Chapter 14 Vocab Competitive Market Perfectly Competitive A Market with MANY buyers a sellers trading IDENTICAL products so that EACH buyer and sellers are PRICE TAKERS Firms can freely ENTER of EXIT the market HORIZONTAL DEMAND CURVE P MR AR No price effect Average Revenue TR Q Marginal Revenue The change in total revenue from an additional unit sold Sunk Cost A cost that has already been committed and cannot be recovered Market Power If a firm can influence the market price of a good it sells Marginal Firm The firm that would exit the market if the price were to go any lower Info A competitive market is when each buyer and seller is small compared to the size of the market and therefore has little ability to influence market prices For all firms AVERAGE REVENUE AR PRICE P of the good For competitive firms MARGINAL REVENUE MR PRICE P of the good In a competitive market AR P MR As long as MR AR P exceeds marginal cost increasing the quantity produced raises profit output output exactly equal If marginal revenue is greater than marginal cost the firm should increase its If marginal cost is greater than marginal revenue the firm should decrease its At the profit maximizing level of output marginal revenue and marginal cost are Because the firm s marginal cost curve determines the quantity of the good the firm is willing to supply at any price the marginal cost curve is also the competitive firm s supply curve A SHUTDOWN refers to a short run decision not to produce anything during a specific period of time because of current market conditions A firm that shuts down temporarily still has to pay its fixed costs EXIT refers to a long run decision to leave the market The short run and long run decisions differ because most firms cannot avoid their fixed costs in the short run but can do so in the long run A firm that exits the market does not have to pay any costs at all fixed or variable If the firm shuts down it loses all revenue from the sale of its product At the same time it saves the variable costs of making its product but must still pay the fixed costs SHUT DOWN if P AVC EXIT if P ATC ENTER P ATC PROFIT P ATC x Q The competitive firm s short run supply curve is the portion of its marginal cost curve that lies above average variable cost The competitive firm s long run supply curve is the portion of its marginal cost curve that lies above average total cost Over short periods of time it is often difficult for firms to enter and exit so the assumption of a fixed number of firms is appropriate But over long periods of time the number of firms can adjust to changing market conditions As long as price is above average variable cost each firm s marginal cost curve is its supply curve The quantity of output supplied to the market equals the sum of the quantities supplied by each individual firm If firms already in the market are profitable then new firms will have an incentive to enter the market This entry will expand the number of firms increase the quantity of the good supplied and drive down prices and profits Conversely if firms in the market are making losses then some existing firms will exit the market Their exit will reduce the number of firms decrease the quantity of the good supplied and drive up prices and profits At the end of this process of entry and exit firms that remain in the market must be making zero economic profit The process of entry and exit ends only when price and average total cost are driven to equality Firms are operating at their efficient scale if the long run equilibrium of a competitive market have free entry and exit MC ATC at its minimum P in this case meaning firms profit maximizing level and earning 0 profit P equals marginal cost MC so the firm is maximizing profits Price also equals average total cost ATC so profits are zero New firms have no incentive to enter the market and existing firms have no incentive to leave the market In a market with free entry and exit there is only one price consistent with zero profit the minimum of average total cost As a result the long run market supply curve must be horizontal at this price as illustrated by the perfectly elastic supply curve in panel b Any price above this level would generate profit leading to entry and an increase in the total quantity supplied Any price below this level would generate losses leading to exit and a decrease in the total quantity supplied Businesses stay in business even though they make 0 ECONOMIC profit because the ACCOUNTING profit is positive There are two reasons that the long run market supply curve might slope upward Availability only in limited quantities Firms may have different costs
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