Chapter 14 Firms in Competitive Markets What is a Competitive Market Competitive market a market with many buyers and sellers trading identical products so that each buyer and seller is a price taker o Firms can enter or exit the market freely Average revenue total revenue divided by the quantity sold tells us how many revenue a firm receives for the typical unit sold for ALL types of firms average revenue the price of the good price x quantity quantity Marginal revenue the change in total revenue from an additional unit sold for ONLY competitive firms when quantity rises by 1 unit total revenue rises by 1 dollar marginal revenue price of the good Profit Maximization and the Competitive Firm s Supply Curve Produce the quantity of a good that makes profit as large as possible total revenue minus total cost OR you can find the marginal revenue change in total revenue divided change in quantity and the marginal cost change in total revenue divided by change in quantity and calculate the change in profit MR MC only get the quantity where the marginal revenue is the same or less than the marginal cost Marginal cost curve is upward sloping Average total cost curve is u shaped Marginal cost curve crosses the average cost curve at the minimum of average total cost The firm maximizes profit by producing the quantity at which marginal cost equals marginal revenue If marginal revenue is more than marginal cost then increase production and it would increase total revenue If marginal revenue is less than marginal cost then decrease production and it would increase total revenue Because a competitive firm is a price taker its marginal revenue equals the market price Profit maximizing quantity of output is found by looking at the intersection of the price with the marginal cost curve 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 Shutdown refers to a short term decision not to produce anything during a specific period of time bc of current market conditions o A firm shuts down if the revenue that it would earn from producing is les than the variable costs of production total revenue variable costs also good s price average variable cost Exit refers to a long run decision to leave the market The competitive firm s short run supply curve is the portion of its marginal cost curve that lies above average variable cost Sunk costs a cost that has already been committed and cannot be recovered Long run decision the firm exits the market if the revenue it would get from producing is less than the total costs total revenue total cost price average total cost The competitive firm s long run supply curve is the portion of its marginal cost curve that lies above average total cost The area of the shaded box between price and average total cost represents the firm s profit The Supply Curve in a Competitive Market In the short run the number of firms in the market is fixed as a result the market supply curve reflects the individuals firms marginal cost curves Long run number of firms can change o New firms enter market expands the number of firms increases the quantity of goods supplied and drives down prices and profits o Old firms exit market reduce the number of firms decrease the quantity of the good supplied and drive up prices and profits o In the long run equilibrium of a competitive market with free entry and exit firms must be operating at their efficient scale Efficient scale level of production with lowest average total cost The response of the market to a change in demand depends on the time horizon Long run supply curve elastic Long run supply curve might slope upward b c o Some resources used in production may be available only in limited quantities o Firms may have different costs Because firms can enter and exit more easily in the long run than in the short run the long run supply curve is typically more elastic than the short run supply curve
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