Ch_06 Firms in Competitive Markets_1642010520.ppt

6
BACKGROUND TO SUPPLY: FIRMS IN
COMPETITIVE MARKETS
FOR USE WITH MANKIW AND TAYLOR, ECONOMICS 4TH EDITION
9781473725331 © CENGAGE EMEA 2017

What 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 largely the same.
◦ Firms are price takers.
◦ Firms can freely enter or exit the market.
9781473725331 © CENGAGE EMEA 2017

What Is A Competitive Market?
As a result of its 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.
◦ Buyers and sellers must accept the price determined by the market.
9781473725331 © CENGAGE EMEA 2017

The Revenue of a Competitive Firm
Total revenue for a firm is the selling price times the quantity sold.
TR = (P  Q)
Total revenue is proportional to the amount of output.
9781473725331 © CENGAGE EMEA 2017

Average revenue tells us
how much revenue a firm
receives for the typical
unit sold.
Average revenue is total
revenue divided by the
quantity sold.
In perfect competition,
average revenue equals
the price of the good.
A
v
e
ra
g
eR
e
v
e
n
u
e=
T
o
ta
lre
v
e
n
u
e
Q
u
a
n
tity
P
ric
e Q
u
a
n
tity
Q
u
a
n
tity
P
ric
e



9781473725331 © CENGAGE EMEA 2017

Marginal revenue is the change in total revenue from an additional
unit sold.
MR =TR/ Q
◦ For competitive firms, marginal revenue equals the price of the good.
9781473725331 © CENGAGE EMEA 2017

Table 4 Total, Average, and Marginal Revenue
for a Competitive Firm
9781473725331 © CENGAGE EMEA 2017

Economic Profit versus Accounting
Profit
Economists measure a firm’s economic profit as total revenue
minus total cost, including both explicit and implicit costs.
Accountants measure the accounting profit as the firm’s total
revenue minus only the firm’s explicit costs.
9781473725331 © CENGAGE EMEA 2017

Economic Profit versus Accounting
Profit
When total revenue exceeds both explicit and implicit costs, the
firm earns economic profit.
◦ Economic profit is smaller than accounting profit.
9781473725331 © CENGAGE EMEA 2017

Figure 6 Economic versus Accountants
Revenue
Total
opportunity
costs
How an Economist
Views a Firm
How an Accountant
Views a Firm
Revenue
Economic
profit
Implicit
costs
Explicit
costs
Explicit
costs
Accounting
profit
9781473725331 © CENGAGE EMEA 2017

Profit Maximization And The
Competitive Firm’s Supply Curve
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.
9781473725331 © CENGAGE EMEA 2017

Profit Maximization
Profit maximization occurs at the quantity where marginal revenue
equals marginal cost.
◦ When MR > MC the firm should increase Q to increase profit
◦ When MR < MC the firm should decrease Q to increase profit
◦ When MR = MC profit is maximized.
9781473725331 © CENGAGE EMEA 2017

Table 5 Profit Maximization: A Numerical
Example
9781473725331 © CENGAGE EMEA 2017

Figure 7 Profit Maximization for a
Competitive Firm
Quantity
0
Costs
and
Revenue
MC
ATC
AVC
MC1
Q1
MC2
Q2
The firm maximizes
profit by producing
the quantity at which
marginal cost equals
marginal revenue.
QMAX
P = MR1 = MR2 P = AR = MR
9781473725331 © CENGAGE EMEA 2017

Normal And Abnormal Profit
Profit is equal to total revenue minus total
cost.
◦ To an economist, total cost includes all of the
opportunity costs of the firm.
◦ When a firm is earning zero profit, this must
mean that the firm's revenues are compensating
the firm's owners for the time and money that
they have expended to keep their businesses
going.
Definition of abnormal profit: the profit over
and above normal profit.
9781473725331 © CENGAGE EMEA 2017

The Marginal-Cost Curve and the
Firm’s Supply Decision
Features of Cost curves.
◦ The marginal cost curve is upward sloping.
◦ The average total cost curve is u-shaped.
◦ The marginal cost curve crosses the average total cost curve at the
minimum of average total cost.
Marginal and average revenue can be
shown by a horizontal line at the market
price.
9781473725331 © CENGAGE EMEA 2017

