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Firms In Competetive Markets_Chapter 14_Microrconomics_G. Mankew
- 1. Chapter 14Chapter 14 Firms inFirms in CompetitiveCompetitive MarketsMarkets ©© 2002 by Nelson, a division of Thomson Canada Limited2002 by Nelson, a division of Thomson Canada Limited
- 2. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • Learn what characteristics make a market competitive. • Examine how competitive firms decide how much output to produce. • Examine how competitive firms decide when to shut down production temporarily. • Examine how competitive firms decide whether to exit or entry the market. • See how firm behaviour determines a market’s short-run and long-run supply curves. • Learn what characteristics make a market competitive. • Examine how competitive firms decide how much output to produce. • Examine how competitive firms decide when to shut down production temporarily. • Examine how competitive firms decide whether to exit or entry the market. • See how firm behaviour determines a market’s short-run and long-run supply curves. In this chapter you will…In this chapter you will…
- 3. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • 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 can freely enter or exit the 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 can freely enter or exit the market. WHAT IS A COMPETITIVEWHAT IS A COMPETITIVE MARKETMARKET
- 4. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • 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. –Each buyer and seller takes the market price as given. • 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. –Each buyer and seller takes the market price as given. WHAT IS A COMPETITIVEWHAT IS A COMPETITIVE MARKETMARKET
- 5. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • A competitive market has many buyers and sellers trading identical products so that each buyer and seller is a price taker. –Buyers and sellers must accept the price determined by the market. • A competitive market has many buyers and sellers trading identical products so that each buyer and seller is a price taker. –Buyers and sellers must accept the price determined by the market. WHAT IS A COMPETITIVEWHAT IS A COMPETITIVE MARKETMARKET
- 6. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • Total revenue for a firm is the selling price times the quantity sold. TR = (PTR = (P ×× Q)Q) • Total revenue is proportional to the amount of output. • 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. • Total revenue for a firm is the selling price times the quantity sold. TR = (PTR = (P ×× Q)Q) • Total revenue is proportional to the amount of output. • 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. The Revenue of a CompetitiveThe Revenue of a Competitive FirmFirm
- 7. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • In perfect competition, average revenue equals the price of the good. • In perfect competition, average revenue equals the price of the good. The Revenue of a CompetitiveThe Revenue of a Competitive FirmFirm Average Revenue = Total revenue Quantity Price Quantity Quantity Price = × =
- 8. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • Marginal revenue is the change in total revenue from an additional unit sold. • For competitive firms, marginal revenue equals the price of the good. • Marginal revenue is the change in total revenue from an additional unit sold. • For competitive firms, marginal revenue equals the price of the good. The Revenue of a CompetitiveThe Revenue of a Competitive FirmFirm MR =MR =∆∆TR/TR/ ∆∆QQ
- 9. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi Table 14-1: Total, Average, and MarginalTable 14-1: Total, Average, and Marginal Revenue for a Competitive FirmRevenue for a Competitive Firm 6 64868 6 64267 6 63666 6 63065 6 62464 6 61863 $ 6 61262 $ 6$ 6$ 61 (MR = ∆TR/∆Q)(AR = TR/ Q)(TR = P x Q)(P)(Q) Marginal Revenue Average Revenue Total RevenuePrice Quantity (in litres)
- 10. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • The goal of a competitive firm is to maximize profit, which equals total revenue minus total cost. • This means that the firm will want to produce the quantity that maximizes the difference between total revenue and total cost. • The goal of a competitive firm is to maximize profit, which equals total revenue minus total cost. • This means that the firm will want to produce the quantity that maximizes the difference between total revenue and total cost. PROFIT MAXIMIZATION AND THEPROFIT MAXIMIZATION AND THE COMPETITIVE FIRM’S SUPPLY CURVECOMPETITIVE FIRM’S SUPPLY CURVE
- 11. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi Table 14-2: Profit Maximization: A NumericalTable 14-2: Profit Maximization: A Numerical ExampleExample (MR - MC) Change in Profit - 3 - 2 - 1 0 1 96 147488 86 438427 76 630366 66 723305 56 717244 246 612183 336 48122 $ 4$ 2$ 6 1561 - $ 3$ 3$ 00 (MC = ∆TC/∆Q) (MR = ∆TR/∆Q)(TR - TC)(TC)(TR)(Q) Marginal Cost Marginal RevenueProfitTotal Cost Total Revenue Quantity (in litres)
- 12. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • Profit maximization occurs at the quantity where marginal revenue equals marginal cost. • When MR > MC increase Q • When MR < MC decrease Q • WhenWhen MR = MCMR = MC Profit isProfit is maximizedmaximized.. • Profit maximization occurs at the quantity where marginal revenue equals marginal cost. • When MR > MC increase Q • When MR < MC decrease Q • WhenWhen MR = MCMR = MC Profit isProfit is maximizedmaximized.. PROFIT MAXIMIZATION AND THEPROFIT MAXIMIZATION AND THE COMPETITIVE FIRM’S SUPPLY CURVECOMPETITIVE FIRM’S SUPPLY CURVE
