Microeconomics: Perfectly Competitive Markets Notes

Introduction to Perfectly Competitive Markets

• Definition and Characteristics:
  • A perfectly competitive market consists of many buyers and sellers.
  • All firms sell identical products (homogeneous).
  • Each buyer and seller is a price taker, meaning they accept the market price.
  • There is free entry and exit in the market, allowing firms to enter without barriers and exit without losing significant investments.

Revenue Concepts

• Key Revenue Definitions:
  • Total Revenue (TR): TR = P imes Q
  • Total amount of money a firm receives from selling its product.
  • Average Revenue (AR): AR = rac{TR}{Q}
  • Revenue per unit sold; for competitive firms, AR = P.
  • Marginal Revenue (MR): MR = rac{ ext{change in TR}}{ ext{change in Q}}
  • The additional revenue from selling one more unit; for competitive firms, MR = P.

Profit Maximization

• Profit Equation: Profit = TR - TC
• Total Cost (TC): TC = FC + VC
  • Fixed Costs (FC): Costs that do not change with the level of output.
  • Variable Costs (VC): Costs that do change with output.
• Maximizing Quantity (Q):
  • A firm maximizes profit by adjusting production to the point where MR = MC (Marginal Cost).
  • If MR > MC, the firm increases output.
  • If MR < MC, the firm decreases output.

Example: Amari's Apple Orchard

• Scenario:

  • Price of apples = 20 per bushel.
  • Capacity = 10 bushels per year.

• Revenue Calculations:

  • Total Revenue at different quantities:
  • At Q=1: TR = 20
  • At Q=10: TR = 200.

• Profit Calculations:

  • Example calculations showing TR, TC, and Profit against various quantities.

Short-run Decisions: Shut Down vs. Continue Production

• When to Shut Down:
  • If TR < VC or P < AVC (Average Variable Cost), the firm should produce Q=0 in the short run.
• Short-run Supply Curve:
  • The firm's short-run supply curve is the portion of the MC curve that lies above the AVC.

Long-run Decisions: Exit or Enter the Market

• Condition for Exiting:
  • A firm should exit the market if TR < TC or equivalently if P < ATC (Average Total Cost).
• Market Dynamics:
  • The number of firms in the market changes based on profit conditions, adjusting until zero economic profits are achieved.

Long-run Supply Curve Characteristics

• Typical Supply Curve:
  • In long-run equilibrium, all firms earn zero economic profit, leading to stable prices at P = min ATC.
  • Under conditions of identical costs for all firms, the long-run supply curve can be horizontal.
  • If costs vary among firms or as firms enter the market, the long-run supply curve slopes upward.

Efficiency in Competitive Markets

• Market Efficiency Condition:
  • At equilibrium, P = MC which maximizes total surplus.
  • Competitive markets yield efficient outcomes because they balance supply and demand at the lowest cost without wastage.

Key Takeaways

• Zero Profit Equilibrium:
  • In long-run equilibrium, firms earn zero economic profit but may still maintain positive accounting profit due to covering implicit costs.
• Market Fluctuations:
  • Changes in demand can lead to short-run profits or losses, but will stabilize towards zero economic profit in the long run.