1、 2009 South-Western,a part of Cengage Learning,all rights reservedC H A P T E REconomicsPremium PowerPoint Slides by Ron Cronovich14What is a perfectly competitive market?What is marginal revenue?How is it related to total and average revenue?How does a competitive firm determine the quantity that m
2、aximizes profits?When might a competitive firm shut down in the short run?Exit the market in the long run?What does the market supply curve look like in the short run?In the long run?1FIRMS IN COMPETITIVE MARKETS2Introduction:A ScenarioThree years after graduating,you run your own business.You must
3、decide how much to produce,what price to charge,how many workers to hire,etc.What factors should affect these decisions?Your costs(studied in preceding chapter)How much competition you faceWe begin by studying the behavior of firms in perfectly competitive markets.FIRMS IN COMPETITIVE MARKETS3Charac
4、teristics of Perfect Competition1.Many buyers and many sellers.2.The goods offered for sale are largely the same.3.Firms can freely enter or exit the market.Because of 1&2,each buyer and seller is a“price taker”takes the price as given.FIRMS IN COMPETITIVE MARKETS4The Revenue of a Competitive FirmTo
5、tal revenue(TR)Average revenue(AR)Marginal revenue(MR):The change in TR from selling one more unit.TRQMR=TR=P x QTRQAR=P5Fill in the empty spaces of the table.$50$105$40$104$103$102$10$101n/a$100TRPQMRAR$106Fill in the empty spaces of the table.$50$105$40$104$103$10$10$10$10$102$10$101n/a$30$20$10$0
6、$100TR=P x QPQTRQMR=TRQAR=$10$10$10$10$10Notice that MR=PFIRMS IN COMPETITIVE MARKETS7MR=P for a Competitive FirmA competitive firm can keep increasing its output without affecting the market price.So,each one-unit increase in Q causes revenue to rise by P,i.e.,MR=P.MR=P is only true for firms in co
7、mpetitive markets.FIRMS IN COMPETITIVE MARKETS8Profit MaximizationWhat Q maximizes the firms profit?To find the answer,“think at the margin.”If increase Q by one unit,revenue rises by MR,cost rises by MC.If MR MC,then increase Q to raise profit.If MR MC,increasing Q raises profit.57751$5101010102 02
8、4$6121086$4$10(continued from earlier exercise)At any Q with MR MC,reducing Q raises profit.FIRMS IN COMPETITIVE MARKETS10P1MRMC and the Firms Supply DecisionAt Qa,MC MR.So,reduce Q to raise profit.At Q1,MC=MR.Changing Q would lower profit.QCostsMCQ1QaQbRule:MR=MC at the profit-maximizing Q.FIRMS IN
9、 COMPETITIVE MARKETS11P1MRP2MR2MC and the Firms Supply DecisionIf price rises to P2,then the profit-maximizing quantity rises to Q2.The MC curve determines the firms Q at any price.Hence,QCostsMCQ1Q2the MC curve is the firms supply curve.FIRMS IN COMPETITIVE MARKETS12Shutdown vs.ExitShutdown:A short
10、-run decision not to produce anything because of market conditions.Exit:A long-run decision to leave the market.A key difference:If shut down in SR,must still pay FC.If exit in LR,zero costs.FIRMS IN COMPETITIVE MARKETS13A Firms Short-run Decision to Shut DownCost of shutting down:revenue loss=TRBen
11、efit of shutting down:cost savings=VC (firm must still pay FC)So,shut down if TR VCDivide both sides by Q:TR/Q VC/QSo,firms decision rule is:Shut down if P AVC,then firm produces Q where P=MC.If P AVC,then firm shuts down(produces Q=0).FIRMS IN COMPETITIVE MARKETS15The Irrelevance of Sunk CostsSunk
12、cost:a cost that has already been committed and cannot be recovered Sunk costs should be irrelevant to decisions;you must pay them regardless of your choice.FC is a sunk cost:The firm must pay its fixed costs whether it produces or shuts down.So,FC should not matter in the decision to shut down.FIRM
13、S IN COMPETITIVE MARKETS16A Firms Long-Run Decision to ExitCost of exiting the market:revenue loss=TRBenefit of exiting the market:cost savings=TC (zero FC in the long run)So,firm exits if TR TCDivide both sides by Q to write the firms decision rule as:Exit if P TC.Divide both sides by Q to express
14、the firms entry decision as:Enter if P ATCFIRMS IN COMPETITIVE MARKETS18The firms LR supply curve is the portion of its MC curve above LRATC.QCostsThe Competitive Firms Supply CurveMCLRATC19Determine this firms total profit.Identify the area on the graph that represents the firms profit.QCosts,PMCAT
15、CP=$10MR50$6A competitive firm20profitQCosts,PMCATCP=$10MR50$6A competitive firmProfit per unit=P ATC=$10 6=$4Total profit=(P ATC)x Q=$4 x 50=$20021Determine this firms total loss,assuming AVC 0.FIRMS IN COMPETITIVE MARKETS332)Costs Rise as Firms Enter the MarketIn some industries,the supply of a ke
16、y input is limited(e.g.,amount of land suitable for farming is fixed).The entry of new firms increases demand for this input,causing its price to rise.This increases all firms costs.Hence,an increase in P is required to increase the market quantity supplied,so the supply curve is upward-sloping.FIRM
17、S IN COMPETITIVE MARKETS34CONCLUSION:The Efficiency of a Competitive MarketProfit-maximization:MC=MRPerfect competition:P=MRSo,in the competitive eqm:P=MCRecall,MC is cost of producing the marginal unit.P is value to buyers of the marginal unit.So,the competitive eqm is efficient,maximizes total sur
18、plus.In the next chapter,monopoly:pricing&production decisions,deadweight loss,regulation.For a firm in a perfectly competitive market,price=marginal revenue=average revenue.If P AVC,a firm maximizes profit by producing the quantity where MR=MC.If P AVC,a firm will shut down in the short run.If P AT
19、C,a firm will exit in the long run.In the short run,entry is not possible,and an increase in demand increases firms profits.With free entry and exit,profits=0 in the long run,and P=minimum ATC.35FIRMS IN COMPETITIVE MARKETS36profitA Firm With ProfitsQCosts,PMCATCPMRQATCprofit per unit=P ATCrevenue p
20、er unit=cost per unit=profit-maximizing quantityFIRMS IN COMPETITIVE MARKETS37ATClossA Firm With LossesQCosts,PMCATCPMRQloss per unitrevenue per unit=cost per unit=loss-minimizing quantityFIRMS IN COMPETITIVE MARKETS38Problems and Applications:4.Bobs lawn-mowing service is a profitmaximizing,competi
21、tive firm.Bob mows lawns for$27 each.His total cost each day is$280,of which$30 is a fixed cost.He mows 10 lawns a day.What can you say about Bobs short-run decision regarding shutdown and his long-run decision regarding exit?38FIRMS IN COMPETITIVE MARKETS398.The market for fertilizer is perfectly c
22、ompetitive.Firms in the market are producing output,but are currently making economic losses.a.How does the price of fertilizer compare to the average total cost,the average variable cost,and the marginal cost of producing fertilizer?39FIRMS IN COMPETITIVE MARKETS40b.Draw two graphs,side by side,ill
23、ustrating the present situation for the typical firm and in the market.c.Assuming there is no change in demand or the firms cost curves,explain what will happen in the long run to the price of fertilizer,marginal cost,average total cost,the quantity supplied by each firm,and the total quantity supplied to the market.40