- 13. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi Costs and Revenue Quantity 0 MC1 Q1 The firm maximizes profit by producing the quantity at which marginal cost equals marginal revenue. MC AVC Q MAX MC2 Q 2 P = MR1 = MR2 P = AR = MR ATC Figure 14-1: Profit Maximization for aFigure 14-1: Profit Maximization for a Competitive FirmCompetitive Firm
- 14. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi Price Quantity 0 MC AVC ATC P2 Q2 This section of the firm’s MC curve is also the firm’s supply curve. Q1 P1 Figure 14-2: Marginal Cost and the Firm’sFigure 14-2: Marginal Cost and the Firm’s Supply CurveSupply Curve
- 15. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • 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. • 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. A Firm’s Short-Run DecisionsA Firm’s Short-Run Decisions
- 16. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • 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. • 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. A Firm’s Short-Run DecisionsA Firm’s Short-Run Decisions
- 17. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • 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 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 A Firm’s Short-Run DecisionsA Firm’s Short-Run Decisions
- 18. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi Price Quantity 0 MC AVC ATC Firm’s short-run supply curve Firm shuts down if P < AVC Figure 14-3: The Competitive Firm’s Short-Figure 14-3: The Competitive Firm’s Short- Run Supply CurveRun Supply Curve If AVC < P < ATC, firm will produce in the S-R but at a loss. If ATC < P the firm will produce at a profit.
- 19. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • The portion of the marginal-cost curve that lies above average variable cost is the competitive firm’s short-run supply curve. • The portion of the marginal-cost curve that lies above average variable cost is the competitive firm’s short-run supply curve. A Firm’s Short-Run DecisionsA Firm’s Short-Run Decisions
- 20. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • 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 • 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 • 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 • 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 A Firm’s Long-Run Decision toA Firm’s Long-Run Decision to Enter or ExitEnter or Exit
- 21. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi Price Quantity 0 MC AVC ATC Firm’slong-run supply curve Firm shuts down if P < ATC Figure 14-4: The Competitive Firm’s Long-Figure 14-4: The Competitive Firm’s Long- Run Supply CurveRun Supply Curve
- 22. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • 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. • 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. THE SUPPLY CURVE INTHE SUPPLY CURVE IN COMPETITIVE MARKETSCOMPETITIVE MARKETS
- 23. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi (a) A Firm with Profits (b) A Firm with Losses Price Quantity 0 MC ATC P = AR = MR Profit P ATC Q Quantity 0 MC ATC P = AR = MRLoss P ATC Q Price Figure 14-5: Profit as the Area between PriceFigure 14-5: Profit as the Area between Price and Average Total Costand Average Total Cost
- 24. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • Market supply equals the sum of the quantities supplied by the individual firms in the market. • Market supply equals the sum of the quantities supplied by the individual firms in the market. THE SUPPLY CURVE INTHE SUPPLY CURVE IN COMPETITIVE MARKETSCOMPETITIVE MARKETS
- 25. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • 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. • 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. The Short Run: Market Supply withThe Short Run: Market Supply with a Fixed Number of Firmsa Fixed Number of Firms
- 26. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi (a) Individual Firm Supply (b) Market Supply Price Quantity (firm) 0 MC 100 Quantity (market) 0 Price $1.00 $2.00 200 MC 100 000 $1.00 $2.00 200 000 Figure 14-6: Market Supply with a FixedFigure 14-6: Market Supply with a Fixed Number of FirmsNumber of Firms
- 27. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • 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. • 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. The Long Run: Market Supply withThe Long Run: Market Supply with Entry and ExitEntry and Exit
- 28. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi (a) Firm’s Zero-Profit Condition (b) Market Supply Price Quantity (firm) 0 MC Quantity (market) 0 Price P = minimum ATC Supply ATC Figure 14-7: Market Supply with Entry andFigure 14-7: Market Supply with Entry and ExitExit
- 29. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • 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. • 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. The Long Run: Market Supply withThe Long Run: Market Supply with Entry and ExitEntry and Exit
- 30. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • 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. • 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. Why Stay in Business if You MakeWhy Stay in Business if You Make Zero Profit?Zero Profit?
