Chapter

13

Firms in Competitive
Markets
 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
 Near-empty restaurants and
off-season miniature golf
• 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
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