İktisada Giriş FIRMS IN COMPETITIVE MARKETS (Chapter 12) FIRMS IN COMPETITIVE MARKETSWhat Is A Competitive Market? A perfectly competitive market has the • following characteristics: There are many buyers and sellers in the – market. The goods offered by the various sellers – are the same (identical). Firms can freely enter or exit the market. – Information is perfect. Buyers and sellers – know all prices offered,...What Is A Competitive Market? As a result of these characteristics, • the perfectly competitive market has the following outcomes: The actions of any single buyer or seller – in the market have a negligible impact on the market price. Each buyer and seller takes the market – price as given. Ex: Gasoline, fish, eggs, pencils, – tomatoes, etc.What Is A Competitive Market? Buyers and sellers must accept the – price determined by the market. No single seller has market power (the power to influence the market price) .“ Demand Faced By A Competitive Firm ” versus “ Market Demand ” Price QTY (ones) P m Demand faced by one competitive firm Market Demand Price QTY (millions)The Revenue of a Competitive Firm Total revenue for a firm is the market • price times the quantity sold . TR = P ? QTable 1 Total, Average, and Marginal Revenue for a Competitive Firm Copyright©2004 South-WesternThe Revenue of a Competitive Firm Average revenue tells us how much • revenue a firm receives for the average unit sold. Average revenue is total revenue • divided by the quantity sold.The Revenue of a Competitive Firm Average revenue equals the price of • the good for all firms. Average Re venue = Total reve nue Quantity Price Quantity Quantity Price ? ? ?The Revenue of a Competitive Firm Marginal revenue is the change in • total revenue from an additional unit sold. MR = ? TR / ? QThe Revenue of a Competitive Firm Only for a competitive firm, marginal 1. revenue equals the price of the good. This is because a firm in a competitive market can sell as much as it wants at the constant market price. If a monopolist or oligopolist sells 2. more, this causes the price of the good to decrease.Profit Maximization and The Competitive Firm’s Supply Curve The goal of a competitive firm is to • maximize profit. This means that the firm wants to • produce the quantity that maximizes the difference between total revenue and total cost .Table 2 Profit Maximization: A Numerical Example Copyright©2004 South-WesternProfit Maximization and The Competitive Firm’s Supply Curve Profit maximization occurs at the • quantity where marginal revenue equals marginal cost .Profit Maximization And The Competitive Firm’s Supply Curve When MR > MC, profit is • increasing , so must produce more . When MR < MC, profit is • decreasing , so must produce less . When MR = MC, profit is constant , • so this is the point where profit is maximized .Figure 1 Profit Maximization for a Competitive Firm Copyright © 2004 South-Western Quantity 0 Costs and Revenue MC MC 1 Q 1 MC 2 Q 2 The firm maximizes profit by producing the quantity at which marginal cost equals marginal revenue. Q MAX P = MR 1 = MR 2 P = AR = MRFigure 2 Marginal Cost as the Competitive Firm’s Supply Curve Copyright © 2004 South-Western Quantity 0 Price MC ATC AVC P 1 Q 1 P 2 Q 2 This section of the firm’s MC curve is also the firm’s supply curve.The Firm’s Short-Run Decision to Shut Down A shutdown refers to a short-run • decision not to produce anything temporarily because the current market price is too low. Exit refers to a long-run permanent • decision to leave the market.The Firm’s Short-Run Decision to Shut Down The firm ignores its fixed costs (= • sunk costs) when deciding to shut down or not in the short-run, but considers them when deciding whether to exit or not in the long-run. Sunk costs are costs that have already – been committed and cannot be recovered in the short-run. See example.The Firm’s Short-Run Decision to Shut Down The firm shuts down if the revenue it • gets from sales 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 –Figure 3 The Competitive Firm’s Short Run Supply Curve Copyright © 2004 South-Western MC Quantity ATC AVC 0 Costs Firm shuts down if P < AVC Firm ’ s short-run supply curve If P > AVC, firm will continue to produce in the short run. If P > ATC , the firm will continue to produce at a profit.The Firm’s Short-Run Decision to Shut Down The part of the marginal-cost curve • that lies above average variable cost is the competitive firm’s short-run supply curve .The Firm’s Long-Run Decision to Exit or Enter