- 31. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • An increase in demand raises price and quantity in the short run. • Firms earn profits because price now exceeds average total cost. • An increase in demand raises price and quantity in the short run. • Firms earn profits because price now exceeds average total cost. Why Stay in Business if You MakeWhy Stay in Business if You Make Zero Profit?Zero Profit?
- 32. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi (a) Initial Condition Price Quantity (firm) 0 Quantity (market) 0 Price MC P1 ATC P Short-run Supply, D1 Demand, D1 Long-run Supply P1 A Q1 Firm Market Figure 14-8: An Increase in Demand in theFigure 14-8: An Increase in Demand in the Short Run and the Long Run.Short Run and the Long Run.
- 33. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi (b) Short-Run Response Price Quantity (firm) 0 Quantity (market) 0 Price MC P1 ATC Short-run Supply, S1 D1 Long-run Supply P1 A Q1 Firm Market P2P2 D2 Profit B Q2 Figure 14-8: An Increase in Demand in theFigure 14-8: An Increase in Demand in the Short Run and the Long Run.Short Run and the Long Run.
- 34. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi (c) Long-Run Response Price Quantity (firm) 0 Quantity (market) 0 Price P1 S1 D1 Long-run Supply P1 A Q1 Market P2 D2 B Q2 MC ATC Firm S2 P1 Long-run Supply P1 C Q3 Figure 14-8: An Increase in Demand in theFigure 14-8: An Increase in Demand in the Short Run and the Long Run.Short Run and the Long Run.
- 35. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi • Some resources used in production may be available only in limited quantities. • Firms may have different costs • Marginal Firm – The marginal firm is the firm that would exit the market if the price were any lower. • Some resources used in production may be available only in limited quantities. • Firms may have different costs • Marginal Firm – The marginal firm is the firm that would exit the market if the price were any lower. Why the Long Run Supply CurveWhy the Long Run Supply Curve Might Slope UpwardMight Slope Upward
- 36. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi SummarySummary • 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. • To maximize profit, a firm chooses the quantity of output such that marginal revenue equals marginal cost. • 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. • To maximize profit, a firm chooses the quantity of output such that marginal revenue equals marginal cost.
- 37. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi SummarySummary • This is also the quantity at which price equals marginal cost. • Therefore, the firm’s marginal cost curve is its supply curve. • 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. • This is also the quantity at which price equals marginal cost. • Therefore, the firm’s marginal cost curve is its supply curve. • 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.
- 38. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi SummarySummary • 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. • 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, when the firm can recover both fixed and variable costs, it will choose to exit if the price is less than average total cost. • 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.
- 39. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi SummarySummary • In the long run, the number of firms adjusts to drive the market back to the zero-profit equilibrium. • In the long run, the number of firms adjusts to drive the market back to the zero-profit equilibrium.
- 40. Mankiw et al. Principles of Microeconomics, 2nd Canadian Edi The EndThe End