Chapter 14 Firms in Competitive Markets Competitive market a market with many buyers and sellers trading identical products so that each buyer and seller is a price taker Buyers and sellers are price takers since they have to take whatever price is given to them in a competitive market Firms can freely enter or exit the market Average Revenue total avenue quantity sold For all types of firms average revenue equals the price of the good For competitive firms marginal revenue equals the price of the good Marginal Revenue the change in total revenue from an additional unit sold Marginal value must exceed marginal for increased quantity to raise profit If Marginal cost is above Marginal revenue decreasing one unit of production means the cost saved would exceed the revenue lost Therefore if marginal cost is above marginal revenue reducing production can increase profit At the profit maximizing level of output marginal revenue and marginal cost are exactly equal In competitive firms market price marginal revenue and average revenue In essence 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 a short run decision not to produce anything during a specific period of time because of current market conditions still has to pay its fixed cost The firm shuts down if the revenue that it would earn from producing is less than its variable costs of production If TR Q VC Q aka P AVC The competitive firm s short run supply curve is the portion of its marginal cost curve that lies above average variable cost Exit a long run decision to leave the market Does not have to pay its fixed cost Sunk cost a cost that had already been committed and cannot be recovered Do not take them into account when making business decisions Size of fix cost does not matter in supply decision The firms long run decision to exit or enter a market The firm exits the market if the revenue it would get from producing is less than its total costs Exit if TR TC TR Q TC Q therefore P ATC ENTER IF P ATC The competitive firm s long run supply curve is the portion of its marginal cost curve that lies above average total cost Profit P ATC xQ Total Revenue Total Cost Short Run Market Supply with a fixed number of firms An operating firm has zero profit if and only if the price of the good equals the average total cost of producing that good The process of entry and exit ends only when price and average total cost are driven to equality In the long run equilibrium of a competitive market with free entry and exit firms must be operating at their efficient scale In a market with free entry and exit there is only one price consistent with zero profit the minimum of average total cost A Shift in Demand in the Short Run and Long Run