Chapter 12; MicroEconmics- Firms in perfect competitive markets

Firms in perfect competitive markets

3 Market Structure Characteristics

1. The number of Firms in the Industry
2.The similarity of the good or service produced by the firms
in the industry
3.The ease with which new firms can enter the industry

Perfect Competition

Number of Firms; Many
Type of product: Identitcal
Ease of entry: High
Examples: Agriculture

Perfectly Competitive Markets

A market that reaches the conditions of 1) many buyers and sellers 2) all firms selling identical products 3) No barriers to new firms entering the market

Prices are determined by the...

Interaction of Supply and demand

Consumers and firms...

Accept the market price

Price taker

a buyer or seller who is unable to effect the price

Each firm is selling the exact amount of the same product..

As many other firms

The Firm can sell..

As much as it wants at the current market price

The firm cannot sell anything..

if it has raised the price by one cent even
->There for the Demand curve is completely horizontal when talking about an individual seller

We assume..

that firms maximize profits

Profit Formula

Total Revenue- Total cost= Profit (Pie symbol)

OR

(Price- ATC) x Quantity

How does a perfectly competitive firm maximize profits?

--> Produce the Quantity where the difference between TR and TC is as LARGE as possible

Total Revenue Formula

TR =Price x Quantity

What is total revenue?

The total amount of funds received by a seller of a goof or service

Average Revenue Formula

TR/Q

What is Average Revenue?

Total Revenue divided by the aunty of the product sold

Marginal Revenue Formula

Change in TR/ Change in Q

What is Marginal Revenue?

The change in Total revenue from selling one more unit of a good or service

Market Price =

Constant (perfect competition)

Average Revenue=

Price ALWAYS!! in this chapter

Marginal Revenue =

Always constant price! ( only in this chapter)

What is the companies goal?

To choose a company that maximizes profits

*Profit maximization condition*

MR=MC

For an individual firm The demand curve is equal to=

MR ( Marginal Revenue) because Price is equal to MR

2 ways to determine the Profit maximizing level of output

1.The profit maximizing level of output is the difference between where TR and TC is the greatest
2. Q* Is also where MR=MC
-Notice that Price=MR
-Therefor MR=MC condition as P=MC

If Price is > ATC then..

π (profit) > 0

If Price is < ATC then..

π (profit)

zero profits -->

Make the ATC curve tangent (touching) the demand curve
P=ATC Profits are zero

Postive profits -->

Make the ATC curve to dip below the demand curve
P>ATC = Positive profits

Negative profits-->

Makes the ATC curve go above the demand curve
P< ATC = Negative profits

NOTE*

Quantity is always positive

Profit Maximization=

Equilibrium point

TWO choices for a firm making a Profit loss

1. Continue to produce

2. Stop production by shutting down temporarily
- Even if the firm stops producing it must pay its fixed cost (Sunk cost)
-The fixed cost becomes a sunk cost
-Deciding whether to produce or not is determined by the relationship between TR and VC

when would you produce

TR> or equal to VC then produce!
or P> AVC
- your earring negative profits
-you have to make sure you can sell stuff and at least pay your workers
- still losing money ( fixed Cost)

when would you shut down

TR< VC then shut down
or P

At the profit-maximizing level of output for a perfectly competitive firm..

MR=MC and ATC= AFC

For a firm in a perfectly competitive market, price is

equal to both average revenue and marginal revenue.

What does the supply curve for a firm tell us ? (short run)

The relationship between P and Q^s

-MC curve is the supply curve
-How do you get rid of dip? take a look at shutdown point
-MR=MC (maximize profits)
-P=MR ( only this chapter!!) therefore P=MC
- once you get rid of anything that had do to w/ shut-in down it is a supply curve!

The Effect of Profits on Entry and Exit
(long run)

-> If firms are making a positive profits in the short run, then new firms will enter the market
- Existing firms remain in the market

->If firms are making negative profits in the short run, then existing firms will exit the market
-No new firms enter market



Another way to think of it


Pos profits today= Create entry ( more firms) in long run
Neg profits today= Exit (less firms) in the long run

ENTRY REDUCES POSITIVE PROFITS TO ZERO!
In long run new companies/ More companies - increase in supply there for..

Supply curve shifts to right and Q increases P decreases
Demand curve shifts down - until we get to zero profits

When does entry stop?

Once the profits are zero

Sweet spot in long run is that..

Entry is gonna shift the supply curve to the right until we get to ZERO profits for the company

Exit Boosts Negative Profits to zero

- Price goes up
-supply curve shifts to left!! ( Matches w P^2 *)
-lower quantity
-How much higher? at the end of the day to zero profits

How Negative Profits Affect an Indidvual Firm?

- Since firms are price takes, then the higher market price shifts the demand curve up
-This leads to a higher Q^s and an increase in π
-Firms will continue to exit as long as they are making negative profits
-Eventually the reduction of firms will eventually make π = 0