Firms in competitive marketPresentation Transcript
Firms in competitive Market
Market It is a social arrangement that allows buyers & seller to discover information and carryout voluntary exchange of goods or services. Mainly 4 kind of markets are there, Monopoly Oligopoly Monopolistic Perfect
Perfect Competition Meaning Characteristics Large no. of buyers & sellers Homogenous product Easy to enter & exit Perfect knowledge to both seller & buyer Perfect mobility Seller are price taker Straight horizontal line demand curve
Conti… 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 no impact on the market price. Each buyer and seller takes the market price as given. Eg: Agricultural products (vegetables, fruits, oils), copper, gold etc.
Conti… Buyers and sellers must accept the price determined by the market. No single seller has market power (the power to influence the market price).
Types of cost Fixed cost Variable cost Marginal cost Average cost Total cost E.g. Telephone bill
Relationship between AC & MC Diagrammatic representation Y MC Cost/Revenue AC X 0 Q1 Output/Sales
“Demand Faced By A Competitive Firm” versus “Market Demand” Price Price Pm QTY (millions) QTY (ones) Market Demand Demand faced by one competitive firm
Price Determination Y Price D S 300 200 100 D S X 20 18 5 3 10 Qty 0
Marginal Revenue & Marginal Cost Marginal revenue the change in total revenue that occurs as a result of a 1-unit change in sales.. Marginal cost is the additional cost from producing one more unit of output.
The Revenue of a CompetitiveFirm Revenue means total income generated through selling of product. Revenue mainly of 3 kinds Total Revenue Average Revenue Marginal Revenue Total revenue for a firm is the market price times the quantity sold. TR = P Q
Total, Average, and Marginal Revenue for a Competitive Firm
Conti… Price is fixed of the product in perfect competition. So, Marginal revenue, average Revenue and price will be same for competitive firm, that can be represented by straight line horizontal curve. Y Price P= AR= MR P X 0 Qty
Profit Maximization & 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. P = TR - TC
The firm maximizes profit by producing the quantity at which MC marginal cost equals marginal revenue. MC 2 ATC = = = = P MR MR P AR MR 1 2 AVC MC 1 Q Q Q 1 2 MAX Figure 1 Profit Maximization for a Competitive Firm Costs and Revenue Quantity 0
Conti… 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.
This section of the firm’s MC curve is also the firm’s supply curve. MC P 2 ATC P 1 AVC Q Q 1 2 Figure 2 Marginal Cost as the Competitive Firm’s Supply Curve Price Quantity 0
Firm’s short-run decision to shut down Shut-down
It’s a decision not to produce anything during a specific period of time because of current market condition.
Have to pay sunk cost, that can not be ignored.
Exit from market
It’s a long run decision to leave the market permanently.
Not have to pay any kind of cost at all (fixed/variable)
Conti… Firm shuts down if the revenue that it would get from production, less than its variable cost of production. Shut down if TR < VC Shut downif TR/Q < VC/Q Shut down if P < AVC Firm will lose money in shut down (paying FC) but it would lose more money staying open.
MC If P > ATC, the firm will continue to produce at a profit. Firm ’ s short-run supply curve ATC If P > AVC, firm will continue to produce in the short run. AVC Firm shuts down if P AVC < Figure 3 The Competitive Firm’s Short Run Supply Curve Costs Quantity 0
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 < ATC
Conti… A firm enters the market if profit is positive. Enter if TR > TC if TR/Q > TC/Q if P > ATC
Measuring profit in competitive firm Profit can be of three kind, Supernormal profit AR > AC Normal profit AR = AC Sub-normal profit (Loss) AR < AC
ATC MC Profit P ATC P = AR = MR Q Figure 5 Profit as the Area between Price and Average Total Cost (a) A Firm with Profits Price Quantity 0 (profit-maximizing quantity)
ATC MC P P = AR = MR Figure 5 Profit as the Area between Price and Average Total Cost (a) A Firm with Profits Price ATC = Q Quantity 0 (profit-maximizing quantity)
ATC MC ATC P P = AR = MR Loss Q Figure 5 Profit as the Area between Price and Average Total Cost (b) A Firm with Losses Price Quantity 0 (loss-minimizing quantity)
Supply curve in a competitive market Market supply equals the sum of the quantities supplied by the individual firms in the market. Market supply curve can be discussed with two cases; Examine market with fixed no. of firms Examine market in which no. of firms can change due to entry & exit.
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.
MC Supply 200 200 100 100 100,000 200,000 100 200 Figure 6:SR Market Supply with a Fixed Number of Firms (a) Individual Firm Supply (b) Short Run Market Supply Price Price SR Quantity (firm) Quantity (market) 0 0
The Long Run: Market Supply with Entry and Exit If in market, suppose everyone has access to same technology for producing the good & access to same markets to buy the input into production. In such market entry & exit depend on incentives facing the owners of existing firms & entrepreneurs who could start new firms.
Conti… Entry Exit Existing firms earning profit. New entry expand no. of firm in market. Expanded no. of firm lead to increase quantity of goods supplied. More supply lead to down in price & profits. Firm in existing market occurring lose. Exit of firm reduce the no. of firm in market. Reduced market decreased the quantity of good supplied. Less supply lead to drive up price & profits.
MC ATC P = minimum Supply ATC Figure 7 Market Supply with Entry and Exit (a) Firm ’ s Zero-Profit Condition (b) Long Run Market Supply Price Price Quantity (market) Quantity (firm) 0 0
Exercise: A Shift in Demand and Short Run & 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.
MC ATC S Short-run supply, 1 A Long-run P P 1 1 supply D Demand, 1 Q 1 Figure 8 An Increase in Demand in the Short Run and Long Run (a) Initial Condition Market Firm Price Price Quantity (firm) Quantity (market) 0 0
Profit ATC S MC 1 B P P 2 2 A P 1 D 2 D 1 Q Q 2 1 Figure 8 An Increase in Demand in the Short Run and Long Run (b) Short-Run Response Market Firm Price Price Long-run P 1 supply Quantity (firm) Quantity (market) 0 0
S 2 C D 2 Q 3 Figure 8 An Increase in Demand in the Short Run and Long Run (c) Long-Run Response Market Firm Price Price S MC 1 ATC B P 2 A P Long-run P 1 1 supply D 1 Quantity (firm) 0 Q Q Quantity (market) 0 2 1
Summary 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.