firms in competitive market
TRANSCRIPT
Firms in competitive Market
Market
It is a social arrangement that allows buyers & seller to discover information and carryout voluntary exchange of goods or services.
Mainly 4 kind of markets are there,MonopolyOligopolyMonopolisticPerfect
Perfect Competition
Meaning Characteristics
Large no. of buyers & sellersHomogenous productEasy to enter & exitPerfect knowledge to both seller & buyerPerfect mobilitySeller are price takerStraight horizontal line demand curve
Conti…
As a result of these characteristics, the perfectly competitive market has the following outcomes:The actions of any single buyer or seller in
the market have no impact on the market price.
Each buyer and seller takes the market price as given.
Eg: Agricultural products (vegetables, fruits, oils), copper, gold etc.
Conti…
Buyers and sellers must accept the price determined by the market. No single seller has market power (the power to influence the market price).
Types of cost
Fixed cost Variable cost Marginal cost Average cost Total cost
E.g. Telephone bill
Conti…
Units FC VC TC MC AC1 10 5 15 - 15
2 10 8 18 3 9
3 10 12 22 4 7.33
4 10 17 27 5 6.75
5 10 23 33 6 6.6
Relationship between AC & MC
Diagrammatic representation
Cost/Revenue
Output/Sales
MC
AC
Q1 X
Y
0
“Demand Faced By A Competitive Firm” versus “Market Demand”
Price
QTY (ones)
Pm
Demand faced by one competitive firm
Market Demand
Price
QTY (millions)
Price Determination
DS
DS
300
100
5 20183
Price Demand Supply100 18 3200 10 10300 5 20
Qty
Price
0
X
Y
200
10
Marginal revenue the change in total revenue that occurs as a result of a 1-unit change in sales..
Marginal cost is the additional cost from producing one more unit of output.
Marginal Revenue & Marginal Cost
The Revenue of a Competitive Firm
Revenue means total income generated through selling of product.
Revenue mainly of 3 kinds Total Revenue Average Revenue Marginal Revenue
Total revenue for a firm is the market price times the quantity sold.
TR = P Q
Total, Average, and Marginal Revenue for a Competitive Firm
Conti…
Price is fixed of the product in perfect competition.
So, Marginal revenue, average Revenue and price will be same for competitive firm, that can be represented by straight line horizontal curve.
0 Qty
Price
P= AR= MRP
X
Y
Profit Maximization & competitive firm’s supply curve
The goal of a competitive firm is to maximize profit.
This means that the firm wants to produce the quantity that maximizes the difference between total revenue and total cost.
P = TR - TC
Conti…
Figure 1 Profit Maximization for a Competitive Firm
Quantity0
Costsand
RevenueMC
ATC
AVC
MC1
Q1
MC2
Q2
The firm maximizesprofit by producing the quantity at whichmarginal cost equalsmarginal revenue.
QMAX
P = MR1 = MR2 P = AR = MR
Conti…
When MR > MC, profit is increasing, so must produce more.
When MR < MC, profit is decreasing, so must produce less.
When MR = MC, profit is constant, so this is the point where profit is maximized.
Figure 2 Marginal Cost as the Competitive Firm’s Supply Curve
Quantity0
Price
MC
ATC
AVCP1
Q1
P2
Q2
This section of thefirm’s MC curve isalso the firm’s supplycurve.
Firm’s short-run decision to shut down
Shut-down
It’s a decision not to produce anything during a specific period of time because of current market condition.
Have to pay sunk cost, that can not be ignored.
Exit from market
It’s a long run decision to leave the market permanently.
Not have to pay any kind of cost at all (fixed/variable)
Conti… Firm shuts down if the revenue that it would
get from production, less than its variable cost of production.
Shut down if TR < VC
Shut down if TR/Q < VC/Q
Shut down if P < AVC
Firm will lose money in shut down (paying FC) but it would lose more money staying open.
Figure 3 The Competitive Firm’s Short Run Supply Curve
MC
Quantity
ATC
AVC
0
Costs
Firmshutsdown ifP< AVC
Firm’s short-runsupply curve
If P > AVC, firm will continue to produce in the short run.
If P > ATC, the firm will continue to produce at a profit.
