CH15- Firms in Competitive Markets

Competitive market

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

Price taker

A buyer or seller who must accept the price the market sets and cannot influence it

Characteristics of a competitive market

Many buyers and sellers, undifferentiated (identical) goods, and free entry and exit (no barriers to entry)

Barriers to entry

Obstacles that keep new firms from entering a market; competitive markets have none

Total revenue (TR)

Price times quantity sold (TR = P × Q)

Average revenue (AR)

Total revenue divided by quantity sold (AR = TR / Q); equals price for every type of firm

Marginal revenue (MR)

The change in total revenue from selling one more unit (MR = ΔTR / ΔQ); equals price for a competitive firm

Profit

Total revenue minus total cost (TR − TC)

Marginal cost (MC)

The change in total cost from producing one more unit (MC = ΔTC / ΔQ)

Average total cost (ATC)

Total cost divided by quantity (TC / Q); also called unit cost

Average variable cost (AVC)

Variable cost divided by quantity (VC / Q)

Profit-maximizing rule

Produce the quantity where marginal revenue equals marginal cost (MR = MC); for a competitive firm, P = MC

Competitive firm's supply curve

The marginal-cost curve, because MC shows the quantity the firm will supply at each price

Short-run supply curve (firm)

The portion of the MC curve above average variable cost

Long-run supply curve (firm)

The portion of the MC curve above average total cost

Shutdown

A short-run decision to produce nothing for a period because of current market conditions; the firm still pays fixed costs

Exit

A long-run decision to leave the market entirely; the firm pays no costs at all

Shutdown rule

Shut down in the short run if TR < VC, which is the same as P < AVC

Exit rule

Exit in the long run if TR < TC, which is the same as P < ATC

Entry rule

A new firm enters in the long run if TR > TC, which is the same as P > ATC

Sunk cost

A cost that has already been committed and cannot be recovered, so it should be ignored in decisions

Fixed costs in the short run

Sunk costs, because they are paid whether or not the firm produces

Short-run market supply

The sum of the identical firms' individual supply curves when the number of firms is fixed

Long-run market supply

Supply with free entry and exit; usually horizontal (perfectly elastic) at minimum ATC

Efficient scale

The quantity that minimizes average total cost; where MC crosses ATC

Zero-profit equilibrium

Long-run competitive equilibrium where P = minimum ATC, so economic profit is zero

Economic profit

Total revenue minus all opportunity costs (explicit and implicit)

Profit area on a graph

Rectangle with height (P − ATC) and width Q

In a competitive market, each buyer and seller is a _____

price taker

Goods sold by different sellers in a competitive market are _____

identical

Competitive markets have free entry and exit, which means there are no _____ to entry

barriers

For any firm, average revenue equals _____

price

For a competitive firm, marginal revenue equals _____

price

A firm aims to maximize _____, not revenue

profit

If MR > MC, the firm should _____ output

increase

If MC > MR, the firm should _____ output

decrease

At the profit-maximizing level of output, MR equals _____

MC

The marginal-cost curve determines the firm's quantity _____ at each price

supplied

The MC curve is typically upward _____

sloping

The ATC curve is typically _____-shaped

U

The MC curve crosses the ATC curve at the _____ of ATC

minimum

A short-run decision to stop producing while still paying fixed costs is called a _____

shutdown

A long-run decision to leave the market is called _____

exit

In the short run, a firm shuts down if price is less than _____

AVC

In the long run, a firm exits if price is less than _____

ATC

A cost that has already been paid and cannot be recovered is a _____ cost

sunk

In the short run, fixed costs are _____ costs

sunk

In the short run, the firm's supply curve is the part of MC above _____

AVC

In the long run, the firm's supply curve is the part of MC above _____

ATC

If P > ATC, new firms will _____ the market

enter

If P < ATC, existing firms will _____ the market

exit

In long-run equilibrium, firms produce at their _____ scale

efficient

In long-run equilibrium, economic profit is _____

zero

Entry and exit make the supply curve more _____ in the long run than in the short run

elastic

Long-run market supply is often perfectly elastic, meaning it is _____

horizontal

Profit is zero when price equals _____

ATC

Which of the following is NOT a characteristic of a competitive market?

Firms sell differentiated products

Why does marginal revenue equal price for a competitive firm?

The firm is a price taker, so each extra unit adds exactly P to total revenue

Which statement about average revenue is true for every type of firm?

AR equals price

What quantity does a profit-maximizing competitive firm produce?

