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Chapter 14

Chapter 14 discusses the characteristics of competitive markets, including the role of price takers and the relationship between marginal revenue and marginal cost for profit maximization. It explains the firm's short-run and long-run decisions regarding production and market entry or exit based on costs and revenues. The chapter also covers the implications of sunk costs and the dynamics of market supply in both the short and long run.

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4 views

Chapter 14

Chapter 14 discusses the characteristics of competitive markets, including the role of price takers and the relationship between marginal revenue and marginal cost for profit maximization. It explains the firm's short-run and long-run decisions regarding production and market entry or exit based on costs and revenues. The chapter also covers the implications of sunk costs and the dynamics of market supply in both the short and long run.

Uploaded by

ltdlinh7411
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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CHAPTER 14

14-1 What is a competitive market?


a. The meaning of competition
- Competitive market: a market with many buyers and sellers trading
identical products so that each buyer and seller is a price taker.
(a price taker: buyers and sellers in perfectly competitive markets
must accept the price the market determines)
- A perfectly competitive market has 2 characteristics:
+ There are many buyers and sellers in the market
+ The goods offered by the various sellers are largely the same
+ Firms can freely enter or exit the market
b. The revenue of a competitive firm
- Profit= Total revenue-total cost
- TR=Price*Quantity
- Average revenue: total revenue divided by the quantity sold ( for all
types of firms, average revenue equals the price of good )
TR
AR= Q = P
- Marginal revenue: the change in total revenue from an additional unit
sold (for competitive firms, marginal revenue equals the price of the
good)
∆ TR
MR= ∆Q

14-2 Profit maximization and the competitive firm’s supply curve


a. A simple example of profit maximization
- If increase Q by one unit, revenue rises by MR, cost rises by MC.
- If MR>MC, increase Q to raise profit
- If MR<MC, decrease Q to raise profit

b. The marginal cost curve and the firm’s supply decision


- This analysis yields 3 general rules for profit maximization:
+ If MR>MC, the firm should increase its output
+ If MC>MR, the firm should decrease its output
+ If MR=MC, it is at the profit-maximizing level of output
- For any given price, the competitive firm’s profit-maximizing
quantity of output is founded by looking at the intersection of the
price and the marginal cost curve.

- 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. ( P=MC=MR is only true
for a perfectly competitive market )
c. The firm’s short-run decision to shut down
- A shutdown: a short-run decision not to produce anything during a
specific period of time because of current market conditions.
- Exit: a long-run decision to leave the market
- Difference: A firm that shuts down temporarily still has to pay its
fixed cost, whereas a firm that exists the market does not have to pay
any costs at all, fixed or variable.
- Cost of shutting down: revenue loss=TR
- Benefit of shutting down: cost savings = VC (firm must still pay FC)
- => The firm shuts down if the revenue that it would earn from
producing is less than its variable costs of production
- >> Shut down if TR<VC
TR VC
 Divide both side by Q: C < Q  Firm’s decision rules is: shut
down if P < AVC

d. Spilt Milk and other sunk costs


- Sunk cost: a cost that has already been committed and cannot be
recovered.
- Sunk costs should be irrelevant to decisions, you must pay them
regardless of your choice
- FC is a sunk cost in a short run: The firm must pay its fixed cost
whether it produces or shuts down
- FC should not matter in the decision to shut down
e. The 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 total cost. (Exit if TR<TC)
- Or we can write the firm’s exit rule is Exit if P < ATC (a firm chooses
to exit if the price of its good is less than the average total cost of
production)
- In the long run, a new firm will enter the market if it is profitable to
do so: if TR>TC  divide both sides by Q to express the firm’s entry
decision as: 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)
f. Measuring profit in our graph for the competitive firm
- P = TR –TC
= ( P – ATC ) * Q => Firm’s profit
- P= (ATC-P)*Q => Firm’s loss
14-3 The supply curve in a competitive market
a. The short run: market supply with a fixed number of firms
- As long as P >= AVC, each firm will produce its profit-maximizing
quantity (P<AVC firms decide to shut down in SR)
- At each price, the market quantity supplied is the sum of quantities
supplied by the firms.

b. The long run: Market supply with entry and exit


- In the long run, the number of firms can change due to entry or exit
- If existing firms earn positive economic profit:
+ New firms enter, SR market supply shifts right
+ Supply increase, demand unchanged -> price falls, reducing profits
and slowing entry
- If existing firms incur losses:
+ Some firms exit, SR market supply shifts left
+ P rises, reducing remaining firms ’losses
c. Why do competitive firms stay in business if they make zero profit?
- Long-run equilibrium:
The process of entry or exit is complete remaining firms earn zero
economic profit.
- Zero economic profit occurs when P=ATC
d. Why the long-run supply curve might slope upward?

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