FIRMS IN COMPETITIVE MARKETS

1. FIRMS IN COMPETITIVE MARKETS Chapter 14

2. The Meaning of Competition • The perfectly competitive market • A market in which no individual supplier has any influence on the market price of the product. • A price taker • A firm that has no influence over the price at which it sells its product.

3. The Meaning of Competition • 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.

4. The Meaning of Competition • A perfectly competitive market has the following outcomes: • The individual firm produces a small portion of total market output. • The firm cannot have any influence over the price it charges.

5. The market in Perfect Competition Market supply and demand S P0 Price ($/unit) D Q0 Market quantity (units/month)

6. The demand curve facing a perfectly competitive firm Individual firm demand Price ($/unit) P0 Di Individual firm’s quantity (units/month)

7. Revenue of a Competitive Firm • Total revenue for a firm is the selling pricetimes the quantity sold.

8. Revenue of a Competitive Firm • Average revenue tells us how much revenue a firm receives for the typical unit sold.

9. Revenue of a Competitive Firm • In perfect competition,average revenue equals the price of the good.

10. Revenue of a Competitive Firm • Marginal revenue is the change in total revenue from an additional unit sold.

11. Revenue of a Competitive Firm • For competitive firms, marginal revenue equals the price of the good.

12. Profit Maximisation for the Competitive Firm • The goal of a competitive firm is to maximise profit.

13. Profit Maximisation for the Competitive Firm • Profit maximisation occurs at the quantity where marginal revenue equals marginal cost.

14. Costs and Revenue Profit Maximisation for the Competitive Firm MC ATC P P = AR = MR AVC 0 Quantity

15. Profit Maximisation for the Competitive Firm • A competitive firm will adjust its production level until quantity reaches QMAX where profit is maximised.

16. Costs and Revenue Profit Maximisation for the Competitive Firm MC ATC P P = AR = MR AVC 0 QMAX Quantity

17. The Firm’s Decision to Shut Down • A shutdown refers to a short-run decision not to produce anything during a specific period of time. • Exitrefers to a long-run decision to leave the market.

18. The Firm’s Decision to Shut Down • The firm considers its sunk costs when deciding to exit, but ignores them when deciding whether to shut down.

19. The Firm’s Decision to Shut Down • The firm shuts down if the revenue it gets from producing is less than the variable cost of production.

20. The Firm’s Decision to Shut Down Costs MC ATC AVC 0 Quantity

21. The Firm’s Decision to Shut Down • The portion of the marginal-cost curve that lies above average variable cost is the competitive firm’s short-run supply curve.

22. Firm’s short-run supply curve The Firm’s Decision to Shut Down Costs MC ATC AVC 0 Quantity

23. The Long-Run Decision to Exit an Industry • In the long-run, the firm exits if the revenue it would get from producing is less than its total cost.

24. The Long-Run Decision to Enter an Industry • A firm will enter the industry if such an action would be profitable.

25. The Competitive Firm’s Long-Run Supply Curve Costs MC ATC AVC 0 Quantity

26. The Competitive Firm’s Long-Run Supply Curve • The competitive firm’s long-run supply curve is the portion of its marginal-cost curve that lies above average total cost.

27. Firm’s long-run supply curve The Competitive Firm’s Long-Run Supply Curve Costs MC ATC AVC 0 Quantity

28. Profit as the Area Between Price and Average Total Cost Price MC ATC P P = AR = MR 0 Quantity

29. Loss as the Area Between Price and Average Total Cost Price MC ATC P P = AR = MR 0 Quantity

30. Supply in a Competitive Market • Market supply equals the sum of the quantities supplied by the individual firms in the market.

31. Supply in a Competitive Market • Market Supply with a Fixed Number of Firms • For any given price, each firm supplies a quantity of output so that price equals its marginal cost.

32. The invisible hand theory • How firms respond to profits and losses • Markets with firms earning economic profits will attract resources. • Markets where firms are experiencing economic losses tend to lose resources.

33. The invisible hand in action • Key concept • Opportunities for private gain seldom remain unexploited for very long.

34. Supply in a Competitive Market • Market Supply with Entry and Exit

35. The Supply Curve in a Competitive Market (a) Firm’s Zero-Profit Condition (b) Market Supply Price Price MC ATC P = minimum ATC Supply 0 Quantity (firm) 0 Quantity (market)

36. Increase in Demand in the Short Run • An increase in demand raises price and quantity in the short-run. • Firms earn profits because price now exceeds average total cost.

37. Initial Condition Market Firm Price Price ATC S MC 1 A Long-run supply P1 P1 D1 0 Quantity (firm) 0 Q1 Quantity (market)

38. Increase in Demand in the Long-Run • Over time, the short-run supply curve shifts as profits encourage new firms to enter the market.

39. Increase in Demand in the Long-Run • Price falls as new firms enter the market.

40. Increase in Demand in the Long-Run • In the new long-run equilibrium profits return to zero and price returns to minimum average total cost.

41. Increase in Demand in the Long-Run • The market has more firms to satisfy the greater demand.

42. Increase in Demand in the Short and Long-Run Market Firm Price Price ATC S1 MC B S2 A C Long-run supply P1 P1 D2 D1 0 Quantity (firm) 0 Q1 Q2 Quantity (market) Q3

43. MC S ATC Economic profit = $104 000/year Price Price ($/kg) 2.00 2.00 Price ($/kg) 1.20 D 130 65 Quantity (1000s of kg/year) Quantity (millions of kg/year) Market price of $2/kg produces economic profits

44. MC S S’ ATC 2.00 2.00 Price ($/kg) Price ($/kg) 1.50 D 130 65 Quantity (1000s of kg/year) Quantity (millions of kg/year) Economic profits attract firms

45. MC S S’ ATC Economic profit = $50 400/year 2.00 2.00 Price ($/kg) Price ($/kg) 1.50 Price 1.50 1.08 D 120 130 65 95 Quantity (1000s of kg/year) Quantity (millions of kg/year) Economic profits attract firms, reducing prices and profits

46. MC ATC S Price ($/kg) Price ($/kg) Price 1.00 1.00 D 90 125 Quantity (1000s of kg/year) Quantity (millions of kg/year) Entry of firms continues until all firms earn a normal profit

47. MC ATC Economic loss = $21 000/year Price ($/kg) S Price ($/kg) 1.05 0.75 0.75 D 140 70 90 Quantity (millions of kg/year) Quantity (1000s of kg/year) Prices below minimum ATC result in economic losses.

48. MC ATC S’ Price ($/kg) S Price ($/kg) 1.00 1.00 Price 0.75 0.75 D 90 125 Quantity (1000s of kg/year) Quantity (millions of kg/year) The departure of firms from the industry increases the market price

49. The invisible hand theory • Observations • In the long run, in a competitive market, all firms will tend to earn zero economic profits. • Zero economic profits are the consequence of price movements.

50. The invisible hand theory • Long-run supply in a competitive market • Example • What is the long-run supply curve for apples?