The Revenue of a Competitive Firm

Transcription

1 Chap 14: s in Competitive Markets A competitive market has many buyers and sellers trading identical products so that each buyer and seller is a price taker. Buyers and sellers must accept the price determined by the market. Aperfectly competitive market has the following characteristics: There are many buyers and sellers in the market and actions of any single buyer or seller in the market have a negligible impact on the market price. The goods offered by the various sellers are largely the same. s can freely enter or exit the market. The Revenue of a Competitive Total revenue for a firm is the selling price times the quantity sold. TR = (P Q) Total revenue is proportional to the amount of output. The Revenue of a Competitive Average revenue tells us how much revenue a firm receives for the typical unit sold, which is the total revenue divided by the quantity sold. In perfect competition, average revenue equals the price of the good. Total revenue Average Revenue = = = The Revenue of a Competitive Marginal revenue is the change in total revenue from an additional unit sold. MR =ΔTR/ΔQ = P Two take-home messages: 1. For competitive firms, marginal revenue equals the price of the good. 2. Average revenue equals the price of the good. Therefore MR = AR = P. This will make more sense later on. 1

2 PROFIT MAXIMIZATION AND THE COMPETITIVE FIRM S SUPPLY CURVE Table 2 Profit Maximization: A Numerical Example The goal of a competitive firm is to maximize profit. This means that the firm will want to produce the quantity that maximizes the difference between total revenue and total cost. The Marginal Cost-Curve and the s Supply Decision Profit maximization occurs at the quantity where marginal revenue equals marginal cost. WhenMR >, increase Q WhenMR <, decrease Q WhenMR =, profit is maximized. Figure 1 Profit Maximization for a Competitive and the 3 rules Costs and Revenue 2 P = MR1 = MR2 Rule 1: The firm maximizes profit by producing the quantity at which marginal cost equals marginal revenue. Suppose the market price is P. Rule 2: If the firm produces Q 2, marginal cost is 2. P = AR = MR AVC 1 Rule 3: If the firm produces Q 1, marginal cost is 1. QMAX Q2 2

3 Figure 2 Marginal Cost as the Competitive s Supply Curve P2 So, this section of the firm s curve is also the firm s supply curve. As P increases, the firm will select its level of output along the curve. AVC The s Short-Run Decision to Shut Down A shutdown refers to a short-run decision not to produce anything during a specific period of time because of current market conditions (Restaurant example: Why are some restaurants closed at night or in the morning?). Exit refers to a long-run decision to leave the market. The firm shuts down if the revenue it gets from producing is less than the variable cost of production. Shut down if TR < VC Shut down if TR/Q < VC/Q Shut down if P < AVC Q2 Figure 3 The Competitive s Short-Run Supply Curve Costs If P > AVC, firm will continue to produce in the short run. If P >, the firm will continue to produce at a profit. The portion of the marginal-cost curve that lies above average variable cost is the competitive firm s short-run supply curve. s short-run supply curve AVC Spilt Milk and Other Sunk Costs The firm considers its sunk costs when deciding to exit, but ignores them when deciding whether to shut down. Sunk costs are costs that have already been committed and cannot be recovered. shuts down if P< AVC 3

4 The s Long-Run Decision to Exit or Enter a Market Figure 4 The Competitive s Long-Run Supply Curve In the long run, the firm exits if the revenue it would get from producing is less than its total cost. Exit if TR < TC Exit if TR/Q < TC/Q Exit if P < A firm will enter the industry if such an action would be profitable. Enter if TR > TC Enter if TR/Q > TC/Q Enter if P > Costs exits if P < enters if P > s long-run supply curve = long-run S Measuring Profit in Our Graph for the Competitive Profit = TR TC Profit = (TR/Q TC/Q) x Q Profit = (P ) x Q This way of expressing the firm s profit allows us to measure profit in our graphs. Remember, to maximize profit MR = Figure 5 Profit as the Area between and Average Total Cost (a) A with Profits Profit = (P ) x Q Profit P P = AR = MR Q (profit-maximizing quantity) 4

5 Figure 5 Profit as the Area between and Average Total Cost (b) A with Losses P Loss Q (loss-minimizing quantity) P = AR = MR THE SUPPLY CURVE IN A COMPETITIVE MARKET The competitive firm s long-run supply curve is the portion of its marginal-cost curve that lies above average total cost. Short-Run Supply Curve The portion of its marginal cost curve that lies above average variable cost. Long-Run Supply Curve The marginal cost curve above the minimum point of its average total cost curve. The Short Run: Market Supply with a Fixed Number of s Figure 6 Short-Run Market Supply For any given price, each firm supplies a quantity of output so that its marginal cost equals price. Market supply equals the sum of the quantities supplied by the individual firms in the market. The market supply curve reflects the individual firms marginal cost curves. $2. 1. (a) Individual Supply $2. 1. (b) Market Supply Supply 1 2 (firm) 1, 2, (market) If the industry has 1 identical firms, then at each market price, industry output will be 1 times larger than the representative firm s output. 5

6 The Long Run: Market Supply with Entry and Exit Figure 7 Long-Run Market Supply s will enter or exit the market until profit is driven to zero (Home Depot and others followed). The long-run market supply curve is horizontal at this price. There is only one price consistent with zero profit the minimum of average total cost (Figure 7). P = minimum (a) s Zero-Profit Condition (b) Market Supply Supply (firm) (market) Why Do Competitive s Stay in Business If They Make Zero Profit? Profit equals total revenue minus total cost. Total cost includes all the opportunity costs of the firm. In the zero-profit equilibrium, the firm s revenue compensates the owners for the time and money they expect to keep the business going. An increase in demand raises price and quantity in the short run. s earn profits because price now exceeds average total cost. Figure 8 An Increase in Demand in the Short Run and Long Run Market Demand, D1 A market begins in long run equilibrium. A Short-run supply, S1 Long-run supply (market) (a) Initial Condition And firms earn zero profit. (firm) 6

7 Figure 8 An Increase in Demand in the Short Run and Long Run The higher P encourages firms to produce An increase in market demand more and generates short-run profit. raises price and output. Market (b) Short-Run Response Figure 8 An Increase in Demand in the Short Run and Long Run Profits induce entry and market supply increases. (c) Long-Run Response Market P2 P 1 A B S1 D1 Long-run supply D2 P2 P 2 A B S 1 C S2 Long-run supply D2 D1 Q2 (market) (firm) Q 1 Q 2 Q3 (firm) (market) The increase in supply lowers market price. In the long run market price is restored, but market supply is greater. Why the Long-Run Supply Curve Might Slope Upward Some resources used in production may be available only in limited quantities. s may have different costs. Marginal The marginal firm is the firm that would exit the market if the price were any lower. 7