Firms in competitive market

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Firms in competitive market

  1. 1. Firms in competitive Market
  2. 2. 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
  3. 3. 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
  4. 4. 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.
  5. 5. 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).
  6. 6. Types of cost  Fixed cost  Variable cost  Marginal cost  Average cost  Total cost  E.g. Telephone bill
  7. 7. Conti… Units FC VC TC MC AC 1 10 5 15 - 15 2 10 8 18 3 9 3 10 12 22 4 7.33 4 10 17 27 5 6.75 5 10 23 33 6 6.6
  8. 8. Relationship between AC & MC Diagrammatic representation Cost/Revenue Output/Sales MC AC Q1 X Y 0
  9. 9. “Demand Faced By A Competitive Firm” versus “Market Demand” Price QTY (ones) Pm Demand faced by one competitive firm Market Demand Price QTY (millions)
  10. 10. Price Determination DS D S 300 100 5 20183 Price Demand Supply 100 18 3 200 10 10 300 5 20 Qty Price 0 X Y 200 10
  11. 11.  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. Marginal Revenue & Marginal Cost
  12. 12. The Revenue of a Competitive Firm  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
  13. 13. Total, Average, and Marginal Revenue for a Competitive Firm
  14. 14. 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. 0 Qty Price P= AR= MR P X Y
  15. 15. 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
  16. 16. Conti…
  17. 17. Figure 1 Profit Maximization for a Competitive Firm Quantity0 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
  18. 18. 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.
  19. 19. Figure 2 Marginal Cost as the Competitive Firm’s Supply Curve Quantity0 Price MC ATC AVC P1 Q1 P2 Q2 This section of the firm’s MC curve is also the firm’s supply curve.
  20. 20. 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)
  21. 21. 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 down if 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.
  22. 22. Figure 3 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.
  23. 23. 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
  24. 24. Conti…  A firm enters the market if profit is positive.  Enter if TR > TC if TR / Q > TC / Q if P > ATC
  25. 25. Figure 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
  26. 26. 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
  27. 27. Figure 5 Profit as the Area between Price and Average Total Cost (a) A Firm with Profits Quantity0 Price P = AR = MR ATCMC P ATC Q (profit-maximizing quantity) Profit
  28. 28. Figure 5 Profit as the Area between Price and Average Total Cost (a) A Firm with Profits Quantity0 Price P = AR = MR ATCMC P (profit-maximizing quantity) Q ATC =
  29. 29. Figure 5 Profit as the Area between Price and Average Total Cost (b) A Firm with Losses Quantity0 Price ATCMC (loss-minimizing quantity) P = AR = MRP ATC Q Loss
  30. 30. 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.
  31. 31. 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.
  32. 32. Figure 6: SR Market Supply with a Fixed Number of Firms (a) Individual Firm Supply Quantity (firm)0 Price MC 100 100 200 200 (b) Short Run Market Supply Quantity (market)0 Price Supply 100 100,000 200 200,000 SR
  33. 33. 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.
  34. 34. Conti… Entry  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. Exit  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.
  35. 35. Figure 7 Market Supply with Entry and Exit (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
  36. 36. 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.
  37. 37. 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 DDemand, 1 SShort-run supply, 1 P1 ATC Long-run supply P1 1Q A MC
  38. 38. Figure 8 An Increase in Demand in the Short Run and Long Run MarketFirm (b) Short-Run Response Quantity (firm)0 Price MC ATCProfit P1 Quantity (market) Long-run supply Price 0 D1 D2 P1 S1 P2 Q1 A Q2 P2 B
  39. 39. Figure 8 An Increase in Demand in the Short Run and Long Run 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
  40. 40. 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.
  41. 41. 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.
  42. 42. Thanking you...

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