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Chapter 13 Firms in Competitive Markets What is a Competitive Market? • The meaning of competition • Competitive market – Market with many buyers and sellers – Trading identical products – Each buyer and seller is a price taker – Firms can freely enter or exit the market 2 What is a Competitive Market? • The revenue of a competitive firm – Maximize profit • Total revenue minus total cost • Total revenue = price times quantity = P ˣ Q 3 What is a Competitive Market? • The revenue of a competitive firm • Marginal revenue – Change in total revenue from an additional unit sold • For competitive firms – Marginal revenue = P 4 Profit Maximization& Competitive Firm’s Supply Curve • A simple example of profit maximization • Maximize profit – Compare marginal revenue with marginal cost • If MR > MC – increase production • If MR < MC – decrease production 5 Profit Maximization& Competitive Firm’s Supply Curve • The marginal-cost curve and the firm’s supply decision • Three general rules for profit maximization: – If MR > MC - firm should increase output – If MC > MR - firm should decrease output – If MR = MC - profit-maximizing level of output 6 Profit Maximization& Competitive Firm’s Supply Curve • The marginal-cost curve and the firm’s supply decision • Marginal-cost curve – Determines the quantity of the good the firm is willing to supply at any price – Is the supply curve 7 Profit Maximization& Competitive Firm’s Supply Curve • Shutdown – Short-run decision not to produce anything • During a specific period of time • Because of current market conditions – Firm still has to pay fixed costs • Exit – Long-run decision to leave the market – Firm doesn’t have to pay any costs 8 Profit Maximization& Competitive Firm’s Supply Curve • Spilt milk and other sunk costs • Sunk cost – Has already been committed – Cannot be recovered – Ignore them when making decisions 9 Near-empty restaurants and off-season miniature golf • Restaurant – stay open for lunch? – Fixed costs • Not relevant • Are sunk costs in short run – Variable costs – relevant – Shut down if revenue from lunch < variable costs – Stay open if revenue from lunch > variable costs • Operator of a miniature-golf course – Ignore fixed costs – Stay open if revenue > variable costs 10 Profit Maximization& Competitive Firm’s Supply Curve • Firm’s long-run decision to exit/enter a market • Competitive firm’s long-run supply curve – The portion of its marginal-cost curve – That lies above average total cost 11 Supply Curve in a Competitive Market • Long run: market supply with entry and exit • Long run – firms can enter and exit the market – If P > ATC – firms make positive profit – New firms enter the market – If P < ATC – firms make negative profit – Firms exit the market – Process of entry and exit ends when 12 Supply Curve in a Competitive Market • Why do competitive firms stay in business if they make zero profit? – Profit = total revenue – total cost – Total cost – includes all opportunity costs – Zero-profit equilibrium • Economic profit is zero • Accounting profit is positive 13 Monopoly Why Monopolies Arise • Monopoly – Firm that is the sole seller of a product without close substitutes – Price maker – Barriers to entry • Monopoly resources • Government regulation • The production process 15 Why Monopolies Arise • Monopoly resources – A key resource required for production is owned by a single firm – Higher price • Government regulation – Government gives a single firm the exclusive right to produce some good or service – Government-created monopolies • Patent and copyright laws • Higher prices; Higher profits 16 Why Monopolies Arise • The production process – A single firm can produce output at a lower cost than can a larger number of producers • Natural monopoly – Arises because a single firm can supply a good or service to an entire market • At a smaller cost than could two or more firms – Economies of scale over the relevant range of output 17 How Monopolies Make Production& Pricing Decisions • Monopoly versus competition – Monopoly • Price maker • Sole producer • Downward sloping demand – Market demand curve – Competitive firm • Price taker • One producer of many • Demand – horizontal line (Price) 18 The Welfare Cost of Monopolies • The deadweight loss • Monopoly – Produce quantity where • MC = MR – Produces less than the socially efficient quantity of output – Charge P>MC – Deadweight loss • Triangle between: demand curve and MC curve 19