Chapter 12 Firms in perfectly Competitive Markets Perfectly competitive industries Unable to control the prices of the products they sell Unable to earn a an economic profit in the long run o Firms in these industries sell identical products o It is easy for new firms to enter these industries Perfectly Competitive Markets Must be many buys and many firms all of which are small relative to the market Products sold by all firms in the market must be identical Must be no barriers to new firms entering the mark Perfectly Competitive Firm cannot affect the market price The actions of any single consumer or firm have no effect on the market price Price taker a buyer or seller that is unable to affect the market price Maximizing profit Profit total revenue minus total cost o Profit TR TC o AR TR Q of a product o MR change in TR change in Q Average revenue total revenue divided by the quantity of the product sold Marginal Revenue the change in total revenue from selling one more unit For a firm in a perfectly competitive market price is equal to both average revenue and marginal revenue Marginal revenue curve for a perfectly competitive firm is the same as is demand curve Optimal decisions are made at the margin 1 Profit maximizing level of output is where the difference between total revenue and total cost is the greatest 2 The profit maximizing level of output is also where marginal revenue equals marginal cost 3 Price is equal to marginal revenue only in a perfectly competitive industry MR MC P MC Profit P ATC x Q ATC TC Q Illustrating When a Firm is breaking even or Operating at a loss 1 P ATC which means the firm makes a profit 2 P ATC which means the firm breaks even its total cost its total revenue 3 P ATC which means the firm experiences a loss Deciding whether to produce or to shut down in the short run A firm experiencing a loss has 2 choices 1 Continue to produce 2 Stop production by shutting down temporarily Sunk cost a cost that has already been paid and cannot be recovered o Treat sunk costs as irrelevant to decision making As long as a firm s total revenue is greater than its variable costs it should continue to produce no matter how large or small its fixed costs are Supply Curve of a Firm in the Short Run A perfectly competitive firm s marginal cost curve is its supply curve If a firm is experiencing a loss it will shut down if its total revenue is less than its variable cost o Total revenue variable cost o P x Q VC o P AVC average variable costs The firm s marginal cost curve is its supply curve only for prices at or above Shutdown point the minimum point on a firm s average variable cost curve o If the price falls below this pint the firm shuts down production in the short run Economic profit a firm s revenues minus all its costs implicit and explicit Economic loss the situation in which a firm s total revenue is less than its total cost including all implicit costs Long run competitive equilibrium the situation in which the entry and exit of firms has resulted in the firm breaking even Long run supply curve a curve that shows the relationship in the long run between market price and the quantity supplied In the long run a perfectly competitive market will supply whatever amount of a good consumers demand t a price determined by the minimum point on the typical firm s average total cost curve o Anything that raises or lowers the costs of the typical firm in the long run will cause the long run supply curve to shift Constant cost industries average costs do not change as the industry expands production Increasing cost industries firm s costs rise as the industry expands Long run supply curve will slop upward Decreasing cost industries firm s costs fall as the industry expands Long run supply curve will slope downward Productive efficiency the situation in which a good or service is produced at the lowest possible cost Only consumers benefits from cost reductions Allocative efficiency a state of the economy in which production represents consumer preferences Every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it 1 Price of a good represents the marginal benefit consumers receive from consuming the last unit of the good sold 2 Perfectly competitive firms produce up to the point where the price of the good equal to the marginal cost of producing the last unit 3 Firms produce up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it