Firms in
Competitive Markets
Chapter 14
The Meaning of Competition
A perfectly competitive market has the
following 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
(which require inputs can freely flow among
markets).
The Meaning of Competition
As a result of its characteristics,the
perfectly competitive market has the
following outcomes:
– The actions of any single buyer or seller in the
market have a negligible impact on the market
price.
– Each buyer and seller takes the market price as
given.
Buyers and sellers in competitive markets
are said to be price takers.
– Buyers and sellers must accept the price
determined by the market.
Revenue of a Competitive Firm
Total revenue for a firm is the selling price
times the quantity sold,TR = (P X Q)
Total revenue is proportional to the amount
of output.
Average revenue tells us how much revenue
a firm receives for the typical unit sold.
In perfect competition,average revenue
equals the price of the good.
Revenue of a Competitive Firm
Marginal revenue is the change in total
revenue from an additional unit sold.
MR =DTR/DQ
For competitive firms,marginal revenue
equals the price of the good.
Total,Average,and Marginal
Revenue for a Competitive Firm
Q u a n t i t y
( Q )
P r i c e
( P )
T o t a l R e v e n u e
( T R = P x Q )
A v e r a g e R e v e n u e
( A R = T R / Q )
M a r g i n a l R e v e n u e
( M R = )
1 $ 6,0 0 $ 6,0 0 $ 6,0 0
2 $ 6,0 0 $ 1 2,0 0 $ 6,0 0 $ 6,0 0
3 $ 6,0 0 $ 1 8,0 0 $ 6,0 0 $ 6,0 0
4 $ 6,0 0 $ 2 4,0 0 $ 6,0 0 $ 6,0 0
5 $ 6,0 0 $ 3 0,0 0 $ 6,0 0 $ 6,0 0
6 $ 6,0 0 $ 3 6,0 0 $ 6,0 0 $ 6,0 0
7 $ 6,0 0 $ 4 2,0 0 $ 6,0 0 $ 6,0 0
8 $ 6,0 0 $ 4 8,0 0 $ 6,0 0 $ 6,0 0
QTR DD /
Profit Maximization for the
Competitive Firm
The goal of a competitive firm is to
maximize profit.
This means that the firm will want to
produce the quantity that maximizes the
difference between total revenue and total
cost.
Profit Maximization,
A Numerical Example
P r i c e
( P )
Q u a n t i t y
( Q )
T o t a l R e v e n u e
( T R = P x Q )
T o t a l C o s t
( T C )
P r o fi t
( T R - T C )
M a r g i n a l R e v e n u e
( M R = )
M a r g i n a l C o s t
M C =
0 $ 0,0 0 $ 3,0 0 - $ 3,0 0
$ 6,0 0 1 $ 6,0 0 $ 5,0 0 $ 1,0 0 $ 6,0 0 $ 2,0 0
$ 6,0 0 2 $ 1 2,0 0 $ 8,0 0 $ 4,0 0 $ 6,0 0 $ 3,0 0
$ 6,0 0 3 $ 1 8,0 0 $ 1 2,0 0 $ 6,0 0 $ 6,0 0 $ 4,0 0
$ 6,0 0 4 $ 2 4,0 0 $ 1 7,0 0 $ 7,0 0 $ 6,0 0 $ 5,0 0
$ 6,0 0 5 $ 3 0,0 0 $ 2 3,0 0 $ 7,0 0 $ 6,0 0 $ 6,0 0
$ 6,0 0 6 $ 3 6,0 0 $ 3 0,0 0 $ 6,0 0 $ 6,0 0 $ 7,0 0
$ 6,0 0 7 $ 4 2,0 0 $ 3 8,0 0 $ 4,0 0 $ 6,0 0 $ 8,0 0
$ 6,0 0 8 $ 4 8,0 0 $ 4 7,0 0 $ 1,0 0 $ 6,0 0 $ 9,0 0
QTR DD / QTC DD /
P = AR = MRP=MR1
MC
Quantity0
Costs
and
Revenue
ATC
AVC
QMAX
The firm maximizes
profit by producing
the quantity at which
marginal cost equals
marginal revenue.
MC1
Q1
MC2
Q2
Profit Maximization for the
Competitive Firm...
Profit Maximization for the
Competitive Firm
Profit maximization occurs at the quantity
where marginal revenue equals marginal
cost.
When MR > MC? increase Q
When MR < MC? decrease Q
When MR = MC? Profit is
maximized.