The quantity where P = MC

What does a competitive firm's marginal-cost curve represent?

The firm's supply curve

What is the key difference between shutdown and exit?

A shutdown firm still pays fixed costs; an exiting firm pays no costs

A firm should shut down in the short run when

TR < VC, or P < AVC

A firm should exit the market in the long run when

TR < TC, or P < ATC

Why should fixed costs be ignored in the short-run shutdown decision?

They are sunk costs paid regardless of whether the firm produces

Where does the MC curve cross the ATC curve?

At the minimum point of ATC

What happens in a competitive market when firms are earning positive economic profit?

New firms enter, price falls, and profits shrink toward zero

In long-run competitive equilibrium, price equals

Minimum average total cost

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

Total cost includes opportunity costs, so zero economic profit still covers the owners' next-best alternative

Why is long-run market supply more elastic than short-run market supply?

Firms can enter and exit the market in the long run

How is the short-run market supply curve found when there is a fixed number of identical firms?

Add up the quantity each firm supplies at each price

After a demand increase in a market in long-run equilibrium, what happens in the long run?

Firms enter, supply shifts right, and price returns to minimum ATC

A cupcake shop in a competitive market sells 150 cupcakes at $4 each. What is total revenue?

$600

The same cupcake shop sells a 151st cupcake. What is the marginal revenue of that cupcake?

$4

A wheat farm earns $9,000 in total revenue from 1,500 bushels. What is average revenue?

$6

A car wash has total revenue of $5,000 and total cost of $3,800. What is its profit?

$1,200

A T-shirt printer's total cost rises from $410 to $428 when output goes from 20 to 21 shirts. What is the marginal cost of the 21st shirt?

$18

A firm's total cost is $2,400 when it produces 300 units. What is ATC?

$8

A competitive firm sells 200 units at P = $12 with ATC = $9. What is its profit?

$600

A competitive firm sells 300 units at P = $5 with ATC = $7. What is its profit?

−$600

A firm sells 1,000 units at P = $4. Variable cost is $5,000 and fixed cost is $2,000. What is its profit if it keeps operating?

−$3,000

Same firm (P = $4, Q = 1,000, VC = $5,000, FC = $2,000). What is its profit if it shuts down in the short run?

−$2,000

A market has 500 identical firms, and each supplies 40 units at P = $15. What is the market quantity supplied at $15?

20,000 units

A competitive firm's price is $10. The 5th unit has MC = $11. How does producing the 5th unit change profit?

Profit falls by $1

Table: Q = 0, 1, 2, 3, 4, 5 and TC = $10, $14, $20, $28, $38, $50. P = $9. What is the profit-maximizing quantity?

3 units

Same table (TC = $10, $14, $20, $28, $38, $50; P = $9). What is profit at the profit-maximizing quantity?

−$1

Same table (TC = $10, $14, $20, $28, $38, $50; P = $9). At Q = 3, AVC = $6. What should the firm do in the short run?

Keep producing 3 units because P > AVC

Graph: P = MR is a horizontal line at $20. MC crosses it at Q = 50. ATC at Q = 50 is $14. What is the firm's profit?

$300

On a profit graph, what are the height and width of the shaded profit rectangle?

Height = P − ATC at Q*, width = Q*

Graph: P = $6, MC crosses P at Q = 30, ATC at Q = 30 is $9, AVC at Q = 30 is $5. What is the firm's result and short-run decision?

Loss of $90; keep operating because P > AVC

Same graph (P = $6, ATC = $9, AVC = $5 at Q = 30). What does the firm do in the long run?

Exit the market because P < ATC

A firm's MC curve shows Q = 10 at P = $4, Q = 14 at P = $6, and Q = 17 at P = $8. Minimum AVC is $5. How much does it supply at P = $4?

0 units, because P is below AVC

Same firm (Q = 14 at P = $6, Q = 17 at P = $8). If price rises from $6 to $8, what happens to quantity supplied?

Rises from 14 to 17, moving up the MC curve

A firm's MC curve crosses its ATC curve at Q = 60, where ATC = $8. What is the long-run equilibrium price in this competitive market?

$8

A market is in long-run equilibrium at P = $10 (minimum ATC). Demand increases and the short-run price rises to $13. What is the price in the long run?

$10

On a two-panel graph (firm and market), price drops below minimum ATC. What happens in the market panel over the long run?

Firms exit, supply shifts left, and price rises back to minimum ATC