Firms in Competitive Markets



The Meaning of Competition

Competitive market (perfectly competitive market): there are three characteristics in competitive market. There needs to be many buyers and sellers and the product sold by many sellers should be identical. And since it is a free market, enter and exit of firms is freely allowed.
-buyers and sellers in competitive market are price takers because they agree to the market prices
-anyone can freely enter or exit the market


The Revenue of a Competitive Firm

Average revenue: Total revenue / Quantity
-allows the amount of revenue that the firm received for every unit sold
-total revenue= P X Q
-for firms, Average revenue = price of product
Marginal revenue: the change in total revenue / each unit sold
-for competitive firms, marginal revenue = price of product


The Marginal Cost Curve and the Firm’s Supply Decision

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-price is horizontal because as previously discussed, firms are price takers. Therefore:
  • P equals AR equals MR
-MR goes beyond MC so increase in production increase profit
-MC is above MR in order to reduce increase in profit
-Quantity Max is where the price line meets MC curve










  • When MR > MC, quantity should increase
  • When MR < MC, quantity should decrease
- To maximize profit, MR = MC
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-Since MC decides the firm’s willingness to supply, MC is firm’s supply curve


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The Firm’s Short-Run Decision to Shut Down

-shut down is when short run firms decide not to do any actions for a while
-Exit is when long run firms decide to completely disappear in the market.
-Most firms cannot do anything to short run’s fixed cost
-In short run, when firms decide to shut down the market, the firm still has to have fixed cost in their consideration
-firms usually shut down when the revenue produced is less than the variable cost
  • SHUT DOWN when TR < VC
    • TR/Q < VC/Q
    • P < AVC
-supply curve of short run firm in competitive market is the amount of its MC.

*sunk cost: decision-made cost that it cannot be fixed



The Firm’s Long-Run Decision to Exit or Enter a Market

-variable cost AND fixed costs are all lost in long run’s exit
-when the revenue is less than the total cost, firms exit
  • EXIT when TR < TC
    • TR/Q < TC/Q
    • P < ATC (Enter when P > ATC)

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Measuring Profit in Our Graph for the Competitive Firm

  • Profit= TR- TC
    = (TR/Q – TC/Q) X Q
    = (P – ATC) X Q

Competitive firm’s long run supply curve








-MC is the supply curve

-MC is over ATC
-when P falls below ATC, firm should exit
Profit as the area between P and ATC
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The Short Run: Market Supply with a Fixed Number of Firms

-When P is above AC, MC curve equals supply curve
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The Long Run: Market Supply with Entry and Exit

-based on incentives, firms have it to enter the market
-increase in Q, decrease in P and profits
-when loosing profit, firms exit
-firms that did not exit the market must make 0 profits
Profit= (P - ATC) X Q
-when P = ATC, entry and exit process
-long run equilibrium in competitive market has functioning efficient scale
IMG_0351.JPG


Summary
A competitive market needs to have many buyers and sellers and the product sold by many sellers should be identical. And since it is a free market, enter and exit of firms is freely allowed. The price of a competitive market is formed when MC equals MR. Firms make different decisions depending on whether they’re in long run or short run.


Questions
1. Price equals _and _
2. When MR > MC, quantity should _

When MR < MC, quantity should _
3. In _shut down, _is considered and in _ exit, fixed cost and variable cost are both considered.
4. For competitive firms, marginal revenue = price of product (T/F)
5. Define Competitive market

Answers
1. Average Revenue and Marginal Revenue
2. increase, decrease
3. Short run, fixed cost, long run
4. T
5. there are three characteristics in competitive market. There needs to be many buyers and sellers and the product sold by many sellers should be identical. And since it is a free market, enter and exit of firms is freely allowed.

pictures from Mankiw's Principles of Microeconomics ch.14