Transcript Chapter Fourteen

Chapter 14
Firms in
Competitive Markets
Objectives
1.) Know the characteristics of a competitive market
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 enter
and leave a market
5.) Understand the determination of the market’s
short-run and long-run supply curves
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
$
Total Revenue
$25
$20
$15
$10
$5
1
2
3
4
5
Quantity
Total Revenue Firm In Perfect Competition
$
Total Revenue
$25
$20
At a market
price of $5,
total revenue
is ($5x1) = $5!
$15
$10
$5
1
2
3
4
5
Quantity
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!
Total, Average, and Marginal Revenue for a Competitive Firm
Quality
Price
Q
P
1gallon
2
3
4
5
6
7
8
$6
6
6
6
6
6
6
6
Total
Revenue
(TR=P*Q)
$6
12
18
24
30
36
42
48
Average
Revenue
Marginal
Revenue
(AR=TR/Q)
(MR= TR / Q)
$6
6
6
6
6
6
6
6
$6
6
6
6
6
6
6
6
Quality
Total
Cost
Profit
(TR)
(TC)
(TR - TC)
0
$0
$3
-$3
$6
$2
1
6
5
1
6
3
2
12
8
4
6
4
3
18
12
6
6
5
4
24
17
7
6
6
5
30
23
7
6
7
6
36
30
6
6
8
7
42
38
4
6
9
8
48
47
1
(Q)
Total
Revenue
Marginal
Revenue
Marginal cost
(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.
Total Revenue Firm In Perfect Competition
$
Total Revenue
$25
$20
$15
$10
Marginal
Revenue
$5
1
2
3
4
5
Quantity
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
Total
Cost
$
$25
$20
$15
$10
$5
1
2
3
4
5
Quantity
Profit Maximization
Total
Cost
$
$25
Total Revenue
$20
$15
$10
$5
1
2
3
4
5
Quantity
Profit Maximization
Total
Cost
$
$25
Total Revenue
$20
$15
$10
$5
1
2
3
4
5
Quantity
Profit Maximization
Total
Cost
$
$25
Total Revenue
$20
Profit
Maximization
at Q = 3 units!
$15
$10
$5
1
2
3
4
5
Quantity
Profit Maximization
Total
Cost
$
$25
Total Revenue
$20
$15
Profit
Maximization
at Q = 3 units!
}
$10
$5
1
2
3
4
5
Quantity
Profit Maximization
Maximum
profits
occur at a quantity
that maximizes the
difference (distance)
between revenue and
costs.
The Competitive Firm’s Cost Curves
Chapter
13 revisit of average cost
curves:
–
The marginal-cost curve (MC) is upward
sloping.
–
The average-total-cost curve (ATC) is Ushaped.
–
Marginal Cost crosses the Average-TotalCost at the minimum ATC.
Graphically.
. . (Figure 14.1)
The Shape of Typical Cost Curves
MC
ATC
Cost ($’s)
AVC
Quantity
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.
Price
The Competitive Firm’s Profit
Maximizing Output
MC
ATC
P=MR=AR
AVC
Quantity
Price
The Competitive Firm’s Profit
Maximizing Output
MC
ATC
P=MR=AR
AVC
Quantity
Price
The Competitive Firm’s Profit
Maximizing Output
MC
ATC
P=MR=AR
AVC
QMax
Quantity
Price
The Competitive Firm’s Profit
Maximizing Output
MC
ATC
P=MR=AR
AVC
QMax
Quantity
Price
The Competitive Firm’s Profit
Maximizing Output
MC
ATC
P=MR=AR
AVC
Maximum
Profits!
QMax
Quantity
The Competitive Firm’s Profit
Maximizing Output
Profit
is maximized when
MR = MC
A
competitive firm will
adjust its level of
production until the
quantity reaches QMax
where profit is maximized.
Copyright © 2001 by Harcourt, Inc. All rights reserved
The Marginal-Cost Curve and the Firm’s
Supply Decision...
Costs
and
Revenue
This section of the
firm’s MC curve is
also the firm’s supply
curve.
MC
P2
ATC
P1
AVC
0
Q1
Q2
Quantity
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
Price
MC
ATC
AVC
P=MR=AR
Quantity
Q Don’t Produce!
Shut Down! Costs are greater than
market price
Price
MC
ATC
AVC
Q Don’t Produce!
Loss!
P=MR=AR
Quantity
The Competitive Firm’s Shut Down
Decision
 Alternative
levels of output produced
because the firm is a price taker.
 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
Price
MC
ATC
AVC
P=MR=AR
Qshort-run
Quantity
The Competitive Firm’s Output Decision
Alternative
levels of output produced
because the firm is a price taker.
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
Price
MC
ATC
P=MR=AR
AVC
QMax
Quantity
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.
The Competitive Firm’s Supply Curve
Price
MC
ATC
P=MR=AR
AVC
P1
Q1
Quantity
The Competitive Firm’s Supply Curve
Price
MC
ATC
P=MR=AR
AVC
P2
P1
Q1
Q2
Quantity
The Competitive Firm’s Supply Curve
Price
MC
P3
ATC
P=MR=AR
AVC
P2
P1
Q1
Q2
Q3
Quantity
The Competitive Firm’s Supply Curve
Price
P3
P2
Firms Short
Run Supply
Curve
P1
Q1
Q2
Q3
Quantity
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 variable
costs, the firm will choose to
remain 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 profitmaximizing competitive
firm compare to its
marginal cost?
When
will a profitmaximizing 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 shortrun, the long-run supply curve is more
elastic than the short-run supply
curve.
Market Supply with Entry and Exit
(Figure 14-7)
(a) Firm’s Zero-Profit Condition
Price
(b) Market Supply
Price
MC
ATC
P=minimum
ATC
0
Supply
Quantity (firm)
0
Quantity (market)
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.