The Meaning of Competition A perfectly competitive market has the following characteristics There are many buyers and sellers in the market The goods offered by the various sellers are largely the same Firms can freely enter or exit the market The Meaning of Competition As a result of its characteristics the perfectly competitive market has the following outcomes The actions of any single buyer or seller in the market have a negligible impact on the market price Each buyer and seller takes the market price as given Buyers and sellers in competitive markets are said to be price takers Revenue of a Competitive Firm Revenue of a Competitive Firm Total revenue for a firm is the selling price times the quantity sold Total revenue is proportional to the amount of output Average revenue tells us how much revenue a firm receives for the typical unit sold In perfect competition average revenue equals the price of the good TR P X Q Average revenue Total revenue Quantity Price Quantity Quantity Price Total Average and Marginal Revenue for a Competitive Firm Revenue of a Competitive Firm Marginal revenue is the change in total revenue from an additional unit sold For competitive firms marginal revenue equals the price of the good MR TR Q Quantity Q 1 2 3 4 5 6 7 8 Price P 6 00 6 00 6 00 6 00 6 00 6 00 6 00 6 00 Total Revenue Average Revenue Marginal Revenue TR PxQ AR TR Q MR TR Q 6 00 6 00 12 00 6 00 6 00 18 00 6 00 6 00 24 00 6 00 6 00 30 00 6 00 6 00 36 00 6 00 6 00 42 00 6 00 6 00 48 00 6 00 6 00 1 Computing Profit Profit Maximization for the Competitive Firm The goal of a competitive firm is to maximize profit This means that the firm will want to produce the quantity that maximizes the difference between total revenue and total cost Profit TR TC Profit P ATC Q Profit P Q TFC TVC Profit P Q TFC AVC Q Profit Maximization A Numerical Example Price P 6 00 6 00 6 00 6 00 6 00 6 00 6 00 6 00 Quantity Q 0 1 2 3 4 5 6 7 8 Total Revenue TR PxQ 0 00 6 00 12 00 18 00 24 00 30 00 36 00 42 00 48 00 Total Cost TC 3 00 5 00 8 00 12 00 17 00 23 00 30 00 38 00 47 00 Profit TR TC 3 00 1 00 4 00 6 00 7 00 7 00 6 00 4 00 1 00 Marginal Revenue Marginal Cost MR TR Q MC TC Q 6 00 6 00 6 00 6 00 6 00 6 00 6 00 6 00 2 00 3 00 4 00 5 00 6 00 7 00 8 00 9 00 Profit Maximization for the Competitive Firm Costs and Revenue MC2 The firm maximizes profit by producing the quantity at which marginal cost equals marginal revenue MC ATC P MR1 P AR MR AVC MC1 0 Profit Maximization for the Competitive Firm When MR MC increase Q When MR MC decrease Q When MR MC Q1 QMAX Q2 Quantity The Marginal Cost Curve and the Firm s Supply Decision Costs and Revenue This section of the firm s MC curve is also the firm s supply curve MC P2 ATC P1 Profit is maximized AVC 0 Q1 Q2 Quantity 2 The Firm s Short Run Decision to Shut Down A shutdown refers to a short run decision not to produce anything during a specific period of time because of current market conditions Exit refers to a long run decision to leave the market The Firm s Short Run Decision to Shut Down 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 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 Sunk costs are costs that have already been committed and cannot be recovered The Firm s Short Run Decision to Shut Down Costs Firm s short run supply curve If P ATC keep producing at a profit ATC If P AVC keep producing in the short run AVC If P AVC shut down Quantity 0 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 MC The Firm s Long Run Decision to Exit or Enter a Market 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 3 The Firm s Long Run Decision to Exit or Enter a Market A firm will enter the industry if such an action would be profitable The Competitive Firm s Long Run Supply Curve Costs MC Long run S Firm enters Enter if TR TC if P ATC ATC Enter if TR Q TC Q Enter if P ATC AVC Firm exits if P ATC 0 The Competitive Firm s Long Run Supply Curve The competitive firm s long run supply curve is the portion of its marginal cost curve that lies above average total cost Quantity The Competitive Firm s Long Run Supply Curve Costs MC Firm s long run supply curve ATC AVC 0 The Firm s Short Run and Long Run Supply Curves Short Run Supply Curve The portion of its marginal cost curve that lies above average variable cost Quantity Measuring Profit in the Graph for the Competitive Firm Price a A Firm with Profits MC Profit P Long Run Supply Curve The marginal cost curve above the minimum point of its average total cost curve ATC P AR MR ATC 0 Q Quantity Profit maximizing quantity 4 Measuring Profit in the Graph for the Competitive Firm b A Firm with Losses Price MC ATC ATC P P AR MR Loss 0 Q Quantity Loss minimizing quantity 5