Quantity0
Costsand
Revenue
MC
ATC
AVC
Q1
P1
P2
Q2
This section of the
firm’s MC curve is
also the firm’s
supply curve.
The Marginal-Cost Curve and the
Firm’s Supply Decision...
The Firm’s Short-Run Decision
to Shut Down
A shutdown refers to a short-run decision not to
produce anything during a specific period of
time because of current market conditions.
Exit refers to a long-run decision to leave the
market.
The firm considers its sunk costs when deciding
to exit,but ignores them when deciding whether
to shut down.
Sunk costs are costs that have already been
committed and cannot be recovered.
The Firm’s Short-Run Decision
to Shut Down
The firm shuts down if the revenue it gets
from producing is less than the variable
cost of production.
Shut down if TR < VC
Shut down if TR/Q < VC/Q
Shut down if P < AVC
The portion of the marginal-cost curve
that lies above average variable cost is the
competitive firm’s short-run supply curve.
Quantity
ATC
AVC
0
Costs
MC
If P < AVC,
shut down.
If P > AVC,
keep producing
in the short run.
If P > ATC,
keep producing
at a profit.
Firm’s short-run
supply curve.
The Firm’s Short-Run Decision
to Shut Down
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.
Exit if TR < TC
Exit if TR/Q < TC/Q
Exit if P < ATC
A firm will enter the industry if such an
action would be profitable,
Enter if TR > TC
Enter if TR/Q > TC/Q
Enter if P > ATC
The Firm’s Long-Run Decision
to Exit or Enter a Market
Quantity
MC = Long-run S
ATC
AVC
0
Costs
Firm enters
if P > ATC
The Competitive Firm’s
Long-Run Supply Curve...
Firm exits
if P < ATC
The Competitive Firm’s
Long-Run Supply Curve...
The competitive firm’s long-run supply
curve is the portion of its marginal-cost
curve that lies above average total cost.
Quantity
MC
ATC
AVC
0
Costs
Firm’s long-run
supply curve
The Competitive Firm’s
Long-Run Supply Curve...
The Firm’s Short-Run and
Long-Run Supply Curves
Short-Run Supply Curve
– The portion of its marginal cost curve that lies
above average variable cost.
Long-Run Supply Curve
– The marginal cost curve above the minimum
point of its average total cost curve.
Profit
Q Quantity0
Price
P = AR = MR
ATCMC
P
ATC
Profit-maximizing quantity
a,A Firm with Profits
Measuring Profit in the Graph for
the Competitive Firm...
Loss
Quantity0
Price
P = AR = MR
ATCMC
P
Q
Loss-minimizing quantity
ATC
b,A Firm with Losses
Measuring Profit in the Graph for
the Competitive Firm...
Supply in a Competitive Market
Market supply equals the sum of the
quantities supplied by the individual
firms in the market,
Two Cases:
– A market with a fixed number of firms.
– A market in which the number of firms can
change.
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 reflects the
individual firms’ marginal cost curves,
(a) Individual Firm Supply
Quantity
(firm)
0
Price
(b) Market Supply
Quantity
(market)
Price
0
SupplyMC
1.00
$2.00
100 200
1.00
$2.00
100,000 200,000
The Short Run,Market Supply with
a Fixed Number of Firms
The Long Run,Market Supply
with Entry and Exit
Firms will enter or exit the market until
economic profit is driven to zero.
In the long run,price equals the minimum
of average total cost where p=MC=AC.
The long-run market supply curve is
horizontal at this price.
(a) Firm’s Zero-Profit Condition
Quantity
(firm)0
Price
P =
minimum
ATC
(b) Market Supply
Quantity
(market)
Price
0
Supply
MC
ATC
The Long Run,Market Supply
with Entry and Exit
At the end of the process of entry and exit,
firms that remain must be making zero
economic profit.
The process of entry & exit ends only
when price and average total cost are
driven to equality.
Long-run equilibrium must have firms
operating at their efficient scale.
The Long Run,Market Supply
with Entry and Exit
Firms Stay in Business
with Zero Profit
Profit equals total revenue minus total
cost.
Total cost includes all the opportunity
costs of the firm.
In the zero-profit equilibrium,the firm’s
revenue compensates the owners for the
time and money they expend to keep the
business going.
Increase in Demand
in the Short Run
An increase in demand raises price and
quantity in the short run.
Firms earn profits because price now
exceeds average total cost.