The Firm’s Long-Run Decision to Exit or Enter a Market
In the long run, the firm exits if the revenue it would get from producing is less than its total cost. Equivalently, firm exits (enters) if the profit is negative (positive).
Exit if TR < TC if TR/Q < TC/Q
if P < ATC
Conti…
A firm enters the market if profit is positive. Enter if TR > TC if TR / Q > TC / Q
if P > ATC
Figure 4 The Competitive Firm’s Long-Run Supply Curve
Copyright © 2004 South-Western
MC = long-run S
Firmexits ifP < ATC
Quantity
ATC
0
CostsFirm’s long-runsupply curve
Firmenters ifP > ATC
Measuring profit in competitive firm
Profit can be of three kind,Supernormal profit
AR > ACNormal profit
AR = ACSub-normal profit (Loss)
AR < AC
Figure 5 Profit as the Area between Price and Average Total Cost
(a) A Firm with Profits
Quantity0
Price
P = AR = MR
ATCMC
P
ATC
Q(profit-maximizing quantity)
Profit
Figure 5 Profit as the Area between Price and Average Total Cost
(a) A Firm with Profits
Quantity0
Price
P = AR = MR
ATCMC
P
(profit-maximizing quantity)Q
ATC =
Figure 5 Profit as the Area between Price and Average Total Cost
(b) A Firm with Losses
Quantity0
Price
ATCMC
(loss-minimizing quantity)
P = AR = MRP
ATC
Q
Loss
Supply curve in a competitive market
Market supply equals the sum of the quantities supplied by the individual firms in the market.
Market supply curve can be discussed with two cases;
Examine market with fixed no. of firmsExamine market in which no. of firms
can change due to entry & exit.
The Short Run: Market Supply with a Fixed Number of Firms
For any given price, each firm supplies a quantity of output so that its marginal cost equals price.
The market supply curve adds up the individual firms’ marginal cost curves.
Figure 6: SR Market Supply with a Fixed Number of Firms
(a) Individual Firm Supply
Quantity (firm)0
Price
MC
100
100
200
200
(b) Short Run Market Supply
Quantity (market)0
Price
Supply
100
100,000
200
200,000
SR
The Long Run: Market Supply with Entry and Exit
If in market, suppose everyone has access to same technology for producing the good & access to same markets to buy the input into production.
In such market entry & exit depend on incentives facing the owners of existing firms & entrepreneurs who could start new firms.
Conti…
Entry Existing firms earning
profit. New entry expand no. of
firm in market. Expanded no. of firm lead
to increase quantity of goods supplied.
More supply lead to down in price & profits.
Exit Firm in existing market
occurring lose. Exit of firm reduce the no.
of firm in market. Reduced market
decreased the quantity of good supplied.
Less supply lead to drive up price & profits.
Figure 7 Market Supply with Entry and Exit
(a) Firm’s Zero-Profit Condition
Quantity (firm)0
Price
(b) Long Run Market Supply
Quantity (market)
Price
0
P = minimumATC
Supply
MC
ATC
Exercise: A Shift in Demand and Short Run & Long Run Consequences
An increase in demand raises price and quantity in the short run.
Firms earn profits because price now exceeds average total cost.
Figure 8 An Increase in Demand in the Short Run and Long Run
Firm(a) Initial Condition
Quantity (firm)0
Price
Market
Quantity (market)
Price
0
DDemand, 1
SShort-run supply, 1
P1
ATC
Long-runsupply
P1
1Q
A
MC
Figure 8 An Increase in Demand in the Short Run and Long Run
MarketFirm(b) Short-Run Response
Quantity (firm)0
Price
MC ATCProfit
P1
Quantity (market)
Long-runsupply
Price
0
D1
D2
P1
S1
P2
Q1
A
Q2
P2B
Figure 8 An Increase in Demand in the Short Run and Long Run
P1
Firm(c) Long-Run Response
Quantity (firm)0
Price
MC ATC
Market
Quantity (market)
Price
0
P1
P2
Q1 Q2
Long-runsupply
B
D1
D2
S1
A
S2
Q3
C
Summary
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.
Summary
To maximize profit, a firm chooses the quantity of output such that marginal revenue equals marginal cost.
This is also the quantity at which price equals marginal cost.
Therefore, the firm’s marginal cost curve is its supply curve.
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