Chapter+14+(Firms+in+Competitive+Markets)

**Chapter 14: Firms in Competitive Markets**
 * by R.Y**


 * Competitive market **: a market with many buyers and sellers trading identical products so that each buyer and seller is a price taker.

Competitive market is sometimes called a ‘//perfectly competitive market //’. Three characteristics: 1) There are many buyers and many sellers in the market. 2) The goods offered by the various sellers are largely the same. 3) Firms can enter and exit the market freely.

Because a competitive firm is a price taker, its '__revenue is proportional to the amount of output it produces.__' The price of the good equals both the firm’s average revenue and its marginal revenue.
 * Price takers **: buyers and sellers in competitive markets who must accept the price the market determines.

The Radcliff Farm produces a quantity of milk, Q, and sells each unit at the market price, P. So the farm’s total revenue is P X Q. For example, if a gallon of milk sells for $ 6 and the farm sells 1,000 gallons, then its total revenue = $ 6,000.

__The revenue is proportional to the amount of output. __ This is because the Radcliff farm is smaller than the big world market for milk, so it must be the price taker. The price of milk does not depend on the quantity of output that the Radcliff Farm produces and sells. The table above shows the revenue for the Radcliff Dairy Farm. The first two columns show the amount of output the farm produces and the price at which it sells the output. The third column is the farm’s total revenue (P X Q). <span style="font-family: 바탕;">The fourth column shows the ‘AVERAGE REVENUE’: the total revenue divided by the quantity sold. (AR = TR/Q) or { AR = (P X Q) / Q } <span style="font-family: 바탕;">Therefore, for all firms average revenue = the price of the good. <span style="font-family: 바탕;">The fifth column shows the MARGINAL REVENUE: the change in total revenue from an additional unit of output.

<span style="font-family: 바탕;">*For competitive firms, **<span style="font-family: 바탕;">MR = P ** *

__<span style="font-family: 바탕;">The goal of a competitive firm is to maximize profit = total revenue – total cost. __

<span style="font-family: 바탕; color: black;"> <span style="font-size: 13pt; font-family: 바탕; display: none;">
 * The Goal of Firms**

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<span style="font-family: 바탕; color: black;">**Profit Maximization for a Competitive firm**

The profit-maximizing quantity Q max is found where the horizontal P line INTERSECTS the MC curve. So, the __quantity at which MC = MR__ is the maximizing profit of the firm.



P = MR= AR Where MR = MC is the Q max.

This graph tells us three rules for PROFIT MAXIMIZATION:

__1) If MR > MC, the firm should increase its output. 2) If MC > MR, the firm should decrease its output. 3) At the profit-maximizing level of output, MR = MC.__

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<span style="font-family: 바탕; color: black;">The graph above shows the MC as the Competitive firm's Supply curve.

- An increase in the P would lead to an increase in the firm's profit maximizing quantity. - __MC = S__ because the MC curve shows the Q supplied by the firm at any given P. <span style="font-family: 바탕; color: black;">__MR = P because a competitive firm is a__ //__price taker.__//

For any P, the competitive firm's profit maximizing Q of output would be found by finding the INTERSECTION of the P with the MC curve.

Because the firm's MC curve determines the Q of the good the firm would be willing to supply at any P, the MC is also the competitive firm's SUPPLY curve.

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<span style="font-family: 바탕; color: black;">**The Relationship between MR, AR, P**

Marginal Revenue (MR): the change in TR from the sale of each ADDITIONAL unit of output.

Ave. Revenue (AR): TR / Amoung of Output (Q) This reflects how much revenue a firm obtains for a unit sold.

__For competitive firms, MR = P So, AR = P in all firms. MR = P in all competitive firms__


 * <span style="font-family: 바탕; color: black;">Relationship between MC and the firm's Supply
 * <span style="font-family: 바탕; color: black;">Q that MAXIMIZES the profit can be found with MC.
 * <span style="font-family: 바탕; color: black;">Marginal Cost crosses the ATC at its minimum.
 * <span style="font-family: 바탕; color: black;">MC intersects MR
 * <span style="font-family: 바탕; color: black;">MC= MR is the point of profit maximizing output, and MC is sufficiently covered.

