quantity QLR

21. 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.

22. Competitive Firm’s SR Supply Curve Price MC ATC P=MR=AR AVC P1 Quantity Q1

23. The Competitive Firm’s Supply Curve Price MC ATC P3 P=MR=AR AVC P2 P1 Quantity Q1 Q2 Q3

24. The Competitive Firm’s Supply Curve Price P3 } P2 Firms Short- Run Supply Curve P1 Quantity Q1 Q2 Q3

25. 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

26. 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 variable costs, the firm will choose to exit if the price is less than average total cost.

27. The Market Supply Curve • For any given 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.

28. 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. • 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.

29. 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.