Chapter 14

Firms in Competition Markets

*Firms supply curve = marginal supply curve above the
Minimum AVC*
Market is competitive is each buyer and seller is small compared to the
size of the market and have little ability to influence market price
What is a Competitive Market?
Market where are many buyers and many sellers and have very
minimal impact on the market Price (Price Takers)
Have 3 Characteristics
o Many Buyers and many Sellers
o Goods offered by various sellers are mainly the same
o Firms can freely enter and exit the market
The Revenue of a Competitive Firm
Firm trying to maximize profits which equals to total revenue
Total cost
o Maximize Profit = Total Revenue (TR) Total Cost (TC)
Revenue of Competitive Firm
o Total Revenue (TR) = Price (P) x Quantity (Q)
Average Revenue tells how much revenue a firm receives for the
typical unit sold. Total Revenue divided by Quantity Sold
o Average Revenue (AR) = P x Q/Q = P
Marginal Revenue is the change in total revenue from additional
unit sold
o MR = Change in total Revenue / Change in Quantity
o For Competitive firms Marginal Revenue = Price of Good
Profit Maximization and the Competitive Firms Supply Curve
How Firms Maximize the Profit and how decision leads to the
supply curve
Rational people think at Margin
If MR > MC, the production of good increased
If MR < MC, the production of good decreased
If MR = MC, the maximizing of profit
The Marginal-Cost Curve and the Firms Supply Decision
Effect on Cost Curves
(MC) Marginal Cost Curve is Upward
(ATC) Average Total Cost is U Shaped

MC curve Crosses the ATC at minimum of Average Total

Cost
Horizontal Line is Market Price (MP) and its horizontal
ecause the firm is price taker

For Competitive Firm, Price = AR = MR

3 rules which are key to make rational decision for making

profi
o If MR is > than MC = Increase Output
o If MC > MR = Decrease the Output
o When making maximize profit MC = MR

The Firms Short-Run Decision to Shut Down

Shut Down VS Exit
o Shut down, a short term decision, not to produce anything
during a period of time because market conditions
o Exit, Long term decision, leave the market
The Long term VS Short term because fixed cost are hard to
managed during Short term than Long Term.
The Firms Short Run Decision to shut down
Firm Loses all revenue from the sale of their product
It saves all the Variable cost but still must pay the fixed cost at
the same time
The firm shut down because revenue is less than variable cost

o Shut Down because TR < VC

o Shut Down because (TR/Q) < (VC/Q)
o Shut Down because P < AVC

Sunk Cost:
The cost which is already pent and cannot be recovered
Ignored when making decisions about various aspects of life and
Business
The Firms Long-Run Decisions to Exit or Enter the Market
When exiting, the firm lose all revenue from product sale
But also save on both Fixed and VC of production
When revenue is less than the total producing costs
o Exit when TR < VC
o When (TR/Q) < (TC/Q)
o When P < ATC
The exit price aligns with the minimum point on ATC Curve
Shutdown Price Align with minimum Point on AVC Curve
The Firm Enters the market if its profitable
When price is greater than ATC

Measuring Profit in Our Graph for the Competitive Firm

Allows us to measure the profit in graphs
o Profit = TR-TC
o Profit=(TR/Q TC/Q) x Q
o Profit = (P ATC) x Q

The Supply Curve in competitive Market

2 case to consider
1. Market with Fixed Number of firms
2. Market changing when old firm are gone and new enter
The Short Run: Market Supply with Fixed Number of Firms
For any given price, each firm supplies a quantity of output
So its marginal cost = price

The

Long Run: Market Supply with Entry and Exit

When market is profitable for older firms
Its a bonus for new firms to enter
The new firm increase the # of Firms, increasing the quantity of
goods supplied and drive down prices and profits
Vice versa
At the end of this process of entry and exit, firms that are still in
market must make zero economic profit

Long Run Equilibrium of competitive market with free entry and

exit must have firm making their efficient scale

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

In the zero Profit Equilibrium, Economic profit is zero, but
accounting profit is positive
A Shift in Demand in the Short Run and Long Run
Firms can enter and exit the market in long run at free well but
not in the short run

The response of the market to change in demand depends on the

time horizon

FIGURE 14.8:

An Increase in Demand in the Short Run and Long Run

Why the Long-Run Supply Curve Might Slope Upward

Two reasons:
1. Some resources used in the production may only be
available in limited quantities
2. Firms may have different cost
3. An Upward Sloping Long-Run Supply Curve :

Short Term Objects of firm to maximize the products

Find Marginal Revenue (MR)
o MR = Profit = Average Margin
Find the quantity where Marginal Revenue (MR) = Marginal Cost
(MS)