Download Competitive Markets

Things to know about all market
systems
1. An equilibrium is where no one has an
incentive to change their production.
 In market systems:
 if a firm can increase their profit by changing
the price or quantity of their goods, they will.
 They will stop changing these factors when
they have reached the maximum amount of
profit they possibly can achieve, given the
current conditions of the market.
 This profit maximizing output and price is the
equilibrium.
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Things to know about all market
systems
2. Firms will produce where MC=MR
 Recall, Marginal Cost (MC) is the additional cost
of producing one more unit of output.
 Marginal Revenue (MR) is the additional
revenue acquired by producing (and as we
assume selling) one more unit of output.
 MR= TR/ Q = (TR1-TR2)/(Q1-Q2)
 MR=P in a competitive market (we will talk about this
more later)
 MR<P in a monopoly (we will talk about this more
later)
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Things to know about all market
systems
2. Firms will produce where MR=MC: we prove this by eliminating all
other possibilities
 If MC<MR, a firm can make a higher profit by increasing their output.
 The additional revenue from selling one more unit is more than the extra
cost to produce that unit.
 So, a firm’s profit will increase if output increases, therefore the firm
producing where MC<MR has an incentive to change their price and/or
output.
 If MC>MR, a firm can make a higher profit by decreasing their
output.
 The additional revenue from selling one more unit is less that the extra
cost to produce that unit.
 So, a firm’s profit will increase if output decreases, therefore the firm
producing where MC>MR has an incentive to change their price and/or
output.
 If MC=MR, a firm is making the highest profit possible.
 At this point, each firm does not have a way to increase profit more, so
they have no incentive to change their price and/or output.
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Competitive Markets
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By the end of this Section, You
should be able to:
 Define Competitive Market and describe
its properties
 Know and use the properties of a
competitive firm’s profit maximizing
quantity and price
 Determine LR and SR choice to enter or
exit the market
 Display the competitive markets in SR and
LR
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Perfectly Competitive Markets
 A perfect competition is a market structure
in which the decisions of individual buyers
and sellers has no effect on the market.
 Each firm and consumer is such a small part
of the market, a change in one firm or one
consumer’s behavior won’t effect the price
 Price is set by market forces (invisible hand)
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Perfectly Competitive Market
Assumptions
1. A competitive firm takes the price as
given or they are a price taker.
2. Products sold by the firms in a
competitive industry homogenous (the
same). They are perfect substitutes.
3. Any firm can enter/exit the market
without serious impediments.
4. Both Buyers and Sellers have equal
access to information.
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Perfectly Competitive Firms
Maximize Profits in the SR
 Note, because the firm is a price taker, a
Competitive Firm maximizes profits by
choosing the optimal amount to produce.
 The Profit Maximizing Quantity is
determined by using one of two strategies:
 1. TR>TC
 Profit maximizing output is where TR exceeds
TC the most.
 2. MC=MR=P
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Applying MR=MC Rule
Graphically
Economic Profit = BH = (Q*)(P-ATC)
Price/Costs
MR = MC
MC
MR = P
P
Economic Profit
ATC
ATC
Q*
Quantity
LO: 7-3
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Entering and Exiting the Market in
the Short Run
 In the short run,
 A firm enters the market by providing output to sell
 a firm can not exit the industry as a whole but can shut down, or
not manufacture the good for a period of time
 If the firm enters the market in the short run:
 Profit = TR – VC – FC
 In the short run, a firm will ALWAYS incur fixed costs.
 Fixed costs in this case are called sunk costs. Sunk costs are
costs already committed to.
 If a firm shuts down (exits the market) in the SR:
 Profit = 0 – 0 – FC
 They produces 0 output and incurs a loss equal to its fixed costs.
 Shutting down prevents them from losing any more profit.
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LR Competitive Equilibrium
 The long run competitive equilibrium is
where economic profit = 0.
 Called the Zero Profit Condition
 Note this is economic profit.
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LR Competitive Equilibrium
Graphically
LR Competitive Equilibrium is where “everything is equal”.
Price
MC
SRAC
P*
LRAC
Notice, where the set
market price (or MR)
crosses the MC
where the SRAC and
the LRAC are at their
minimum. This also
follows MC=MR=P.
MR
Q*
Quantity
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Entering and Exiting the Market in
the Long Run
 In the long run,
 A firm enters the market by choosing to provide the
good to sell.
 A firm will enter the market as long as the current firms are
making a positive profit.
 A firm exits the industry by choosing to not produce a
good to sell any more.
 Once firms stop making a positive profit, firms will no longer
choose to enter the market.
 If firms are making a negative profit, firms will exit the
market.
 They will exit the market until LR profits = 0.
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