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Thai Nguyen University

Thai Nguyen University of Technology


Faculty of International Training

(ECEN 4503)
Engineering Economics
Lecture #9:

Firms in Competitive Markets


June 06th 2015
Lecturer: Nguyen Minh Y, Ph.D.

Reviewing

Supply,
demand and
government
policies
- Controls of
price
- Taxes

Market and
welfare
- Consumer,
producer and
the efficiency of
markets
- Taxes
- International
Trading

Department of Electrical Engineering taught in English

Firm behavior
and the
organization
of industry
- Cost of
production
- Firms in
competitive
markets

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Introduction
Competitive market
Firms in the market?
Market power?

Firm behavior
How firms make production decision in competitive market?
Which types of cost are important:
Fixed

costs
Variable costs
Average total cost
Marginal cost

Department of Electrical Engineering taught in English

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1. What is Competitive Market?


1.1 The meaning of competition
Competitive market a market with many buyers and sellers

trading identical products so that each buyer and seller is a pricetaker.


Property of perfectly competitive market
Many buyers and sellers
The goods offered by the various sellers are largely the same
Firms can freely enter or exist the market

Example:
Market for milk:
Sellers: diary farmers
Buyers: population
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Department of Electrical Engineering taught in English

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1. What is Competitive Market?


1.2 The revenue of a competitive firm
Competitive firms:
Objective of a competitive firm
Maximize

the profit
Profit = Total revenue Total cost

Example: The Vaca Family Diary Farm


Price-taker

Total revenue = Price Quantity


Average revenue the total revenue divided by the quantity sold.
Marginal revenue the change in total revenue from an additional

unit sold.
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Department of Electrical Engineering taught in English

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2. Profit Maximization and The Competitive


Firms Supply Curve
2.1 An example of profit maximization (Vaca Diary Farm)

Quantity
(Q)

Total
revenue
(TR)

Total
cost
(TC)

Profit
(TR-TC)

0 gallons
1
2
3
4
5
6
7
8

$0
6
12
18
24
30
36
42
48

$3
5
8
12
17
23
30
38
47

$3
1
4
6
7
7
6
4
1

Marginal
Marginal cost
revenue
(MC=TC/Q)
(MR=TR/Q)

Department of Electrical Engineering taught in English

$6
6
6
6
6
6
6
6

$2
3
4
5
6
7
8
9

Change in
profit
(MR-MC)

$4
3
2
1
0
1
2
3

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2. Profit Maximization and The Competitive


Firms Supply Curve
Other way: Think at margin?
Comparing marginal revenue and marginal cost?

Quantity
(Q)

Total
revenue
(TR)

Total
cost
(TC)

Profit
(TR-TC)

0 gallons
1
2
3
4
5
6
7
8

$0
6
12
18
24
30
36
42
48

$3
5
8
12
17
23
30
38
47

$3
1
4
6
7
7
6
4
1

Marginal
Marginal cost
revenue
(MC=TC/Q)
(MR=TR/Q)

Department of Electrical Engineering taught in English

$6
6
6
6
6
6
6
6

$2
3
4
5
6
7
8
9

Change in
profit
(MR-MC)

$4
3
2
1
0
1
2
3
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2. Profit Maximization and The Competitive


Firms Supply Curve
Think at margin?
If marginal revenue is greater

than marginal cost


The firm should increase its

output.
If marginal cost is greater than

marginal revenue
The firm should decrease its

output.
Marginal revenue and marginal

cost are exactly equal


The profit-maximizing level of

output
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Department of Electrical Engineering taught in English

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Profit Maximization Problem


General problem
There is a firm in competitive market
Total cost
TC(Q)

Market price
Price-taker

Problem is to determine the production (Q) to maximize the profit

Max Profit ,
Q

Given P

Proof?

Department of Electrical Engineering taught in English

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2. Profit Maximization and The Competitive


Firms Supply Curve
2.2 The marginal-cost curve and the firms supply decision
Cost curves

The marginal cost (MC) curve is


upward sloping.

The

average total cost (ATC)


curve is U-shaped.

The market price is a horizontal


line with the price P (i.e., price
taker)

Because the firms 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 firms supply curve.
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Department of Electrical Engineering taught in English

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2.3 The Firms Short-run Decision to Shut Down


Some circumstance, the firm may decide to shut down?
Temporary shut down a short-run decision not to produce
anything during a specific period of time.
Exist from the market a long-run decision to lease the market.
What cost incur with different shut down?
Fixed costs
E.g.,

farmer: Land for farming


Variable costs
E.g., farmer: Fertilizer, pesticide, etc.
Sunk cost a cost that has already been committed and cannot be
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recovered.
Department of Electrical Engineering taught in English

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2.3 The Firms Short-run Decision to Shut Down


Some circumstance, the firm may decide to shut down?
The firm shuts down if the revenue that it would get from
producing is less than its variable costs of production.
Shut down if TR < VC
Or
Price

Shut down if P < AVR

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Department of Electrical Engineering taught in English

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2.3 The Firms Short-run Decision to Shut Down


Competitive firms short-run supply curves
The competitive firms short-run supply curve is the portion of its marginal-cost
curve that lies above average variable cost.

