Download Competitive Firm

Market Structure
Competition
Competitive Firm
P
P
Industry
Firm
P0
P0
P0
d
D
10,000,000
50,000,000
10
30
Competitive Firm
• A competitive firm can sell any quantity at the
market price. The firm decides how much to
produce but not the price. Competitive firms are
“price takers”.
• A competitive firm (not the industry) faces an
horizontal demand function.
• A competitive firm usually represents a small
share of the entire industry.
Marginal Revenue-Competitive Firm
Price $50
Quantity
Marginal
Revenue
1
Total Revenue
Price x Quantity
50
2
100
50
3
150
50
4
200
50
50
Marginal revenue is constant at the level of the market price
Production Decision-The Firm
• The general rule to maximize profits was
to produce up to the point in which
marginal revenue equals marginal cost
(conditional on profits>0).
• Marginal revenue is equal to price for a
competitive firm. Therefore, a competitive
firm produces a quantity at which price
equals marginal cost.
The supply curve (firm) is equal to
the marginal cost curve but…
Marginal Cost Curve
Quantity
1
2
3
4
5
6
Marginal
Cost
20
30
40
50
60
70
Supply Curve
Price
Quantity
20
1
30
2
40
50
60
70
3
4
5
6
$ per
bicycle
$ per
bicycle
The supply curve-The Firm
S
d’’
d’
d
MC
Q
Q
The rule for a competitive firm is to produce
up to the point where the marginal cost
equals the price.
Which marginal costs? Long run
marginal cost or short run marginal
costs?
The firm has a short run supply function and
a long run supply function.
U-Shaped Marginal Cost
S
Only the upward slopping part of the
marginal cost is relevant for the
production decision.
MC
50
MR
Q1
Q2
Q
“Shutdown Decision”
Profit=TR-TC=TR-FC-VC (TC=FC+VC)
If the firm “shuts down” it still pays the FC
Therefore, the firm will operate if
TR-VC>0 or TR>VC
TR=P*Q then TR>VC→P>AVC=VC/Q
The fix costs are irrelevant in the short run because the firm
pays them even if it shuts down. Sunk cost are irrelevant
even in the long run. What is considered fix cost will
depend on the length of period the firm is considering.
Putting Everything Together-The Short
Run Supply Function (the FIRM)
S
MC
AC
AVC
Q2
Q
The Supply of the Industry
P
Sc
Sb
Sa
Industry
Supply
P0
Q1 Q2
Q1+Q2
Q
The Supply of the Industry
P
Sc
Sb
Sa
P0
Industry
Supply
P1
Q
The Competitive Industry in the
Short Run
P
The Industry
The Firm
P
s
S
P0
d
D
Q0
Q
q0
q
A Change in fixed costs
What is the effect in the short
run?
The Competitive Industry in the Short
Run- A Change in Variable Costs
The Industry
P
S’
P
s’
The Firm
s’’
S
P2
s
d’
P0
d
D
Q2
Q0
Q
q2 q0 q2’
q
The Competitive Industry in the Short
Run- A Change in Demand
P
P
s
S
P3
d’
P0
d
D’
D
Q0
Q3
Q
q0 q3
q
The Planner’s Problem
Suppose a country wants to produce 1 million units of a good at the
minimum possible cost. You are told to tell “each firm” in the industry
how much to produce to reach this goal.
How would you do this?
Suppose a firm is producing the last unit at a marginal cost of $5 and
another firm is producing the last unit at a marginal cost of $3. You
can tell the firm which is producing at a higher cost to produce one
less unit and the firm producing at a lower cost to produce an
additional unit. The level of output is maintained and you save $2 of
cost. When every firm produces the last unit at the same marginal
cost the total costs are at the minimum possible.
In a competitive equilibrium every firm produces at a point where
marginal costs are equal to the price (and the price is equal for all of
the firms). Hence, the market automatically produces at the lowest
possible cost.
The Firm in the Long Run
The long run supply function (firm) is equal to the
long run marginal cost when the marginal cost
is above the average costs.
Firms may exit the industry in the long run. They
exit if profits are negative. Profits is Revenues
minus OPORTUNITY costs.
TR-TC=P*Q-TC>0 →P>TC/Q=AC
The firm “breaks even” when the price is equal to
the average cost
Break Even Price-The Firm
S
AC
MC
P**
Break Even Price
P*
Q
Q’
Q
Long Run and Short Run Responses
Rent Control-The Industry
P
S’
S
LRS
P2
P0=P3
P1
D
Q1
Q2 Q0’ Q0=Q3
Q