Firms in a Competitive Market

1. 9 Firms in a Competitive Market

2. Previously—1 • Economists break cost into explicit costs and implicit costs, and consider economic profit. • Marginal cost plays the most crucial role in a firm’s cost structure. • The MC curve always leads (pulls) the ATC and AVC curves.

3. Average Cost Curves and Marginal Cost

4. Previously—2 • Economists break cost into explicit costs and implicit costs, and consider economic profit. • Marginal cost plays the most crucial role in a firm’s cost structure. • The MC curve always leads the ATC and AVC curves. • Scale economies determine long-run costs.

5. Big Questions • How do competitive markets work? • How do firms maximize profits? • What does the supply curve look like in perfectly competitive markets?

6. Competitive Markets • Competitive markets • Many buyers and sellers • Similar goods • Firms are price takers • Free entry and exit

7. Are These Markets Really “Perfectly” Competitive?—1

8. Are These Markets Really “Perfectly” Competitive?—2

9. Economics in South Park, “Gnomes” • Harbucks moves into town, creating dire effects on the local coffee shop.

10. Economics in Two and a Half Men, “Dead from the Waist Down” • Alan tries to earn money by entering the competitive industry of personal massage.

11. Economics in The Simpsons, “Mr. Plow” • Homer buys a snow plow and goes into the snow removal business.

12. How Do Firms Maximize Profits? • How many driveways should Mr. Plow clear to maximize profits? • Want to derive a firm’sprofit-maximizing rule

13. Calculating Profits: Price = $10—1

14. Profit-Maximizing Rule—1 • Mr. Plow wants to compare his marginal revenue to his marginal cost. • Marginal revenue (MR) • MR = ΔTR ÷ ΔQ • Marginal cost (MC) • MC = ΔTC ÷ ΔQ

15. Profit-Maximizing Rule—2 • Marginal profit • Δ Profit = MR – MC • Profit-maximizing rule: • Profit is maximized by choosing the level of output such that MR = MC

16. Calculating Profits: Price = $10—2

17. Profit-Maximizing Rule—3 • Profit is maximized by choosing the level of output such that MR = MC • What should the firm do if MR > MC? • What should the firm do if MR < MC?

18. Deciding How Much to Produce • Mr. Plow will maximize profits where MR = MC. • Since he is a price taker: P* = MR.

19. Profit Maximization

20. How to Calculate Profit • Profit = (Price – Average Total Cost) x Q • Π = ($10 – $8.75) x 8 = $10

21. Class Activity: Think-Pair-Share Suppose you are the owner of a firm producing jelly beans at the average cost per case in the table below. Initially, you produce 200 cases of jelly beans per time period. Then, a new customer calls and places an order for a case, requiring you to increase your output to 201 cases. She offers you $350 for the case. Should you produce it?

22. The Firm in the Short Run • Firms can’t always make a profit. • Shutting down: • A firm will shut down if it cannot cover variable costs. • Shutting down is not the same as going out of business and exiting the industry.

23. When to Operate or Shut Down

24. Profit and Loss in the Short Run

25. Short-Run Supply Curve

26. Long-Run Supply Curve

27. Long-Run Shut Down Criteria

28. Sunk Costs • Sunk costs • Unrecoverable costs that have been incurred as a result of past decisions • Sunk-cost fallacy • Considering sunk costs when making new decisions at the margin

29. Economics in The Big Bang Theory,“The Einstein Approximation” • Leonard has a new ringtone—audio of a sinister laugh by the Joker from Batman.

30. Sunk-Cost Fallacies in Your Life—1 You are waiting in a long line with your friend at one food court restaurant while there is no line at another. Your friend says, “We might as well stay in line. We've already been waiting for 15 minutes.”

31. Sunk-Cost Fallacies in Your Life—2 After one semester of college “I’m not getting much from my experience at Tech, but I’ve already spent time and money for a whole semester here, so I don’t want to transfer to State.”

32. Practice What You Know—1 Steve runs a competitive sandwich shop. Right now, he is producing output at a level where MR > MC. To increase his profits, Steve should try to use more capital in his production. try to use more labor in his production. produce less output. produce more output.

33. Practice What You Know—2 Suppose a competitive firm is faced with a price in the short run that is below ATC but above AVC. In the short run, this firm should shut down. exit the industry. raise the price of the good. produce at the output level where MR = MC.

34. Practice What You Know—3 A competitive firm will shut down and produce output level Q = 0 if price < min. (ATC). min. (AVC) < price < min. (ATC). price < min. (AVC). P = MR.

35. The Perfectly Competitive Market Supply Curve • Our analysis so far has focused on a typical firm. • Now, we want to derive the market supply curve in the short run and long run.

36. Short-Run Market Supply

37. Signals • Signals convey information about the profitability of various markets. • What happens if existing firms are earning positive or negative profits? • When firms make zero economic profit, the market is in long-run equilibrium.

38. Practice What You Know—Short Run or Long Run?—1 • Short run: clap • Long run: snap • Either/both: stomp your feet • Dave’s Bar & Grill is producing output, but Dave is doing so with a fixed level of capital. • Short run—capital is fixed in the short run

39. Practice What You Know—Short Run or Long Run?—2 • Short run: clap • Long run: snap • Either/both: stomp your feet • Jaime owns a firm in a perfectly competitive industry. She is making positive economic profits. • Short run—in PC industries, profits can be positive in the SR but will be zero in long-run equilibrium

40. Practice What You Know—Short Run or Long Run?—3 • Short run: clap • Long run: snap • Either/both: stomp your feet • Pizza Barn builds a new restaurant. • Long run—changing levels of capital

41. Practice What You Know—Short Run or Long Run?—4 • Short run: clap • Long run: snap • Either/both: stomp your feet • Kyle is producing output and can cover his VC but not his FC expenses. • Short run—in the long run we don’t have FC expenses

42. Practice What You Know— Short Run or Long Run?—5 • Short run: clap • Long run: snap • Either/both: stomp your feet • Eric is a farmer. Given the price of corn, he chooses how much to produce. • Either/both—a profit maximizing firm always will choose the optimal q* output in both the short run and long run

43. Long-Run Market Supply

44. A Reminder about Economic Profits—1 • Why join an industry if you can’t earn an economic profit in the long run? • When a firm breaks even, they just cover both their explicit costs and implicit costs. • So the firm covers the opportunity costs of their next-best alternative business venture.

45. A Reminder about Economic Profits—2

46. Economics in I Love Lucy, “The Diner” • Ricky and Fred Mertz decide to go into business together and start a diner.

47. Market in Long-Run Equilibrium

48. Short-Run Adjustment to Demand Decrease

49. Long-Run Adjustment to Demand Decrease

50. Adjustment to a Demand Increase—1 • Let’s do it with words. Follow along and fill in the blanks. • Suppose the grape market operates in long-run equilibrium. The price is equal to _____, and firms in the market earn an economic profit equal to ______.