1. Firms in Competitive Markets Chapter 14 Copyright © 2001 by Harcourt, Inc. All rights reserved. Requests for permission to make copies of any part of the work should be mailed to: Permissions Department, Harcourt College Publishers, 6277 Sea Harbor Drive, Orlando, Florida 32887-6777.

2. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Meaning of Competition u A perfectly competitive market has the following characteristics: u There are many buyers and sellers in the market. u The goods offered by the various sellers are largely the same. u Firms can freely enter or exit the market.

3. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Meaning of Competition u As a result of its characteristics, the perfectly competitive market has the following outcomes: u The actions of any single buyer or seller in the market have a negligible impact on the market price. u Each buyer and seller takes the market price as given. u Thus, each buyer and seller is a price taker.

4. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Example of Competitive Markets n Eggs vs. Nike Sneakers. n Pay attention to the difference between the two market structures. n Which brand names do you recognize?

5. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Revenue of a Competitive Firm Total revenue for a firm is the selling price times the quantity sold. TR = (P X Q)

6. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Revenue of a Competitive Firm Marginal revenue is the change in total revenue from an additional unit sold. MR =  TR/  Q

7. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Revenue of a Competitive Firm For competitive firms, marginal revenue equals the price of the good.

8. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Total, Average, and Marginal Revenue for a Competitive Firm

9. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Profit Maximization for the Competitive Firm u The goal of a competitive firm is to maximize profit. u This means that the firm will want to produce the quantity that maximizes the difference between total revenue and total cost.

10. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Profit Maximization: A Numerical Example

11. P = AR = MR P=MR 1 MC Profit Maximization for the Competitive Firm... Quantity 0 Costs and Revenue ATC AVC Q MAX The firm maximizes profit by producing the quantity at which marginal cost equals marginal revenue. MC 1 Q1Q1 MC 2 Q2Q2 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

12. Profit Maximization for the Competitive Firm Profit maximization occurs at the quantity where marginal revenue equals marginal cost.

13. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Profit Maximization for the Competitive Firm When MR > MC  increase Q When MR < MC  decrease Q When MR = MC  Profit is maximized. The firm produces up to the point where MR=MC

14. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Interaction of Firms and Markets in Competition Firm Market PriceAndCosts Price qFqFqFqF QMQMQMQM a b c d A B q1q1q1q1 q2q2q2q2 q3q3q3q3 q4q4q4q4 Q1Q1Q1Q1 Q2Q2Q2Q2 MC P=MR 0 ATC P=MR 1 AVC S1S1S1S1 S2S2S2S2 D0D0D0D0 $10 ATC=$7 10 units

15. The Marginal-Cost Curve and the Firm’s Supply Decision... Quantity 0 Costs and Revenue MC ATC AVC Copyright © 2001 by Harcourt, Inc. All rights reserved Q1Q1 P 1 P 2 Q2Q2 This section of the firm’s MC curve is also the firm’s supply curve (long- run).

16. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Firm’s Short-Run Decision to Shut Down u A shutdown refers to a short-run decision not to produce anything during a specific period of time because of current market conditions. u Exit refers to a long-run decision to leave the market.

17. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Firm’s Short-Run Decision to Shut Down The firm considers its sunk costs when deciding to exit, but ignores them when deciding whether to shut down. u Sunk costs are costs that have already been committed and cannot be recovered.

18. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Firm’s Short-Run Decision to Shut Down u The firm shuts down if the revenue it gets from producing is less than the variable cost of production. Shut down if TR < VC Shut down if TR/Q < VC/Q Shut down if P < AVC

19. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Firm’s Short-Run Decision to Shut Down... Quantity ATC AVC 0 Costs MC If P < AVC, shut down. If P > AVC, keep producing in the short run. If P > ATC, keep producing at a profit. Firm’s short-run supply curve.

20. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Firm’s Short-Run 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.

21. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Firm’s Long-Run Decision to Exit or Enter a Market u In the long-run, the firm exits if the revenue it would get from producing is less than its total cost. Exit if TR < TC Exit if TR/Q < TC/Q Exit if P < ATC

22. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Firm’s Long-Run Decision to Exit or Enter a Market u A firm will enter the industry if such an action would be profitable. Enter if TR > TC Enter if TR/Q > TC/Q Enter if P > ATC

23. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Competitive Firm’s Long- Run Supply Curve... Quantity MC = Long-run S ATC AVC 0 Costs Firm enters if P > ATC Firm exits if P < ATC