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The Firms and the Competitive Market

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This presentation basically tells how the firm makes decisions in a competitive market. To make concepts here more understable, I have prepared graphs and mathematical equations.

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The Firms and the Competitive Market

  1. 1. PERFECTLY COMPETITIVE MARKET Prepared by: Richard L. Toledo
  2. 2. OBJECTIVE <ul><li>To examine how the firms make production decisions in competitive markets </li></ul>
  3. 3. Three Characteristics of a Perfectly Competitive Market <ul><li>There are many buyers and sellers in the market </li></ul><ul><li>The goods offered by the various sellers are largely the same </li></ul><ul><li>Firms can freely enter and exit the market </li></ul>
  4. 4. DEFINITION <ul><li>A market with many buyers and sellers trading identical products so that each buyer and seller is a price taker </li></ul>
  5. 5. The Revenue of a Competitive Firm <ul><li>Total revenue ( TR = P X Q )‏ </li></ul><ul><li>Average revenue ( AR = TR / Q )‏ </li></ul><ul><li>Marginal revenue ( MR = ∆TR / ∆Q )‏ </li></ul>
  6. 6. PRICE, AVERAGE REVENUE AND MARGINAL REVENUE <ul><li>Since AR = TR / Q and P = TR / Q, then, AR = P </li></ul><ul><li>Since TR = P X Q, and P is fixed, then, when Q rises by 1 unit, TR rises by P. Therefore, MR = P </li></ul>
  7. 7. PROFIT MAXIMIZATION AND THE COMPETITIVE FIRM'S SUPPLY CURVE <ul><li>The goal of a competitive firm is to maximize profit. </li></ul><ul><li>Profit = TR - TC </li></ul>
  8. 8. Profit Maximization: A Numerical Example
  9. 9. The Marginal-Cost Curve and the Firm's Supply Decision <ul><li>Three features of a cost curves </li></ul><ul><li>Marginal-cost curve (MC) is upward sloping </li></ul><ul><li>Average-total-cost curve (ATC) is U-shaped, and </li></ul><ul><li>Marginal-cost curve crosses the average- total-curve at the minimum of average total cost </li></ul>
  10. 10. Profit Maximization: Graphical Illustration COST AND REVENUE QUANTITY MC ATC P = AR = MR AVC P = MR 1 = MR 2 Q 2 Q MAX Q 1 0 MC 1 MC 2 The firm maximizes profit by producing the quantity at which marginal cost equals marginal revenue
  11. 11. Three General Rules for Profit Maximization <ul><li>If MR › MC, the firm should increase its output </li></ul><ul><li>If MC › MR, the firm should decrease its output </li></ul><ul><li>At the profit-maximizing level of output, MR = MC </li></ul>
  12. 12. MARGINAL COST AS THE FIRM'S SUPPLY CURVE PRICE QUANTITY P 2 P 1 0 Q 1 Q 2 AVC ATC MC
  13. 13. THE COMPETITIVE FIRM'S SHORT-RUN SUPPLY CURVE MC ATC AVC COSTS QUANTITY Firm's shuts down if P ‹ AVC Firm's short-run supply curve
  14. 14. The Firm's Short-Run Decision to Shut Down <ul><li>SHUTDOWN </li></ul>Refers to a short-run decision not to produce anything during a specific period of time because of current market conditions
  15. 15. When Does the Firm Need to Shutdown <ul><li>If TR ‹ VC </li></ul><ul><li>If TR / Q ‹ VC / Q </li></ul><ul><li>If P ‹ AVC for P = TR / Q and AVC = VC / Q </li></ul>
  16. 16. THE COMPETITIVE FIRM'S LONG-RUN SUPPLY CURVE MC ATC COSTS QUANTITY 0 Firms exits if P ‹ ATC Firm's long-run supply curve
  17. 17. The Firm's Long-Run Decision to Exit or Enter a Market <ul><li>EXIT AND ENTER </li></ul>Refers to a long-run decision of the firm to leave and enter the market
  18. 18. When Does The Firm Need to Exit and Enter the Market <ul><li>Exit if TR ‹ TC </li></ul><ul><li>Exit if TR /Q ‹ TC /Q </li></ul><ul><li>Exit if P ‹ ATC, and </li></ul><ul><li>Enter if P › ATC </li></ul>
  19. 19. References <ul><li>Mankiw, Gregory N., 2007. Principles of Economics: Fourth Edition, Thomson Learning Asia, 5 Shenton Way #01-01 UIC Building, Singapore </li></ul><ul><li>http://en.wikipedia.org/wiki/Perfect_competition </li></ul><ul><li>http://faculty.oxy.edu/whitney/classes/ec250/notes/content/iv.htm </li></ul>

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