Download Firms in perfectly competitive markets

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All costs are variable in the long run
Long-run cost is affected by the production function, ie. the relationship between output and
the quantities of all inputs used
Returns to scale
• Long-run average costs curve: a curve showing the lowest cost at which the firm is able to
produce a given quantity of output in the long run, when no inputs are fixed
• Economies of scale: (increasing returns to scale) exist when a firms long run average costs
fall as it increases its scale of production and the quantity of output it produces
Returns to scale vs. diminishing returns
• Decreasing returns to scale
- a given % increase in all the firms inputs results in the firms output increasing by a smaller
%
• Law of diminishing returns:
- as a firm uses more of a variable input (labor), with a given quantity of fixed inputs, the
marginal product of the variable input eventually diminishes
• That is, the returns to scale are a long run phenomenon, all inputs are variable
• While diminishing returns is a short run phenomenon as one input (capital) is fixed
Lecture 5
Firmsinperfectlycompetitivemarkets
Chp 9
1. Market Structures
• Economists group industries into four market structures
1. Perfect competition
2. Monopolistic competition
3. Oligopoly
4. Monopoly
Characteristic
Number of firms
Perfect
Competition
Many
Monopolistic
Competition
Many
Type of product
Identical
Differentiated
Ease of entry
High
High
Examples
- Bananas
- Wheat
- Selling DVDs
- Restaurants
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Oligopoly
Few
Identical or
differentiated
Low
- Banking
- Car
manufacturing
Monopoly
One
Unique
Entry blocked
- Letter delivery
- Tap water
The decision about which industry belongs to which market structure depends on three key
characteristics:
1. Number of firms in the industry
2. Similarity of the good/service produced by the firms in the industry
3. The ease with which new firms can enter the industry
2. Perfectly Competitive Market
• Many buyers & sellers, all of whom are small relative to the market
• All firms sell identical products
• There are no barriers to new firms entering the market or to existing firms leaving the market
• A perfectly competitive firm cannot affect the market price:
Price Taker
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à a buyer or seller that is unable to affect the market price
à the demand curve for a price taker is horizontal, or perfectly elastic
E.g. oats: $4 a bushel
- the intersection of market supply and demand determines the equilibrium price for oats
- this must be accepted by all sellers in the market
Profit = Total Revenue – Total Cost
Profit = TR – TC
In economics, implicit opportunity costs are included with explicit costs
3. How a firm maximizes revenue in a perfectly competitive market
• Average revenue:
total revenue divided by total number of units sold
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Marginal revenue:
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à in a perfectly competitive market, price cannot be affected by the quantity provided
Determining the profit maximizing level of output
• Since producers in a perfectly competitive market can sell as much produce as they wish to at the
same constant price
AR = MR
• Profit-maximizing level of output is where the difference between total revenue and cost is the
greatest
• Also where Marginal Revenue = Marginal Cost, MR=MC
4. Illustrating profit/loss on the cost curve graph
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ATC = actual total cost
When a firm is breaking even or operating at a loss
• If P > ATC, the firm makes a profit
• If P = ATC, the firm breaks even
- its per unit cost equals its per unit revenue
- thus, total cost = total revenue
• If P < ATC, the firm experiences losses
5. Deciding whether to produce or shut down in the short run
• In the short run a firm suffering losses has two choices:
- continue to produce
- stop production by shutting down temporarily