Chapter+Fourteen

=Chapter 14 = = =  Competitive Market


 I Characteristics of Competitive Market - identical product - many sellers and buyers - free entry and exit How do competitive market get their revenue? Revenue is same as other firms: it’s total revenue minus total cost Average revenue = total revenue/ Quantity Total revenue = P X Q So, average revenue always equals Price

II. How do competitive firm maximize profit At MR = MC The firm maximizes profit when marginal cost equal marginal revenue. Source: http://images.google.co.kr/imgres?imgurl=http://www.personal.psu.edu/faculty/d/x/dxl31/econ2/Spring_2000/maxprof.gif&imgrefurl This graph shows that when marginal cost equals marginal revenue or the demand(price line in competitive firm), the quantity it produces at the point maximizes profit. Competitive firm produce at the point Qmax.

In previous chapters, we learned that in competitive market marginal revenue equals average revenue, which also equals the price. When marginal revenue is less than marginal cost, then decreasing quantity raises profit. When marginal revenue is greater than marginal cost, then increasing quantity raises profit When marginal revenue exactly equal marginal cost, competitive firms produce at that point.

Now let’s talk about all the curves in competitive firm graph Price line is horizontal because the firm is a price taker. Price again equals AR and MR Source: www.mfu.ac.th/.../ aniGif(1).gif

 This graph shows how competitive firm maximizes profit. It produces where marginal cost equals marginal revenue (demand) and down to the average total cost. Profit= (Price minus Average Total Cost) Quantity

Marginal cost curve is upward sloping because it represents firm’s willingness to supply at any price. Average total cost is the sum of fixed cost and variable cost and it is a U-shaped. For any given price, the competitive firm’s profit-maximizing quantity equals intersection of the price (MR or AR) with marginal cost.

III. Shut down (short run) or Exit(long run) When there is loss, firms either shut down or exit. Difference between shut down and exit is that if you shut down, you keep everything, but stop producing the good temporary because of market conditions, but if you exit, you leave the market completely. You shut down if and only if - Price is less than Average Variable Cost It means that production is not profitable, but you stop producing until your average variable cost goes up. You also exit the market if and only if - Price is less than Average Total cost. It means that the revenue you get from producing is less than its total cost. So when do firms enter the market? Firms enter the market when there is profit. More specifically firms enter if and only if - Price is greater than Average Total cost.

IV. Profit It previously said that profit is Total revenue minus Total cost. But there is one specific way to measure profit. To rewrite formula for profit: Profit= (Price minus ATC) Quantity As shown in this graph, Price has to be greater than the Average Total Cost and make a profit rectangle. If Price is less than the ATC, then there is loss.

V. Supply curve The difference between firm and market is that market is in big scale and includes a lot more people. The quantity of output supplied to the market equals the sum of the quantities supplied by each of the 1,000 individual firms. In the short run, marginal cost curve or supply curve of the firm and the market are identical in the short run. In the long run, supply curve is different. Let’s say that the firm is making profit in the long run. Profit encourages other firms to enter the market. The entry would shift the supply curve to the right, increase quantity of goods supplied, and decrease prices and profits. On the other hand, if the firm were making losses, more firms would leave the market. Their exit would shift the supply curve left, decrease quantity supplied, and drive up the prices and profits. This continuous process entry and exit would only end when Average Total Cost is equal to the Price. At the end of the process, the firms that remain in the market would be making zero economic profit. This analysis leads to the argument that when marginal cost curve is equal to average total cost, the average total cost is in its minimum. We call this efficient scale. If firms in the market would be making zero profit in the long run, why do firms stay in this business? The answer is simple: total cost covers all expenses. It includes the worker’s wages, the opportunity cost, and money for inputs. Even when the firm is making zero profit, they are satisfied with their business.


<span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"> - Competitive Market is a price taker. The price line is horizontal. Price equals marginal revenue and average revenue. - To maximize profit, firm produces at the intersection of marginal cost and marginal revenue. This point of intersection is called profit maximizing quantity - If firms cannot produce goods that cover the variable costs, the firm would temporarily shut down. If firms cannot cover their average total cost, then the firm would exit the market in the long run. In contrast, if the firm is able to make goods greater than the average total cost, then the firm would enter the market - The profit is zero in the long run because in the long run, firms produce at the efficient scale, which is ATC’s minimum.

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<span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"><span style="font-size: 110%; font-family: 'Comic Sans MS',cursive;"> 1. Define characteristics of competitive market

2. In what circumstances does the firm shut down and exit? Explain both.

3. How do we specifically measure profit? a. total cost minus average total cost b. Total revenue minus marginal revenue c. (Price minus Average Total cost) times the quantity d. (Price minus Variable Cost) times inputs and outputs

4. Why do firms stay in the market when they are making zero profit?

Answer to chap 14

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