MarketFirm
Quantity
(firm)0
Price
MC ATC
P1
Quantity
(market)
Price
0
D1
P1
Q1
A
S1
Long-run
supply
(a) Initial Condition
P
Increase in Demand
in the Short Run
D2
MarketFirm
Quantity
(firm)0
Price
MC ATC
P1
Quantity
(market)
Price
0
D1
P1
Q1
A
S1
Long-run
supply
(b) Short-Run Response
Q2
B
P2 P2
Profit
Increase in Demand
in the Short Run
MarketFirm
Quantity
(firm)0
Price
MC ATC
P1
Quantity
(market)
Price
0
D1
P1
Q1
A
S1
Long-run
supply
(c) Long-Run Response
D2
B
Q2
P2
S2
C
Q3
Increase in Demand
in the Short Run
Why the Long-Run Supply Curve
Might Slope Upward
Some resources used in production may
be available only in limited quantities.
Firms may have different costs.
Marginal Firm
The marginal firm is the firm that would
exit the market if the price were any lower.
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.
To maximize profit a firm chooses the
quantity of output such that marginal
revenue equals marginal cost,
Summary
This is also the quantity at which price equals
marginal cost.
Therefore,the firm’s marginal cost curve is its
supply curve.
In the short run when a firm cannot recover its
fixed costs,the firm will choose to shut down
temporarily if the price of the good is less than
average variable cost.
In the long run when the firm cannot recover
both fixed and variable costs,it will choose to
exit if the price is less than average total cost.
Summary
In a market with free entry and exit,
profits are driven to zero in the long run
and all firms produce at the efficient scale.
Changes in demand have different effects
over different time horizons.
Exercise # 14
Problems and applications
– #3,#5,#12
经济学可以更有趣
为什么牛奶的盒子是方的，可乐的瓶子是圆的？
为什么普通冰箱的冷藏柜里有灯而冷冻柜没有？
Sub-Zero生产的 pro 48在每一个单独的冰格里都安了灯。
售价是 14450美元！
为什么 DVD和 CD光盘的大小一样，但是包装盒子 DVD却比
CD大得多。再联系一下盗版光盘。
为什么一辆售价 2万美元的新车租金为 40美元一天，而 500美元一件的晚礼服租金却要 90美元一天？
为什么我们买的家用电器的功能远多于我们常用的？
为什么顾客临时取消预订，租车公司不另外收费而酒店和航空公司却要另外收费？
Competitive Markets
Chapter 14
The Meaning of Competition
A perfectly competitive market has the
following 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
(which require inputs can freely flow among
markets).
The Meaning of Competition
As a result of its characteristics,the
perfectly competitive market has the
following outcomes:
– The actions of any single buyer or seller in the
market have a negligible impact on the market
price.
– Each buyer and seller takes the market price as
given.
Buyers and sellers in competitive markets
are said to be price takers.
– Buyers and sellers must accept the price
determined by the market.
Revenue of a Competitive Firm
Total revenue for a firm is the selling price
times the quantity sold,TR = (P X Q)
Total revenue is proportional to the amount
of output.
Average revenue tells us how much revenue
a firm receives for the typical unit sold.
In perfect competition,average revenue
equals the price of the good.
Revenue of a Competitive Firm
Marginal revenue is the change in total
revenue from an additional unit sold.
MR =DTR/DQ
For competitive firms,marginal revenue
equals the price of the good.
Total,Average,and Marginal
Revenue for a Competitive Firm
Q u a n t i t y
( Q )
P r i c e
( P )
T o t a l R e v e n u e
( T R = P x Q )
A v e r a g e R e v e n u e
( A R = T R / Q )
M a r g i n a l R e v e n u e
( M R = )
1 $ 6,0 0 $ 6,0 0 $ 6,0 0
2 $ 6,0 0 $ 1 2,0 0 $ 6,0 0 $ 6,0 0
3 $ 6,0 0 $ 1 8,0 0 $ 6,0 0 $ 6,0 0
4 $ 6,0 0 $ 2 4,0 0 $ 6,0 0 $ 6,0 0
5 $ 6,0 0 $ 3 0,0 0 $ 6,0 0 $ 6,0 0
6 $ 6,0 0 $ 3 6,0 0 $ 6,0 0 $ 6,0 0
7 $ 6,0 0 $ 4 2,0 0 $ 6,0 0 $ 6,0 0
8 $ 6,0 0 $ 4 8,0 0 $ 6,0 0 $ 6,0 0
QTR DD /
Profit Maximization for the
Competitive Firm
The goal of a competitive firm is to
maximize profit.
This means that the firm will want to
produce the quantity that maximizes the
difference between total revenue and total
cost.
