1. Chapter 14 Firms in Competitive Markets

2. Different market structures shape a firm’s pricing and production decisions
Monopoly
Oligopoly
Perfectly Comp
Monop Compet

3. What is a Competitive Market?
Characteristics:
Many buyers & sellers
Goods offered are largely the same
Firms can freely enter &/or exit the market
Buyers & sellers are price takers

4. Revenue of a Competitive Firm
Total Revenue = Price x Quantity
(remember these types of firms can’t change price, so they have to change Q)
Average Revenue = TR/Quantity
Marginal Revenue = Change in TR/Change in Q
For perfectly competitive firms, AR & MR are equal to the price

5. Profit Maximization If MR > MC, increasing output raises profit
If MR < MC, decreasing output raises profit
Therefore, profit maximization is where
MR = MC

6. Profit Maximization
Since MR = Market Price for perfectly competitive firms, it looks like…

7. Profit Maximization
Since MC determines Q, it becomes the competitive firm’s supply curve

8. Short-Run Decision to Shut Down
Shutdown vs. Exit
If you temporarily shut down, you still pay fixed costs
You shut down if TR < VC or similarly, P < AVC
Competitive Firm’s short-run supply curve is portion of MC curve above AVC

9. Short-Run Decision to Shut Down

10. Sunk Costs
Cost has already been committed and cannot be recovered – ignore them in decisionmaking
Cases: Near Empty Restaurants & Off-Season Miniature Golf

11. Firm’s Long-Run Decision to Exit or Enter a Market
Firm will exit market if revenue it would get from producing is less than its total costs
(exit if P < ATC)
Firm will enter market if P > ATC
Firm’s long-run supply curve is the portion of its MC curve that lies above ATC

12. Measuring Profit
Profit = (P – ATC) x Q

13. Short Run: Fixed # of Firms
As long as P > AVC, each firm’s MC curve is its supply curve
Market is just a sum of the Q for each indiv. firm

14. Long Run: Entry & Exit
Firms will enter or exit based on incentives (are existing firms profitable?)
At the end of the process, firms that remain in the market must be making zero economic profit
This happens when P = ATC or TR = TC
SO…

15. Long-Run Equilibrium
If firms maximize profit at P = MC and P = ATC to make economic profits equal zero then…
The level of production
will be at the efficient
scale where MC = ATC

16. Why stay in business with Zero Profit?
Zero profit includes opportunity costs, so to stay in business, firm’s revenues must be compensating owner for opp. costs

17. Shift in Demand in Short & Long Run
Side by Side Analysis
If market is in long-run equilibrium, firms earn zero profit and P = min. of ATC
If demand increases, price increases and firms will produce more in short run… so, P is now greater than ATC and firms are earning profit
Profit attracts new firms and supply curve shifts to right, lowering price and returning us to zero economic profit

18. Side by Side Analysis

19. Why Long-Run Supply Curve Might Slope Upward
Normally, we assume all entrants to market face same costs (Constant Cost Industry) and ATC was unaffected by entry of others, so long-run Supply curve of industry is horizontal line at minimum of ATC

20. Why Long-Run Supply Curve Might Slope Upward
2 possible reasons why this might not be the case:
If a resource is limited in quantity, entry will increase price of resource and raise ATC
If firms have different costs, it’s likely those with lowest costs enter industry first. If demand then increases, firms that would enter will likely have higher costs