<span style="font-family: 바탕; color: black;">**The Firm's Short-Run Decision to SHUT DOWN**


 * Shutdown**: A decision in the short run to stop production temporarily because of market conditions.
 * Exit**: a long-run decision to leave the market.

Shortrun and longrun differ because most firms cannot avoid the fixed costs in the SHORT run but can avoid fixed costs in the LONG run. A firm that SHUTSDOWN for a while has to pay the fixed costs, while a firm that EXITS the market does not have to pay any money.



Looking at the graph above, it is important to know that: <span style="font-family: 바탕; color: black;"> <span style="font-family: 바탕; color: black;"> __* The firm SHUTS DOWN if the revenue that it would get from producing is LESS than its VC (variable costs) of production.__
 * <span style="font-family: 바탕; color: black;">__In the short run, the competitive firm's SUPPLY curve = MC curve above the AVC.__
 * <span style="font-family: 바탕; color: black;">__If the P falls below the AVC, the firm should SHUT DOWN.__

Shut down if TR < VC

Shut down if TR/Q < VC/Q

Shut down if P < AVC

__*The competitive firm's short-run supply curve is the portion of its MC curve that lies above AVC.__

**<span style="font-family: 바탕; color: black;">Sunk cost: This is a cost that is unable to be recovered because it has already been committed. **

<span style="font-family: 바탕; color: black;"> **Firm's 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 TC. <span style="font-family: 바탕; color: black;"> The competitive firm's long fun supply curve is the portion of its MC curve that lies above ATC.
 * <span style="font-family: 바탕; color: black;">Exit if TR < TC
 * <span style="font-family: 바탕; color: black;">Exit if TR/Q < TC/Q
 * <span style="font-family: 바탕; color: black;">Exit if P < ATC
 * <span style="font-family: 바탕; color: black;">Enter if P > ATC

<span style="font-family: 바탕; color: black;">
 * Measuring Profit in our Graph for the Competitive Firm**
 * <span style="font-family: 바탕; color: black;">Profit = TR - TC
 * <span style="font-family: 바탕; color: black;">Profit = (TR/Q - TC/Q) x Q
 * <span style="font-family: 바탕; color: black;">Profit = (P - ATC) x Q

Looking at the graph above, it is important to know that: <span style="font-family: 바탕; color: black;">
 * <span style="font-family: 바탕; color: black;"> __In the Long run, if the price falls below the ATC, the firm is better off EXITING the market.__
 * <span style="font-family: 바탕; color: black;"> __In the Long run, the competitive firm's supply curve is its MC above ATC.__

__If P > ATC, the firm has positive profit.__ The firm's profit would be the area of the rectangle: (P-ATC) x Q.

__If P < ATC, the firm has losses.__ The height of the rectangle is ATC-P, and the width = Q. So the area is (ATC-P) x Q, which is the firm's loss.


 * Short Run Market Supply**

In the shortrun, the # of firms in a market is FIXED. So, the market SUPPLY curve shows the firm's MC curves.

In individual firm supply, the supply curve is known as the 'Marginal Cost curve'. In the Market Supply. it is just the 'supply curve.'

<span style="font-family: 바탕; color: black;"> <span style="font-family: 바탕; color: black;">

<span style="font-family: 바탕; color: black;">**Long Run: Market Supply with Entry and Exit**

If market is //making profit//... New firms will have an incentive to enter the market if the market earns alot of profit. --> Expand the # of firms, increase the Q of the good supplied, and decrease P and profits.

If market is //making losses//... Some firms already existing in the market would EXIT --> Reduce the # of firms, reduce the Q of good supplied, and increase P and profits.