Profit Maximization,
A Numerical Example
P r i c e
( P )
Q u a n t i t y
( Q )
T o t a l R e v e n u e
( T R = P x Q )
T o t a l C o s t
( T C )
P r o fi t
( T R - T C )
M a r g i n a l R e v e n u e
( M R = )
M a r g i n a l C o s t
M C =
0 $ 0,0 0 $ 3,0 0 - $ 3,0 0
$ 6,0 0 1 $ 6,0 0 $ 5,0 0 $ 1,0 0 $ 6,0 0 $ 2,0 0
$ 6,0 0 2 $ 1 2,0 0 $ 8,0 0 $ 4,0 0 $ 6,0 0 $ 3,0 0
$ 6,0 0 3 $ 1 8,0 0 $ 1 2,0 0 $ 6,0 0 $ 6,0 0 $ 4,0 0
$ 6,0 0 4 $ 2 4,0 0 $ 1 7,0 0 $ 7,0 0 $ 6,0 0 $ 5,0 0
$ 6,0 0 5 $ 3 0,0 0 $ 2 3,0 0 $ 7,0 0 $ 6,0 0 $ 6,0 0
$ 6,0 0 6 $ 3 6,0 0 $ 3 0,0 0 $ 6,0 0 $ 6,0 0 $ 7,0 0
$ 6,0 0 7 $ 4 2,0 0 $ 3 8,0 0 $ 4,0 0 $ 6,0 0 $ 8,0 0
$ 6,0 0 8 $ 4 8,0 0 $ 4 7,0 0 $ 1,0 0 $ 6,0 0 $ 9,0 0
QTR DD / QTC DD /
P = AR = MRP=MR1
MC
Quantity0
Costs
and
Revenue
ATC
AVC
QMAX
The firm maximizes
profit by producing
the quantity at which
marginal cost equals
marginal revenue.
MC1
Q1
MC2
Q2
Profit Maximization for the
Competitive Firm...
Profit Maximization for the
Competitive Firm
Profit maximization occurs at the quantity
where marginal revenue equals marginal
cost.
When MR > MC? increase Q
When MR < MC? decrease Q
When MR = MC? Profit is
maximized.
Quantity0
Costsand
Revenue
MC
ATC
AVC
Q1
P1
P2
Q2
This section of the
firm’s MC curve is
also the firm’s
supply curve.
The Marginal-Cost Curve and the
Firm’s Supply Decision...
The Firm’s Short-Run Decision
to Shut Down
A shutdown refers to a short-run decision not to
produce anything during a specific period of
time because of current market conditions.
Exit refers to a long-run decision to leave the
market.
The firm considers its sunk costs when deciding
to exit,but ignores them when deciding whether
to shut down.
Sunk costs are costs that have already been
committed and cannot be recovered.
The Firm’s Short-Run Decision
to Shut Down
The firm shuts down if the revenue it gets
from producing is less than the variable
cost of production.
Shut down if TR < VC
Shut down if TR/Q < VC/Q
Shut down if P < AVC
The portion of the marginal-cost curve
that lies above average variable cost is the
competitive firm’s short-run supply curve.
Quantity
ATC
AVC
0
Costs
MC
If P < AVC,
shut down.
If P > AVC,
keep producing
in the short run.
If P > ATC,
keep producing
at a profit.
Firm’s short-run
supply curve.
The Firm’s Short-Run Decision
to Shut Down
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.
Exit if TR < TC
Exit if TR/Q < TC/Q
Exit if P < ATC
A firm will enter the industry if such an
action would be profitable,
Enter if TR > TC
Enter if TR/Q > TC/Q
Enter if P > ATC
The Firm’s Long-Run Decision
to Exit or Enter a Market
Quantity
MC = Long-run S
ATC
AVC
0
Costs
Firm enters
if P > ATC
The Competitive Firm’s
Long-Run Supply Curve...
Firm exits
if P < ATC
The Competitive Firm’s
Long-Run Supply Curve...
The competitive firm’s long-run supply
curve is the portion of its marginal-cost
curve that lies above average total cost.
Quantity
MC
ATC
AVC
0
Costs
Firm’s long-run
supply curve
The Competitive Firm’s
Long-Run Supply Curve...
The Firm’s Short-Run and
Long-Run Supply Curves
Short-Run Supply Curve
– The portion of its marginal cost curve that lies
above average variable cost.
Long-Run Supply Curve
– The marginal cost curve above the minimum
point of its average total cost curve.
