FIRMS IN COMPETITIVE MARKETS. Characteristics of Perfect Competition. There are many buyers and sellers in the market. The goods offered by the various sellers are largely the same. Firms can freely enter or exit the market. The individual firm produces a small portion of total market output.
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Characteristics of Perfect Competition • There are many buyers and sellers in the market. • The goods offered by the various sellers are largely the same. • Firms can freely enter or exit the market. • The individual firm produces a small portion of total market output. • The firm cannot have any influence over the price it charges. • The individual firm in a perfectly competitive market is a price taker. • It takes the price determined by the market as the price that it will receive for its output.
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.
Profit Maximization for the Competitive Firm • Profit maximization occurs at the quantity where marginal revenue equals marginal cost. If MR > MC, increase Qto increase profit. If MR < MC, decrease Q to increase profit. If MR = MC, profit is maximized.
Costs and Revenue Profit Maximization for the Competitive Firm 0 Quantity
Costs and Revenue Profit Maximization for the Competitive Firm ATC AVC 0 Quantity
Costs and Revenue Profit Maximization for the Competitive Firm MC ATC AVC 0 Quantity
Costs and Revenue Profit Maximization for the Competitive Firm MC ATC P P = AR = MR AVC 0 Quantity
Costs and Revenue Profit Maximization for the Competitive Firm The firm maximizes profit by producing the quantity at which marginal cost equals marginal revenue. MC ATC P P = AR = MR AVC 0 QMAX Quantity
Costs and Revenue Profit Maximization for the Competitive Firm MC ATC P P = AR = MR AVC 0 QMAX Quantity
Costs and Revenue Profit Maximization for the Competitive Firm MC ATC P = MR1 P = AR = MR AVC MC1 0 Q1 QMAX Quantity
Costs and Revenue Profit Maximization for the Competitive Firm MC ATC P = MR1 P = AR = MR AVC MC1 MR > MC, increase Q 0 Q1 QMAX Quantity
Costs and Revenue Profit Maximization for the Competitive Firm MC MC2 ATC P = MR2 P = AR = MR AVC 0 QMAX Q2 Quantity
Costs and Revenue Profit Maximization for the Competitive Firm MC MC2 ATC P = MR2 P = AR = MR AVC MR < MC, decrease Q 0 QMAX Q2 Quantity
The Firm’s Decision to Shut Down • 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.
The Firm’s Decision to Shut Down • The firm considers its sunk costs when deciding to exit, but ignores them when deciding whether to shut down. Sunk costsare costs that have already been committed and cannot be recovered.
The Firm’s Decision to Shut Down • The firm shuts down if the revenue it gets from producing is less than the variable cost of production. Shut down if TR < VC Shut down if TR/Q < VC/Q Shut down if P < AVC
The Firm’s Decision to Shut Down Costs If P > ATC, keep producing at a profit. MC ATC If P > AVC, keep producing in the short run. AVC 0 Quantity
The Firm’s Decision to Shut Down Costs If P > ATC, keep producing at a profit. MC ATC If P > AVC, keep producing in the short run. AVC If P < AVC, shut down. 0 Quantity
The Firm’s Decision to Shut Down • The portion of the marginal-cost curve that lies above average variable cost is the competitive firm’s short-run supply curve.
The Firm’s Decision to Shut Down Costs If P > ATC, keep producing at a profit. MC ATC If P > AVC, keep producing in the short run. AVC If P < AVC, shut down. 0 Quantity
Firm’s short-run supply curve The Firm’s Decision to Shut Down Costs MC ATC AVC 0 Quantity
The Long-Run Decision to Exit an Industry • In the long-run, the firm exits if the revenue it would get from producing is less than its total cost. Exit if TR < TC Exit if TR/Q < TC/Q Exit if P < ATC
The Long-Run Decision to Enter an Industry • A firm will enter the industry if such an action would be profitable. Enter if TR > TC Enter if TR/Q > TC/Q Enter if P > ATC
Costs MC Firm enters if P > ATC ATC AVC Firm exits if P < ATC 0 Quantity The Competitive Firm’s Long-Run Supply Curve
Firm’s long-run supply curve The Competitive Firm’s Long-Run Supply Curve Costs MC ATC AVC 0 Quantity
The Firm’s Short-Run and Long-Run Supply Curves • Short-Run Supply Curve The portion of its marginal cost curve that lies above average variable cost. • Long-Run Supply Curve The marginal cost curve above the minimum point of its average total cost curve.