The Marginal-Cost Curve and the
Firm’s Supply Decision
Profit maximising level of output.
◦ If marginal revenue is greater than the marginal
cost, the firm can increase its profit by increasing
output.
◦ If marginal cost is greater than marginal
revenue, the firm can increase its profit by
decreasing output
◦ At the profit-maximizing level of output, marginal
revenue is equal to marginal cost.
◦ The firm’s MC curve above ATC = firm’s supply
curve.
9781473725331 © CENGAGE EMEA 2017

Figure 8 Marginal Cost as the Competitive
Firm’s Supply Curve
Quantity
0
Price
MC
ATC
AVC
P1
Q1
P2
Q2
This section of the
firm’s MC curve is
also the firm’s supply
curve.
9781473725331 © CENGAGE EMEA 2017

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.
9781473725331 © CENGAGE EMEA 2017

The Firm’s Short-Run 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 portion of the marginal cost curve that lies above average variable
cost is the competitive firm’s short-run supply curve.
9781473725331 © CENGAGE EMEA 2017

Figure 9 The Competitive Firm’s Short Run
Supply Curve
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.
9781473725331 © CENGAGE EMEA 2017

Sunk Costs
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.
9781473725331 © CENGAGE EMEA 2017

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.
◦ Exit if TR < TC
◦ Exit if TR/Q < TC/Q
◦ Exit if P < ATC
9781473725331 © CENGAGE EMEA 2017

The Firm’s Long-Run Decision to Exit
or Enter a Market
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
9781473725331 © CENGAGE EMEA 2017

Figure 10 The Competitive Firm’s Long-Run
Supply Curve
MC = long-run S
Firm
exits if
P < ATC
Quantity
ATC
0
Costs
Firm
’s long-run
supply curve
Firm
enters if
P > ATC
9781473725331 © CENGAGE EMEA 2017

Measuring Profit
Profit = TR - TC.
Because TR = P x Q and TC = ATC x Q, we can rewrite this
equation
Profit = (P – ATC) x Q.
9781473725331 © CENGAGE EMEA 2017

Figure 11a. Profit as the Area between Price
and Average Total Cost
(a) A Firm with Profits
Quantity
0
Price
P = AR = MR
ATC
MC
P
ATC
Q
(profit-maximizing quantity)
Profit
9781473725331 © CENGAGE EMEA 2017

Figure 11b. Profit as the Area between Price
and Average Total Cost
(b) A Firm with Losses
Quantity
0
Price
ATC
MC
(loss-minimizing quantity)
P = AR = MR
P
ATC
Q
Loss
9781473725331 © CENGAGE EMEA 2017

The Supply Curve In A
Competitive Market
The competitive firm’s long-run supply curve is the portion of its
marginal cost curve that lies above average total cost.
9781473725331 © CENGAGE EMEA 2017

Figure 10 The Competitive Firm’s Long-Run
Supply Curve
MC
Quantity
ATC
0
Costs
Firm
’s long-run
supply curve
9781473725331 © CENGAGE EMEA 2017

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 marginal cost curve above the minimum point of its average total
cost curve.
Market supply equals the sum of the quantities supplied by the
individual firms in the market.
9781473725331 © CENGAGE EMEA 2017

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 reflects the individual firms’ marginal
cost curves.
9781473725331 © CENGAGE EMEA 2017

Figure 12 Market Supply with a Fixed
Number of Firms
(a) Individual Firm Supply
Quantity (firm)
0
Price
MC
1.00
100
€ 2.00
200
(b) Market Supply
Quantity (market)
0
Price
Supply
1.00
100,000
€ 2.00
200,000
9781473725331 © CENGAGE EMEA 2017

The Long Run: Market Supply with
Entry and Exit
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.
The long-run market supply curve is horizontal at this price.
9781473725331 © CENGAGE EMEA 2017

Figure 13 Market Supply with Entry and Exit
(a) Firm’s Zero-Profit Condition
Quantity (firm)
0
Price
(b) Market Supply
Quantity (market)
Price
0
P = minimum
ATC
Supply
MC
ATC
9781473725331 © CENGAGE EMEA 2017

The Long Run: Market Supply with
Entry and Exit
At the end of the process of entry and exit, firms that remain must
be making zero economic profit.
The process of entry and exit ends only when price and average
total cost are driven to equality.
Long-run equilibrium must have firms operating at their efficient
scale.
9781473725331 © CENGAGE EMEA 2017

