Download ZOMU www.zomuedu.com Unit 7 Competitive Markets A

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Unit 7
Competitive Markets
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A ​competitive market​, also known as a ​perfectly competitive market​, has many
buyers and sellers in the market, and has goods or services sold in the market that are
virtually the same.
Because of the immense amount of consumers and producers, every single individual
person or firm has negligible impact on the overall market
In addition, firms and individuals of the market are ​price takers​, because of the negligible
impact that each specific individual has the market
Firms and individuals can also freely enter or exit the markets
Profits in a Competitive Market
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The total revenue for a competitive firm is the quantity of the good multiplied by the price
of the good
Because firms are price takers, the price for every good is the same
Because the price of every good is the same, the marginal revenue remains the same
The marginal cost does increase because of diminishing marginal product (see Micro
Unit 6)
The profit of the firm is thus the total revenue subtracted by total cost
The ​Profit Maximizing ​quantity is the quantity where marginal revenue equals marginal
cost, because it is then where profit has reached 0.
If there is never a quantity where marginal revenue equals marginal cost, choose the
quantity closest to 0 where profit is still positive, meaning that marginal revenue is only
slightly above marginal cost
Because the marginal cost curve determines the quantity of the good that is supplied at
any price, it is the firm’s supply curve in a competitive market
Short Run Shut Down​: a short run decision to shut down the firm when total revenue is
less than the variable cost
○ When total revenue and variable cost are divided by quantity, the rule to shut
down is when the average total revenue is less than the average variable cost.
○ Because average total cost is equal to price in a competitive market, the final
equation is: ​Shut Down if P < AVC
○ The firm’s short run supply curve is where the marginal cost curve is above the
average variable cost
Sunk Cost​: a cost that has already been used and lost
○ Because sunk costs cannot be brought back, a firm’s business decisions should
not include consideration of sunk costs
Long Run Exit​: a long decision to exit the market if the revenue is less than total cost
○ The rule to shut down is if total revenue is less than total cost
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When both sides are divided by quantity, the rule to exit is if average total
revenue is less than average total cost
○ Because average total cost is equal to price in a competitive market, the final
equation is: ​Exit if P < ATC
○ Thus, the rule to enter the market is: ​Enter if P > ATC
○ The firm’s long run supply curve is where the marginal cost curve is above the
average total cost
Because profit = total revenue - total cost, when the TR and TC is divided by quantity,
the equation is profit = (TR/Q-TC/Q)*Q
Thus, because average revenue is equal to price, and average cost is average total
cost, the final equation for profit is: ​Profit = (P - ATC) * Q
The rectangle on the graph measures profit, where ​P-ATC​ is the height and ​Q​ is the
width.
When there is a loss, the rectangle height is ​ATC-P​ and the width is ​Q​.
The Competitive Market Supply Curve
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In the short run, there is a fixed amount of firms. The quantity supplied to the market is
the quantity supplied from each individual firm, multiplied by the number of firms
In the long run, firms are allowed to enter and exit the market. If the market was
profitable, more firms would enter the market. If the market operated at a loss, more
firms would leave the market. Thus, when the process of entry and exit end, the
remaining firms in the market will be earning zero economic profit
The process of entry and exit only ends when the price and the average total cost are
equal
At long run equilibrium, all firms will be operating at their efficient scale
Although firms are earning zero economic profit, they are STILL earning accounting
profit. So, the firms remain in business.