chapter 13

13.1 Competitive Market Economics

• Characteristics of a competitive market:

  • Full Information: Everyone knows what they are trading and the prices; no one has more information than the other.

  • Price Takers: Buyers and sellers cannot affect market prices. Market power indicates deviation from a competitive market.

  • Standardized Goods: Goods are interchangeable with the same characteristics; commodities like gold and oil fit this definition.

  • Free Entry and Exit: This is not essential but important, as lack of it can lead to collusion.

13.2 Revenue in a Perfectly Competitive Market

• In a perfectly competitive market:

  • Producers can sell limitless quantities without affecting market prices.

  • Total Revenue (TR): Price times quantity produced.

  • Average Revenue (AR): Total revenue divided by quantity.

  • Marginal Revenue (MR): Revenue generated by selling an additional unit; in such markets: Price = MR = AR.

13.3 Profits and Production Decisions

• Firms aim to maximize profits by responding to marginal costs.

• The profit-maximizing output is where:

  • MR = MC

  • The graphical determination shows:

    • Point A: More production if MR > MC.

    • Point B: Profit-maximization at MR = MC.

    • Point C: Loss occurs if MC > MR.

  • Rule of Thumb: Increase production as long as MR > MC since total profit increases.

13.4 Deciding When to Operate

• Firms must choose:

  • To produce or shut down in the short run.

  • To exit the market in the long run.

• Short Run: Shut down to avoid variable costs, while fixed costs remain.

  • Sunk costs are irrelevant in the short run.

  • Produce if Price > AVC.

• Long Run: All costs are variable; decisions based on Total Cost.

  • Exit if Price < ATC.

13.5 Supply Curve

• Short-Run Supply Curve:

  • Number of firms in the market is fixed.

  • Total quantity supplied is the sum of individual firm supplies, represented by marginal cost curves.

• Long-Run Supply Curve:

  • Firms can enter/exit the market, affecting supply.

  • Zero Economic Profits: When market adjustments reach P = ATC.

  • Positive profits lead to market entry; negative profits lead to market exit.

Economic Profits vs Accounting Profits

• Economic Profits: Consider all opportunity costs; can be negative while accounting profits are positive.

• Long-Run Supply at Efficient Scale:

  • Efficient scale is where quantity minimizes average total cost.

  • Firms produce where P = MC = MR.

  • In the long run, equilibrium is maintained as firms adjust to zero economic profits.

Why Long-Run Supply Shouldn't Slope Upward

• Competitive market theory suggests horizontal supply curves.

• Reality: Most long-run curves slope upward due to varying cost structures among firms.

  • Market Entry: Higher costs for new entrants lead to price increases.

Long-Run Economic Profits

• In theory, all firms should earn zero economic profits, but:

  • Price = min ATC typically applies only to the least efficient firm.

  • More efficient firms can earn positive economic profits due to lower ATC.

Long-Run Adjustments Due to Production Costs

• Changes like technology improvements decrease MC and ATC.

• Marginal costs influence AVC and ATC curves’ lowest points.

• Firms shut down if the market price is below AVC.

• Market dynamics lead to: Firms exiting cause prices to increase until economic profits reach zero.