2Competitive Firm P P Industry Firm P0 P0 P0 d D 10,000,000 50,000,000 30
3Competitive FirmA competitive firm can sell any quantity at the market price. The firm decides how much to produce but not the price. Competitive firms are “price takers”.A competitive firm (not the industry) faces an horizontal demand function.A competitive firm usually represents a small share of the entire industry.
4Marginal Revenue-Competitive Firm Price $50 QuantityTotal RevenuePrice x QuantityMarginal Revenue150210031504200Marginal revenue is constant at the level of the market price
5Production Decision-The Firm The general rule to maximize profits was to produce up to the point in which marginal revenue equals marginal cost (conditional on profits>0).Marginal revenue is equal to price for a competitive firm. Therefore, a competitive firm produces a quantity at which price equals marginal cost.
6The supply curve (firm) is equal to the marginal cost curve but… QuantityMarginal Cost120230340450560670Supply CurvePriceQuantity201302403504605706
7The supply curve-The Firm $ per bicycle$ per bicycleSd’’d’dMCQQ
8The rule for a competitive firm is to produce up to the point where the marginal cost equals the price.Which marginal costs? Long run marginal cost or short run marginal costs?The firm has a short run supply function and a long run supply function.
9U-Shaped Marginal Cost Only the upward slopping part of the marginal cost is relevant for the production decision.MC50MRQ1Q2Q
10“Shutdown Decision” Profit=TR-TC=TR-FC-VC (TC=FC+VC) If the firm “shuts down” it still pays the FCTherefore, the firm will operate ifTR-VC>0 or TR>VCTR=P*Q then TR>VC→P>AVC=VC/QThe fix costs are irrelevant in the short run because the firm pays them even if it shuts down. Sunk cost are irrelevant even in the long run. What is considered fix cost will depend on the length of period the firm is considering.
11Putting Everything Together-The Short Run Supply Function (the FIRM) MCACAVCQ2Q
12The Supply of the Industry ScSbSaIndustry SupplyP0Q1Q2Q1+Q2Q
13The Supply of the Industry ScSbSaIndustry SupplyP0P1Q
14The Competitive Industry in the Short Run The IndustryThe FirmPPsSP0dDQ0q0qQ
15What is the effect in the short run? A Change in fixed costsWhat is the effect in the short run?
16The Competitive Industry in the Short Run- A Change in Variable Costs The IndustryThe FirmS’Ps’Ps’’sSP2d’P0dDQ2Q0q2q0q2’qQ
17The Competitive Industry in the Short Run- A Change in Demand Q0Q3q0q3qQ
18The Planner’s ProblemSuppose a country wants to produce 1 million units of a good at the minimum possible cost. You are told to tell “each firm” in the industry how much to produce to reach this goal.How would you do this?Suppose a firm is producing the last unit at a marginal cost of $5 and another firm is producing the last unit at a marginal cost of $3. You can tell the firm which is producing at a higher cost to produce one less unit and the firm producing at a lower cost to produce an additional unit. The level of output is maintained and you save $2 of cost. When every firm produces the last unit at the same marginal cost the total costs are at the minimum possible.In a competitive equilibrium every firm produces at a point where marginal costs are equal to the price (and the price is equal for all of the firms). Hence, the market automatically produces at the lowest possible cost.
19The Firm in the Long RunThe long run supply function (firm) is equal to the long run marginal cost when the marginal cost is above the average costs.Firms may exit the industry in the long run. They exit if profits are negative. Profits is Revenues minus OPORTUNITY costs.TR-TC=P*Q-TC>0 →P>TC/Q=ACThe firm “breaks even” when the price is equal to the average cost
20Break Even Price-The Firm SACMCP**Break Even PriceP*QQ’Q
21Long Run and Short Run Responses Rent Control-The Industry LRSP2P0=P3P1DQ1Q2Q0’Q0=Q3Q