Chapter 14: Firms in Competitive Markets

Why do competitive firms stay in business if they make zero profit?

1. In the zero profit equilibrium, the firm's revenue must compensate the owners for the time and money they expend in the business

What is the entry criterion for the market?

If price exceeds average total cost

Farming as an Example of a Sunk Cost

If the farmer decides to leave farming all together, he can sell the land and the cost of land is not sunk

In the long run, when does a firm exit the market?

If the revenue it would get from producing is less than its total costs; if price is less than average total cost

As long as marginal revenue (change in Total Revenue/ Change in Quantity) exceeds marginal cost (change in Total Cost/Change in Quantity)...

Increasing the quantity produced raises profit; therefore, if firms think at the margin and make incremental adjustments to the level of production, they are naturally led to produce the profit maximizing quantity

When can a firm re-open in the aforementioned scenario?

If conditions change so that the price exceeds the average variable cost

Marginal Firm

The firm that would exit the market if the prices were any lower

A Competitive Firm's Short Run Supply Curve

1. A competitive firm's short-run supply curve is the portion of its marginal cost curve that lies above average variable cost 2. If the price falls below average variable cost, the firm is better off shutting down

Profit Maximization for a Competitive Firm

1. At the quantity Q1, marginal revenue MR1 exceeds marginal cost MC1, so raising production increases profit 2. At the quantity Q2, marginal cost MC2 exceeds marginal revenue MR2, so reducing production increases profit 3. At the profit maximizing level of output, marginal revenue and marginal cost are exactly equal

A market with 1,000 firms...

1. For any given price, each firm supplies a quantity where marginal cost = price 2. As long as price is above the average variable cost, each firm's marginal cost curve is its supply curve

A Competitive Firm's Long Run Supply Curve

1. In the long-run, the competitive firm's supply curve is its marginal cost curve above the average total cost 2. If price falls below average total cost, the firm is better exiting the market

What is true of the market for milk?

1. No single buyer of milk can influence the price of milk because each buyer purchases a small amount relative to the size of the market. 2. Each seller of milk has limited control over the price because many other sellers are offering milk that is essentially identical 3. Each seller can sell all they want at the going price and has little reason to charge less

What are the reasons that the long-run market supply curve might slope upward?

1. Some resources used in production may be available only in limited quantities 2. Firms may have different costs

Market Supply with Entry and Exit

1. The number of firms adjusts to ensure that all demand is satisfied at this price. Price is the minimum of average total cost 2. The long run market supply curve is horizontal at this price

What are the three characteristics of a perfectly competitive market?

1. There are many buyers and sellers in the market 2. The goods offered by the various sellers are largely the same 3. Firms can freely enter or exit the market

Sunk Cost

A cost that has already been committed and cannot be recovered

How do the short run and long run decisions to exit the market differ?

A firm shuts down temporarily and still has to pay the fixed costs, but a firm that exits the market saves both its fixed and variable costs

Competitive Market

A market with many buyers and sellers trading identical products so that each buyer and seller is a price taker

In competitive markets, total revenue is proportional to...

Amount of Output

Opportunity Cost vs. Sunk Cost

An opportunity cost is what you have to give up to choose one thing instead of another, but a sunk cost cannot be avoided. Therefore, since nothing can be done, they can be ignored when making decisions

Entry and Exit

Because firms can enter and exit more easily in the long run than in the short run, the long run supply curve is typically more elastic than the short run supply curve

At the end of the process of exit and entry...

Firms that remain in the market must be making zero economic profit

The long run equilibrium of a competitive market with free entry and exit must always...

Have firms operating at their efficient scale

If firms already in the market are profitable...

New firms will have an incentive to enter the market, this entry will expand the number of firms, increase the quantity of the good supplied and drive down prices/profit

The process of entry and exit ends only when...

Price and Average Total Cost are driven to equality

For all competitive firm's, average revenue equals...

Price of the Good

For all competitive firm's, marginal revenue equals...

Price of the Good

Buyers and sellers in competitive markets must accept the price the market determines and are said to be...

Pricetakers

Exit

Refers to the long-run decision to leave the market

Shutdown

Refers to the short-run decision not to produce anything during a specific period of time because of the current market conditions

If firms in the market are making losses...

Some existing firms will exit the market, their exit will reduce the number of firms and decrease the quantity of the good while driving up prices/profit

Why is the firm's marginal cost curve the competitive firm's supply curve?

The firm's marginal cost curve determines the quantity of the good that the firm is willing to supply at any price

A Firm with Losses

The height of this box is (ATC-P), and the width of this box is quantity of output. In this case, maximizing profit means minimizing losses. B/C a firm in this market is not making enough revenue to cover average total cost, the firm should exit the market

A Firm with Profits

The height of this box is (P-ATC), and the width of the box is quantity of output, with the profit maximizing quantity (Where Marginal Cost = Marginal Revenue)

When choosing to produce, the firm compares...

The price it receives for the typical unit to the average variable cost that it must incur to produce the typical unit.

Efficient Scale

The quantity of output that minimizes average total cost

A firm shuts down if...

The revenue it would get from producing is less than its variable costs of production; is price is less than average variable costs

Average Revenue

The total revenue divided by the quantity sold

Profit

Total Revenue minus Total Cost

When price equals average total cost, profits are...

Zero