YR1SM1 MICROECONOMICS: Chapter 15 Firms in Competitive Markets

For competitive firms, which monetary values equal each other? (3)

Average revenue = price = marginal revenue

What does TR =

P x Q

What does Average Revenue (AR) =

TR / Q

How does average revenue equal price?

Since average revenue equals total revenue / Q, then it is also equal to P x Q / Q, and Q will cancel out

Marginal revenue =

∆TR / ∆Q

How is marginal revenue equal to price in a competitive market?

Since firms are price-takers, meaning that they cannot change the price, the only way revenue changes is through a change in quantity, meaning that [(P1)(Q2) - (P1)(Q1)] / [Q2 - Q1] simplifies to [P1 / 1]

Profit rises with an increase in quantity as long as ..

the rise in revenue, or marginal revenue, exceeds the rise in cost, or marginal cost

On a quantity output vs costs graph, why do profits rise when MC < MR?

Although MC is rising, for now the additional production costs are ~low compared to the substantial amount of output being made

Why do profits fall when MC > MR?

Since production costs rise at a rate faster than the output being produced, marginal cost becomes higher and higher and outweighs the marginal revenue

Why does the intersection of MC and MR on a quantity output vs costs graph represent “thinking at the margin”?

The cost of increasing a variable input by 1 equals the additional revenue this increase brings in, meaning that profit will not increase since it has reached its maximum, but it’s still advisable for firms to do this because it will still increase efficiency

Which quantity, in any sort of market, maximizes profit in the short run?

the quantity at which marginal revenue = P = marginal cost, given that this intersection is above AVC

On a quantity vs costs graph, how are the MR and MC lines displayed?

The marginal cost curve is simplified to strictly a positive linear line, but marginal revenue stays constant/flat at y =, or in this context, P, = some value

When price rises due to market forces, what happens?

Since firms produce at the quantity where MR = MC, firms will produce a higher quantity now, which aligns with the law of supply

What is another name for the supply curve and why?

Marginal cost curve, because where the marginal cost curve intersects the price/MR line determines the quantity produced, which should obey the law of supply

Shutdown vs exit

Shutdown refers to a short-run decision to temporarily stop production, meaning that fixed costs are still prevalent. However, exit refers to a long-run decision to leave the market, meaning that all inputs, including fixed, are eliminated

By entering into a shutdown, what are the costs of shutting down and the savings of shutting down?

the cost is the loss of potential total revenue, while the savings is the variable costs that no longer have to be paid

In which case should firms shut down? 2 other ways of stating this?

If the savings of shutting down outweigh the costs of shutting down

If total revenue < the variable costs for that period, or in other words, if P < AVC

In regards to a shut down, what part of the MC line represents the supply curve?

Only the part at prices that exceed the AVC, and the quantity of output made is determined by wherever this price/MR and MC intersection is

In regards to a shut down, what part of the MC line DOES NOT represent the supply curve?

the part at prices which fall below AVC, because this area indicates a period of shut down and no production

What are sunk costs? EX?

costs that have already been committed and cannot be recovered, and are ignored when making the decision to shut down; EX = fixed costs short run

What is the cost and benefit of exiting the market in the long run?

COST = revenue loss (TR)

BENEFIT = cost savings, TC (because FC = 0 in the long run)

Why are fixed costs = 0 in the long run?

no fixed costs because all fixed costs become variable costs

In which case should firms exit the market? 2 other ways of stating this?

If the savings of exiting outweigh the costs, or if TC > TR or if ATC > P

In which case should firms enter the market? 2 other ways of stating this?

If the costs of exiting outweigh the savings of exiting, or if TR > TC or if P > ATC

Name the two ways to calculate a firm’s LR profit

1) area representing TR - area representing TC

2) (P - ATC)(Q)

On a quantity output vs costs graph, how to find area that represents TR?

quantity where MC = MR * current price

On a quantity output vs costs graph, how to find area that represents TC?

quantity where MC = MR * cost at the intersection between this quantity and the ATC curve

For (P - ATC)(Q), how to find P, ATC, and Q?

P = current price

ATC = cost at which the MR = MC quantity intersects the ATC curve

Q = quantity at which MR = MC

What are 2 assumptions about firm costs in a competitive market?

since firms are identical, both existing firms and potential entrants have identical cost curves

a firm’s costs do not change due to the exit or entrance of another firm

In regards to entering/exiting, what part of the MC represents the LR supply curve?

Only the parts at prices above the ATC curve, because firms are actually in the market here and producing

Combining long run and short run: what if current price is above the AVC curve but below the ATC curve?

In the short run, the firm will continue producing because price > AVC; however, by continuing production, the firm will incur a loss (the area bound by: quantity made at current price * difference between the ATC at the quantity and the current price)

What is an assumption about the # of firms in a competitive market?

The # of firms is fixed in the short run but variable in the long run due to the long time required to develop or get rid of fixed inputs

How does price compare to ATC when firms gain positive economic profit?

P > ATC

In the long run, what happens if existing firms gain positive economic profit?

New firms see this potential for profit and enter (the LR aspect), causing short run market supply to increase and P to decrease, which will reduce profits and slow further entry

The market starts at LR EQ, but an increase in demand causes a rightward shift of the demand curve

PART 1

Increased demand raises price, which allows firms to gain profit = the area bound by new optimal quantity * the difference between current price and old price

The market starts at LR EQ, but an increase in demand causes a rightward shift of the demand curve

PART 2

Positive economic profit encourages entry. More firms causes a rightward shift in the supply curve

The market starts at LR EQ, but an increase in demand causes a rightward shift of the demand curve

PART 3

A right shift in the supply curve decreases price until long run equilibrium is restored

When firms incur negative economic profit, how does price compare to ATC?

p < ATC

In the long run, what happens if existing firms incur loss?

Some firms will exit, causing short run market supply to decrease and P to rise, which will actually reduce the losses of the remaining firms

When will exits and entries stop?

when profit = 0, or when P = the minimum ATC

What does the zero economic profit condition entail?

how at LR EQ, or when firms produce at their optimal quantity, P = MR = MC, and since this optimal quantity occurs at the efficiency scale, P = MR = MC = minimum ATC

If firms gain zero economic profit at the efficiency scale, why do they still produce here?

economic profit is zero, but accounting profit is above zero

In order to reach equilibrium, what two requirements of firms must be met?

no firms should be entering or exiting the market, and individual firms should be producing at their optimal quantity/efficiency scale, or when P = MC = minimum ATC

On a P vs Q graph, what does the long run supply line look like?

It is a horizontal line that crosses the intersection of price = minimum ATC = MC

What does a flat LR supply line indicate?

that although market forces cause price fluctuations, over time firms resolve this instability by enter/exiting until production returns to the price at which MR = MC = minimum ATC, which is the same price as LR EQ from before. Only production at this price is sustainable.

What two factors would cause the long run supply curve to slope upward?

firms have different costs or costs rise as firms enter the market, so an increase in price is needed for sellers to stay in the market and for new sellers to enter the market (idea of the marginal seller)

Why does the entry of new firms into the markets cause an increase in costs?

The greater number of firms increases demand for a limited input, causing the input’s price to increase and thus the firms’ production costs to increase, meaning that an increase in selling price is needed to make production worthwhile