__* At the end of this process of entry and exit, firms that remain in the market must be making zero economic profit.__

Firm's profit = ( P - ATC) x Q

The equation shows that: <span style="font-family: 바탕; color: black;"> __* The long-run equilibrium of a competitive market with free entry and exit must have firms operating at their efficient scale.__
 * <span style="font-family: 바탕; color: black;">A firm has O profit if the P = ATC.
 * <span style="font-family: 바탕; color: black;">If P < ATC, profit is neg. which makes some firms exit.
 * <span style="font-family: 바탕; color: black;">__The process of entry and exit end only when P = ATC.__
 * <span style="font-family: 바탕; color: black;">MC = ATC only when firm is operating at the MINIMUM of ATC.


 * An Increase in Demand in the Short Run and Long Run**



For explanation of the graph above, read below.

Initial condition: Market starts in a long-run equilibrium. Each firm makes 0 profit, and P = minimum ATC

1. Short-run Reponse: When demand rises from D to D', the equilibrium increases and price rises from P to P'. The quantity sold rises. Because P > ATC, firms make profit, which over time makes new firms enter the market.

2. Long-run Response: <span style="font-family: 바탕; color: black;"> This entry shifts the short-run supply curve to the right. The equilibrium returns to P but the quantity sold increases to Q'. Profits = 0. Price is back to the MINIMUM of ATC, but the market has more firms to satisfy the GREATER DEMAND. <span style="font-family: 바탕; color: black;">


 * Why Do Competitive Firms Stay in Business If they Make Zero Profit?**

Accountants keep track of explicit costs, NOT implicit costs. Whereas economists measure both. Accountants measure costs that require an outflow of money from the firm, but they do not include the oppurtunity costs of production that don't involve outflow of money.

So, at Zero-Profit Equilibrium, economic profit = O, but accounting profit = POSTIVE.


 * Why the Long Run supply curve might slope upward**

1) Some resources used in production may be available only in limited quantities.

2) Firms may have different costs.

__* The Long-run supply curve is typically more ELASTIC than the short-run supply curve because firms can ENTER and EXIT more easily in long run than in short run.__

<span style="font-family: 바탕; color: black;">
<span style="font-family: 바탕; color: black;"> Questions: Q1. What are some characteristics of competitive markets?

Q2. What are 'price takers'?

Q3. a) What is the goal of competitive firms? b) What is the formula for finding profit?

Q4.What point does the Marginal cost curve cross the ATC?

Q5. What is 'Shutdown' and 'Exit'?

Q6. When does the firm shut down?

Q7. What is a sunk cost?

Answers: A1. 1) There are many buyers and many sellers in the market. 2) The goods offered by the various sellers are largely the same. 3) Firms can enter and exit the market freely.

A2. buyers and sellers in competitive markets who must accept the price the market determines.

A3. a) To maximize the profit. b) total revenue- total cost

A4. At the minimum of ATC.

A5. Shutdown: A decision in the short run to stop production temporarily because of market conditions. Exit: a long-run decision to leave the market.

A6. If the revenue that it would get from producing is LESS than its VC (variable costs) of production.

A7.This is a cost that is unable to be recovered because it has already been committed.


 * Sources:**

Book __The Principles of Microeconomics__ by: N. Gregory Mankiw of Havard University <span style="font-family: 바탕; color: black;"> Sites: http://en.wikipedia.org/wiki/Perfect_competition http://tutor2u.net/economics/content/topics/competition/competition.htm http://www.investopedia.com/university/economics/economics6.asp http://www.economyprofessor.com/economictheories/perfect-competition.php http://william-king.www.drexel.edu/top/prin/txt/Comp/PC2.html http://www.investopedia.com/articles/trading/121001.asp?partner=answers http://www.jurgilas.net/fpdb/Econ%20111%20sum04/chapter14.htm http://en.wikipedia.org/wiki/Market_form http://www.econmodel.com/classic/ucost1.htm [|http://www.oswego.edu/~atri/e101ch910.html] http://www.auhy69.dsl.pipex.com/dd202index.html

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