In the short run, the firm produces on the MC curve if P > AVC, but shuts down
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if P < AVC.

Department of Electrical Engineering taught in English

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2.4 The Firms Long-term Decision to Shut Down


Some circumstance, the firm may decide to shut down?
The firm exist the market if the revenue it would get from
producing is less than its total costs of production.
Exit if TR < TC
Or
Shut down if P < ATC
That is the firm chooses to exit if the price of its good is less than

the average total cost of production.

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Department of Electrical Engineering taught in English

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2.4 The Firms Long-term Decision to Shut Down


A competitive firms long-run profit maximization strategy:
If the firm is in the market, it produces the quantity at which
marginal cost equals the price of the good.
MC = P
If the price is less than average total cost at that quantity, the firm

chooses to exit the market.


P < ATC
Thus, the competitive firms long-run supply curve is the portion of
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its marginal-cost curve that lies above average total cost.

Department of Electrical Engineering taught in English

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2.5 Measuring Profit in Graph for the Competitive


Firms
The profit equal total revenue (TR) minus total cost (TC):

Profit = TR TC
= (P ATC) Q

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Department of Electrical Engineering taught in English

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Practice

Quanti Total Total


ty
fixed variab
cost le cost

Ex3. Ball Bearing Inc. faces cost of production as

follows:
Calculate the companys average fixed cost,
average variable cost, average total cost, and
marginal cost.
b) The price of a case of ball bearing is $50. Seeing
that she cannot make a profit, the chief executive
officer (CEO) decides to shut down operation.
What are the firms profit/losses? Was this a wise
decision? Explain.
c) Vaguely remembering his introductory economics
course, the Chief Financial Officer tell the CEO it
is better to produce 1 case of ball bearing, because
marginal revenue equals marginal cost at the
quantity. What are the firms profit/losses at that
level of production? Was this the best decision?
Explain.of Electrical Engineering taught in English
Department
a)

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$100

$0

100

50

100

70

100

90

100

140

100

200

100

360

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3. The Supply Curve in a Competitive


Market
Short term:
It is difficult for new firms to enter or exit the market
Market with fixed number of firms

Long-term:
The number of firms can change
Old firms exit, new firms enter the market

3.1 The Short-run: Market supply with fixed number of


firms
Each firm supplies a quantity at which marginal cost (MC) equals

the price (P)


Quantity output of the market equals the sum of the quantities
supplied by each individual firm.
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Department of Electrical Engineering taught in English

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3. The Supply Curve in a Competitive


Market
3.2 The Long-run: Market supply enter and exit
Suppose that everyone has the same access to
Technology to produce goods and service
Input for productions

The same cost curves.


If firms already in the market are profitable
New firms will have incentive to enter the market
The number of firms increases
The quantity supplied increases
The marker price and profit reduce
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Department of Electrical Engineering taught in English

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3. The Supply Curve in a Competitive


Market
3.2 The Long-run: Market supply enter and exit
If firms already in the market are losing
Some firms will choose to exit the market
The number of firms reduces
The quantity supplied reduces
The marker price and profit increase

At the end, firms that remains in the market must be making zero

profit.
Profit = (P ATC) Q
The price and average total cost are driven to equality.
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Department of Electrical Engineering taught in English

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3. The Supply Curve in a Competitive


Market
3.2 The Long-run: Market supply enter and exit
Thus, in the long-run equilibrium of a competitive market with

free entry and exit, firms must be operating at their efficient scale.

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In markets with entry and exit, there is only one price consistent with zero profit the
minimum of average total cost. As a result, the long-run market supply curve must be
horizontal at this price.
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Practice
Ex6. Analyze the two following situations for firms in

competitive markets:
Suppose that TC = 100 + 15q, where TC is total cost and q is
the quantity produced. What is the minimum price necessary for
this firm to produce any output in the short run?
b) Suppose that MC = 4q, where MC is marginal cost. The
perfectly competitive firm maximizes profits by producing 10
units of output. At what price does it sell these units?
a)

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Department of Electrical Engineering taught in English

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Conclusion
Firms objective
Profit maximization

Max Profit ,
Q

Given P

Firm decisions

Shut down the production

or exit the market


P < AVC ?
P < ATC ?
Market supply

Optimality condition:

Short-run

P = MC

Long-run

Fixed number of firms


Free enter and exit the

market
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