a Market In the long run, the firm exits if the • revenue it would get from producing is less than its total cost. Equivalently, firm exits (enters) if the profit is negative (positive). Exit if TR < TC – if TR/Q < TC/Q if P < ATCThe Firm’s Long-Run Decision to Exit or Enter a Market A firm enters the market if profit is • positive. Enter if TR > TC – if TR / Q > TC / Q if P > ATCFigure 4 The Competitive Firm’s Long-Run Supply Curve Copyright © 2004 South-Western MC = long-run S Firm exits if P < ATC Quantity ATC 0 Costs Firm ’ s long-run supply curve Firm enters if P > ATC THE SUPPLY CURVE IN A COMPETITIVE MARKET The competitive firm’s long-run supply • curve is the part of its marginal-cost curve that lies above average total cost.THE SUPPLY CURVE IN A COMPETITIVE MARKET Short-Run Supply Curve • The portion of its marginal cost curve – that lies above average variable cost. Long-Run Supply Curve • The portion of the marginal cost curve – above the minimum point of its average total cost curve.Figure 5 Profit as the Area between Price and Average Total Cost Copyright © 2004 South-Western (a) A Firm with Profits Quantity 0 Price P = AR = MR ATC MC P ATC Q (profit-maximizing quantity) ProfitFigure 5 Profit as the Area between Price and Average Total Cost Copyright © 2004 South-Western (b) A Firm with Losses Quantity 0 Price ATC MC (loss-minimizing quantity) P = AR = MR P ATC Q LossFIRM VERSUS MARKET SUPPLY Market supply equals the sum of the • quantities supplied by the individual firms in the market. The Short Run: Market Supply with a Fixed Number of Firms For any given price, each firm • supplies a quantity of output so that its marginal cost equals price. The market supply curve adds up the • individual firms’ marginal cost curves. Figure 6: SR Market Supply with a Fixed Number of Firms Copyright © 2004 South-Western (a) Individual Firm Supply Quantity (firm) 0 Price MC 1.00 100 $2.00 200 (b) Short Run Market Supply Quantity (market) 0 Price Supply 1.00 100,000 $2.00 200,000 SRThe Long Run: Market Supply with Entry and Exit Long run equilibrium is the case when • there are no more entries or exits in the market. Firms will enter or exit the market until • profit approaches to zero. Then long- run equilibrium happens when profit equals zero.Then at the long run equilibrium, price must equal the minimum of average total cost.The Long Run: Market Supply with Entry and Exit Then long-run market supply curve is • horizontal at price = min(ATC). At the long-run equilibrium firms • operate at their efficient scale (scale that minimizes ATC).Figure 7 Market Supply with Entry and Exit Copyright © 2004 South-Western (a) Firm ’ s Zero-Profit Condition Quantity (firm) 0 Price (b) Long Run Market Supply Quantity (market) Price 0 P = minimum ATC Supply MC ATC LR Supply SR D Demand, 1Why Do Competitive Firms Stay in Business If They Make Zero Profit? Remember that accounting (nominal) • profit is positive even if economic profit is zero. The firm making zero economic profit • means the firm is doing the best it can and there is no other alternative that will give better profit. If there was, current economic profit would be negative.Exercise: A Shift in Demand and Short Run and Long Run Consequences An increase in demand raises price • and quantity in the short run. Firms earn profits because price now • exceeds average total cost.Figure 8 An Increase in Demand in the Short Run and Long Run Firm (a) Initial Condition Quantity (firm) 0 Price Market Quantity (market) Price 0 D Demand, 1 S Short-run supply, 1 P 1 ATC Long-run supply P 1 1 Q A MCFigure 8 An Increase in Demand in the Short Run and Long Run Copyright © 2004 South-Western Market Firm (b) Short-Run Response Quantity (firm) 0 Price MC ATC Profit P 1 Quantity (market) Long-run supply Price 0 D 1 D 2 P 1 S 1 P 2 Q 1 A Q 2 P 2 BFigure 8 An Increase in Demand in the Short Run and Long Run Copyright © 2004 South-Western P 1 Firm (c) Long-Run Response Quantity (firm) 0 Price MC ATC Market Quantity (market) Price 0 P 1 P 2 Q 1 Q 2 Long-run supply B D 1 D 2 S 1 A S 2 Q 3 CSummary Because a competitive firm is a price • taker, its revenue is proportional to the amount of output it produces. The price of the good equals both the • firm’s average revenue and its marginal revenue.Summary To maximize profit, a firm chooses the • quantity of output such that marginal revenue equals marginal cost. This is also the quantity at which price • equals marginal cost. Therefore, the firm’s marginal cost • curve is its supply curve.