Why Do Competitive Firms Stay in
Business If They Make Zero Profit?
Profit equals total revenue minus total cost.
Total cost includes all the opportunity costs of the firm.
In the zero-profit equilibrium, the firm’s revenue compensates the
owners for the time and money they expend to keep the business
going.
9781473725331 © CENGAGE EMEA 2017

A Shift in Demand in the Short Run
and Long Run
An increase in demand raises price and quantity in the short run.
Firms earn profits because price now exceeds average total cost.
9781473725331 © CENGAGE EMEA 2017

Figure 14a. 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
P1
ATC
Long-run
supply
P1
1
Q
A
MC
9781473725331 © CENGAGE EMEA 2017

Figure 14b. An Increase in Demand in the
Market
Firm
(b) Short-Run Response
Quantity (firm)
0
Price
MC ATC
Profit
P1
Quantity (market)
Long-run
supply
Price
0
D1
D2
P1
S1
P2
Q1
A
Q2
P2
B
9781473725331 © CENGAGE EMEA 2017

Figure 14c. An Increase in Demand in the
P1
Firm
(c) Long-Run Response
Quantity (firm)
0
Price
MC ATC
Market
Quantity (market)
Price
0
P1
P2
Q1 Q2
Long-run
supply
B
D1
D2
S1
A
S2
Q3
C
9781473725331 © CENGAGE EMEA 2017

Why the Long-Run Supply Curve
Might Slope Upward
Some resources used in production may be available only in
limited quantities.
Firms may have different costs.
 The marginal firm is the firm that would exit the market if the price were any lower.
9781473725331 © CENGAGE EMEA 2017

Summary
The goal of firms is to maximize profit, which
equals total revenue minus total cost.
When analysing a firm’s behavior, it is
important to include all the opportunity costs of
production.
Some opportunity costs are explicit while other
opportunity costs are implicit.
9781473725331 © CENGAGE EMEA 2017

Summary
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 (MR).
To maximize profit, a firm chooses the quantity of
output such that MR equals MC.
This is also the quantity at which price equals
marginal cost (MC).
Therefore, the firm’s marginal cost curve is its
supply curve.
9781473725331 © CENGAGE EMEA 2017

Summary
In a market with free entry and exit, profits are
driven to zero in the long run and all firms
produce at the efficient scale.
Changes in demand have different effects over
different time horizons.
In the long run, the number of firms adjusts to
drive the market back to the zero-profit
equilibrium.
9781473725331 © CENGAGE EMEA 2017

Summary
In the short run, when a firm cannot recover its
fixed costs, the firm will choose to shut down
temporarily if the price of the good is less than
average variable cost.
In the long run, when the firm can recover both
fixed and variable costs, it will choose to exit if
the price is less than average total cost.
9781473725331 © CENGAGE EMEA 2017

Summary
A firm’s costs reflect its production process.
A typical firm’s production function gets flatter
as the quantity of input increases, displaying
the property of diminishing marginal product.
A firm’s total costs are divided between fixed
and variable costs. Fixed costs do not change
when the firm alters the quantity of output
produced; variable costs do change as the firm
alters quantity of output produced.
9781473725331 © CENGAGE EMEA 2017

Summary
Average total cost is total cost divided by the
quantity of output.
Marginal cost is the amount by which total cost
would rise if output were increased by one unit.
The marginal cost always rises with the
quantity of output.
Average cost first falls as output increases and
then rises.
9781473725331 © CENGAGE EMEA 2017

Summary
The average total cost curve is U-shaped.
The marginal cost curve always crosses the
average total cost curve at the minimum of
ATC.
A firm’s costs often depend on the time horizon
being considered.
In particular, many costs are fixed in the short
run but variable in the long run.
9781473725331 © CENGAGE EMEA 2017

Ch_06 Firms in Competitive Markets_1642010520.ppt

Recommended

Recommended

More Related Content

Similar to Ch_06 Firms in Competitive Markets_1642010520.ppt

Similar to Ch_06 Firms in Competitive Markets_1642010520.ppt (20)

Recently uploaded

Recently uploaded (20)

Ch_06 Firms in Competitive Markets_1642010520.ppt