Chapter Firms in Competitive Markets 13

What is a Competitive Market? The meaning of competition Competitive market – Market with many buyers and sellers – Trading identical products – Each buyer and seller is a price taker – Firms can freely enter or exit the market 2

What is a Competitive Market? The revenue of a competitive firm – Maximize profit Total revenue minus total cost Total revenue = price times quantity = P ˣ Q 3

What is a Competitive Market? The revenue of a competitive firm Marginal revenue – Change in total revenue from an additional unit sold For competitive firms – Marginal revenue = P 4

Profit Maximization& Competitive Firm’s Supply Curve A simple example of profit maximization Maximize profit – Compare marginal revenue with marginal cost If MR > MC – increase production If MR < MC – decrease production 5

Profit Maximization& Competitive Firm’s Supply Curve The marginal-cost curve and the firm’s supply decision Three general rules for profit maximization: – If MR > MC - firm should increase output – If MC > MR - firm should decrease output – If MR = MC - profit-maximizing level of output 6

Profit Maximization& Competitive Firm’s Supply Curve The marginal-cost curve and the firm’s supply decision Marginal-cost curve – Determines the quantity of the good the firm is willing to supply at any price – Is the supply curve 7

Profit Maximization& Competitive Firm’s Supply Curve Shutdown – Short-run decision not to produce anything During a specific period of time Because of current market conditions – Firm still has to pay fixed costs Exit – Long-run decision to leave the market – Firm doesn’t have to pay any costs 8

Profit Maximization& Competitive Firm’s Supply Curve Spilt milk and other sunk costs Sunk cost – Has already been committed – Cannot be recovered – Ignore them when making decisions 9

Restaurant – stay open for lunch? – Fixed costs Not relevant Are sunk costs in short run – Variable costs – relevant – Shut down if revenue from lunch < variable costs – Stay open if revenue from lunch > variable costs Operator of a miniature-golf course – Ignore fixed costs – Stay open if revenue > variable costs Near-empty restaurants and off-season miniature golf 10

Profit Maximization& Competitive Firm’s Supply Curve Firm’s long-run decision to exit/enter a market Competitive firm’s long-run supply curve – The portion of its marginal-cost curve – That lies above average total cost 11

Supply Curve in a Competitive Market Long run: market supply with entry and exit Long run – firms can enter and exit the market – If P > ATC – firms make positive profit – New firms enter the market – If P < ATC – firms make negative profit – Firms exit the market – Process of entry and exit ends when 12

Supply Curve in a Competitive Market Why do competitive firms stay in business if they make zero profit? – Profit = total revenue – total cost – Total cost – includes all opportunity costs – Zero-profit equilibrium Economic profit is zero Accounting profit is positive 13

Monopoly

Why Monopolies Arise Monopoly – Firm that is the sole seller of a product without close substitutes – Price maker – Barriers to entry Monopoly resources Government regulation The production process 15

Why Monopolies Arise Monopoly resources – A key resource required for production is owned by a single firm – Higher price Government regulation – Government gives a single firm the exclusive right to produce some good or service – Government-created monopolies Patent and copyright laws Higher prices; Higher profits 16

Why Monopolies Arise The production process – A single firm can produce output at a lower cost than can a larger number of producers Natural monopoly – Arises because a single firm can supply a good or service to an entire market At a smaller cost than could two or more firms – Economies of scale over the relevant range of output 17

How Monopolies Make Production& Pricing Decisions Monopoly versus competition – Monopoly Price maker Sole producer Downward sloping demand – Market demand curve – Competitive firm Price taker One producer of many Demand – horizontal line (Price) 18

The Welfare Cost of Monopolies The deadweight loss Monopoly – Produce quantity where MC = MR – Produces less than the socially efficient quantity of output – Charge P>MC – Deadweight loss Triangle between: demand curve and MC curve 19