1. Market Structure Competition

2. Competitive Firm P P Industry Firm P0 P0 P0 d D 10,000,000 50,000,00030

3. Competitive Firm
A competitive firm can sell any quantity at the market price. The firm decides how much to produce but not the price. Competitive firms are “price takers”.
A competitive firm (not the industry) faces an horizontal demand function.
A competitive firm usually represents a small share of the entire industry.

4. Marginal Revenue-Competitive Firm Price $50
Quantity
Total Revenue
Price x Quantity
Marginal Revenue 1 50 2
100 3
150 4
200
Marginal revenue is constant at the level of the market price

5. Production Decision-The Firm
The general rule to maximize profits was to produce up to the point in which marginal revenue equals marginal cost (conditional on profits>0).
Marginal revenue is equal to price for a competitive firm. Therefore, a competitive firm produces a quantity at which price equals marginal cost.

6. The supply curve (firm) is equal to the marginal cost curve but…
Quantity
Marginal Cost 1 20 2 30 3 40 4 50 5 60 6 70
Supply Curve
Price
Quantity 20 1 30 2 40 3 50 4 60 5 70 6

7. The supply curve-The Firm
$ per bicycle
$ per bicycle S
d’’ d’ d MC Q Q

8. The rule for a competitive firm is to produce up to the point where the marginal cost equals the price.
Which marginal costs? Long run marginal cost or short run marginal costs?
The firm has a short run supply function and a long run supply function.

9. U-Shaped Marginal Cost
Only the upward slopping part of the marginal cost is relevant for the production decision. MC 50 MR Q1 Q2 Q

10. “Shutdown Decision” Profit=TR-TC=TR-FC-VC (TC=FC+VC)
If the firm “shuts down” it still pays the FC
Therefore, the firm will operate if
TR-VC>0 or TR>VC
TR=P*Q then TR>VC→P>AVC=VC/Q
The fix costs are irrelevant in the short run because the firm pays them even if it shuts down. Sunk cost are irrelevant even in the long run. What is considered fix cost will depend on the length of period the firm is considering.

11. Putting Everything Together-The Short Run Supply Function (the FIRM)MC AC
AVC Q2 Q

12. The Supply of the IndustrySc Sb Sa
Industry Supply P0 Q1 Q2
Q1+Q2 Q

13. The Supply of the IndustrySc Sb Sa
Industry Supply P0 P1 Q

14. The Competitive Industry in the Short Run
The Industry
The Firm P P s S P0 d D Q0 q0 q Q

15. What is the effect in the short run?
A Change in fixed costs
What is the effect in the short run?

16. The Competitive Industry in the Short Run- A Change in Variable Costs
The Industry
The Firm S’ P s’ P
s’’ s S P2 d’ P0 d D Q2 Q0 q2 q0
q2’ q Q

17. The Competitive Industry in the Short Run- A Change in DemandQ0 Q3 q0 q3 q Q

18. The Planner’s Problem
Suppose a country wants to produce 1 million units of a good at the minimum possible cost. You are told to tell “each firm” in the industry how much to produce to reach this goal.
How would you do this?
Suppose a firm is producing the last unit at a marginal cost of $5 and another firm is producing the last unit at a marginal cost of $3. You can tell the firm which is producing at a higher cost to produce one less unit and the firm producing at a lower cost to produce an additional unit. The level of output is maintained and you save $2 of cost. When every firm produces the last unit at the same marginal cost the total costs are at the minimum possible.
In a competitive equilibrium every firm produces at a point where marginal costs are equal to the price (and the price is equal for all of the firms). Hence, the market automatically produces at the lowest possible cost.

19. The Firm in the Long Run
The long run supply function (firm) is equal to the long run marginal cost when the marginal cost is above the average costs.
Firms may exit the industry in the long run. They exit if profits are negative. Profits is Revenues minus OPORTUNITY costs.
TR-TC=P*Q-TC>0 →P>TC/Q=AC
The firm “breaks even” when the price is equal to the average cost

20. Break Even Price-The FirmS AC MC
P**
Break Even Price P* Q Q’ Q

21. Long Run and Short Run Responses Rent Control-The Industry
LRS P2
P0=P3 P1 D Q1 Q2
Q0’
Q0=Q3 Q