Profit
Q Quantity0
Price
P = AR = MR
ATCMC
P
ATC
Profit-maximizing quantity
a,A Firm with Profits
Measuring Profit in the Graph for
the Competitive Firm...
Loss
Quantity0
Price
P = AR = MR
ATCMC
P
Q
Loss-minimizing quantity
ATC
b,A Firm with Losses
Measuring Profit in the Graph for
the Competitive Firm...
Supply in a Competitive Market
Market supply equals the sum of the
quantities supplied by the individual
firms in the market,
Two Cases:
– A market with a fixed number of firms.
– A market in which the number of firms can
change.
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 reflects the
individual firms’ marginal cost curves,
(a) Individual Firm Supply
Quantity
(firm)
0
Price
(b) Market Supply
Quantity
(market)
Price
0
SupplyMC
1.00
$2.00
100 200
1.00
$2.00
100,000 200,000
The Short Run,Market Supply with
a Fixed Number of Firms
The Long Run,Market Supply
with Entry and Exit
Firms will enter or exit the market until
economic profit is driven to zero.
In the long run,price equals the minimum
of average total cost where p=MC=AC.
The long-run market supply curve is
horizontal at this price.
(a) Firm’s Zero-Profit Condition
Quantity
(firm)0
Price
P =
minimum
ATC
(b) Market Supply
Quantity
(market)
Price
0
Supply
MC
ATC
The Long Run,Market Supply
with Entry and Exit
At the end of the process of entry and exit,
firms that remain must be making zero
economic profit.
The process of entry & exit ends only
when price and average total cost are
driven to equality.
Long-run equilibrium must have firms
operating at their efficient scale.
The Long Run,Market Supply
with Entry and Exit
Firms Stay in Business
with Zero Profit
Profit equals total revenue minus total
cost.
Total cost includes all the opportunity
costs of the firm.
In the zero-profit equilibrium,the firm’s
revenue compensates the owners for the
time and money they expend to keep the
business going.
Increase in Demand
in the Short Run
An increase in demand raises price and
quantity in the short run.
Firms earn profits because price now
exceeds average total cost.
MarketFirm
Quantity
(firm)0
Price
MC ATC
P1
Quantity
(market)
Price
0
D1
P1
Q1
A
S1
Long-run
supply
(a) Initial Condition
P
Increase in Demand
in the Short Run
D2
MarketFirm
Quantity
(firm)0
Price
MC ATC
P1
Quantity
(market)
Price
0
D1
P1
Q1
A
S1
Long-run
supply
(b) Short-Run Response
Q2
B
P2 P2
Profit
Increase in Demand
in the Short Run
MarketFirm
Quantity
(firm)0
Price
MC ATC
P1
Quantity
(market)
Price
0
D1
P1
Q1
A
S1
Long-run
supply
(c) Long-Run Response
D2
B
Q2
P2
S2
C
Q3
Increase in Demand
in the Short Run
Why the Long-Run Supply Curve
Might Slope Upward
Some resources used in production may
be available only in limited quantities.
Firms may have different costs.
Marginal Firm
The marginal firm is the firm that would
exit the market if the price were any lower.
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.
To maximize profit a firm chooses the
quantity of output such that marginal
revenue equals marginal cost,
Summary
This is also the quantity at which price equals
marginal cost.
Therefore,the firm’s marginal cost curve is its
supply curve.
In the short run when a firm cannot recover its
fixed costs,the firm will choose to shut down
temporarily if the price of the good is less than
average variable cost.
In the long run when the firm cannot recover
both fixed and variable costs,it will choose to
exit if the price is less than average total cost.
Summary
In a market with free entry and exit,
profits are driven to zero in the long run
and all firms produce at the efficient scale.
Changes in demand have different effects
over different time horizons.
Exercise # 14
Problems and applications
– #3,#5,#12
经济学可以更有趣
为什么牛奶的盒子是方的，可乐的瓶子是圆的？
为什么普通冰箱的冷藏柜里有灯而冷冻柜没有？
Sub-Zero生产的 pro 48在每一个单独的冰格里都安了灯。
售价是 14450美元！
为什么 DVD和 CD光盘的大小一样，但是包装盒子 DVD却比
CD大得多。再联系一下盗版光盘。
为什么一辆售价 2万美元的新车租金为 40美元一天，而 500美元一件的晚礼服租金却要 90美元一天？
为什么我们买的家用电器的功能远多于我们常用的？
为什么顾客临时取消预订，租车公司不另外收费而酒店和航空公司却要另外收费？
