Quiz next Thursday (March 15) Problem Set given next Tuesday (March 13) Due March 29

1. Quiz next Thursday (March 15) • Problem Set given next Tuesday (March 13) • Due March 29 • Writing Assignment given next Tuesday (March 13) • Due April 3

2. ECON 102.004 – Principles of Microeconomics S&W, Chapter 7 The Competitive Firm Instructor: Mehmet S. Tosun, Ph.D. Department of Economics University of Nevada, Reno

3. Lecture Outline • Revenue, costs and profit maximization • Entry and exit decisions • Market supply curve • Long-run and short-run supply curves • Accounting vs. Economic profits

4. Competition • Many firms do business in industries with a great deal of competitive pressure. • The flower seller at the local farmer’s market • A chip manufacturer in China or South Korea • A large firm such as Microsoft • All face stiff competition in their industries.

5. Revenue • A firm's income or total revenue, TR = pQ. • Marginal Revenue: the extra revenue a firm earns from selling one extra unit • MR = ∆TR/∆Q = slope of the total revenue curve

7. Costs • Total costs are made up of variable costs (costs that vary with output) and fixed costs (or sunk costs which have already been paid and cannot be recovered). • Total costs = variable costs + fixed costs • TC = VC + FC • Marginal Cost: the extra cost of producing one additional unit of output • MC = ∆TC/∆Q = slope of the total cost curve • Average Cost: the cost per unit of output • Can also be decomposed into variable and fixed categories • Average costs = average variable costs + average fixed costs • AC = AVC + AFC

9. MC = MR (b) • Firms produce where the difference between total revenue and total cost is greatest. • This occurs where the slope of TR and the slope of TC are equal. • The slope of the TR curve is MR. • The slope of the TC curve is MC. • Profits are at a maximum where MR = MC. • Here the revenue earned on the last unit sold equals the cost of making the last unit.

10. Competitive Markets • Many buyers and sellers of a homogeneous product • Information is good, if not perfect. • Firms can enter and exit the market. • These conditions imply • Competitive firms are small compared to the large market they sell in so they are price takers. • MR = price; the firm can always sell the next unit at the going market price. • Competitive firms maximize profits where MR = MC, or p = MC. • This means that the marginal cost curve is the supply curve for the firm since the MC curve gives the profit maximizing quantity supplied for any price.

11. Entry (a) • When should a firm not currently in the market enter the market? • Answer: when it can make a profit.

13. Average Cost Curves • Different firms may have different average cost curves. • Due to: • Differences in scale • Differences in management • Different locations • And so on • These firms will enter the market at different prices; the more efficient firms will enter first.

14. Exit (a) • What causes a firm in an industry to leave an industry? • A firm leaves the industry if leaving is the best option. • That is, if the firm loses less when shut than when producing. • When a firm exits or goes out of business, it loses its sunk costs. • If its losses when producing exceed its sunk costs, the firm shuts down. • Shut if Loss > FC or if TC – TR > FC • Shut if TC = VC + FC > FC + TR (cancel FC from both sides) • Shut if VC > TR or if VC > pQ (now divide by Q) • Shut if AVC > p • Operate if p >= AVC

18. Looking Beyond the Basic Model: Sunk Costs, Entry, and Competition • The basic model of competition assumes that an industry has many firms. • Even without a large number of firms, competition may still hold. • The theory of contestable markets: the mere threat of entry may be sufficient to keep prices to competitive levels. • If sunk costs are low, any significant price increase over minimum average cost will induce entry and lower prices.

20. Long‑Run Supply versus Short‑Run Supply • Also entry and exit are more of a factor in the long run than in the short run. • So long‑run supply will be more elastic just because of entry and exit. • The long‑run supply curve may be horizontal.

21. Why Do Firms Produce If in the Long Run Profits Are Zero? • Firms produce to make profits, but under competition, economic profits are eventually driven to zero. • Most people define profits as the excess of income over expenses. • Economists define profits as income net of all costs including the opportunity costs, especially the opportunity costs of the owner's capital.

22. Owners Opportunity Costs and Economic Profit • Firms must be owned just as they must be staffed by workers. • Workers are paid a wage to compensate them for the opportunity cost of their time; this is a cost to the firm. • Likewise, owners are paid to compensate them for the opportunity cost of their capital and this is also a cost to the firm. • Owners can earn the rate of interest at the bank so a firm must pay owners at least this return. • If firms pay owners returns above the return paid by banks the extra is called economic profit.

23. Opportunity Costs (b) • Suppose the interest rate is 5% but the firm yields an 8% return to its owners. • The additional 3% is economic profit, or above normal profit. • In the long run, competition drives economic profit to zero. • So owners get just the return they could get from the bank. • This means there is no reason for firms to exit or enter. • If there were economic profits in the long run then other firms would enter. • The market supply would increase and prices would fall reducing profits. • This process continues until economic, or above normal, profit is competed away to zero.

24. Economic Rent • For most people, rent is the payment for the use of land or buildings. • For economists, rent is the extra return on an input resulting from its qualitative superiority and scarcity, rather than its marginal cost. • In a competitive industry, the marginal firm makes no profit. • Other firms earn profits that should be called economic rents. • If all firms have the same technology and face the same input prices, they will all make a zero profit in competitive equilibrium. • Some firms have a technological advantage over others or have lower input prices; they earn an economic rent.