Principles of Microeconomics - Competitive Markets

8/3/2019 Principles of Microeconomics - Competitive Markets

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Firms in Competitive Markets

Dr. Katherine Sauer

Principles of Microeconomics

ECO 2020


2/25

Overview:

I.The Firms Marginal Revenue and DemandII. The Firms Output

III. The Firms Profits: Graphically

IV. Market Dynamics

V. Efficiency


3/25

Recall the characteristics of a competitive market:

many sellershomogeneous product

no barriers to entry

A firm in a competitive market is a price taker. That is,

whatever the market price is, that is the price the firm will

charge.

- if charge more, will lose sales to other firms- no reason to charge less


4/25

I. The Firms Marginal Revenue and Demand

Assume the firm sets its price equal to the market price, P*.

So, thenTR = P* x Q

AR = P*


5/25

MR = TR2 TR1Q2 Q1 = P* x Q2 P* x Q1Q2 Q1 = P*( Q2 Q1)Q2 Q1 = P*

For a competitive firm:

marginal revenue is always equal to the market price.


6/25

The demand curve for a competitive firm is a horizontal

line at the market price.

- because the firm is just one of many firms selling an

identical product, its demand curve isperfectly elastic

- if the firm charged higher than the market price, no

one would buy from it

- the firm would not charge a price lower than themarket price


7/25

Market for Soybeans Farmer Frans Soybeans

S

D

Q

P

P*

Q*

D

P

P*

q

= MR


8/25


S

D

Q

P

P*

Q*

D

P

P*

q

= MR

Suppose that it is announced that soy can help promote heart

health.

D2

P2

Q2

P2 D2 = MR2


9/25

When the forces of supply and demand affect the market

price, the individual firms

- demand

- marginal revenue

curves will shift.

Ifmarket price rises: firm demand and MR shift up

(increases).

Ifmarket price falls: firm demand and MR shift down

(decreases).


10/25

II. The Firms Level of Output

We learned previously that the firm will produce the level

of output where marginal revenue is equal to marginal cost.

Graphically: P

P*

q

D= MR

MC

q*


11/25

Mathematically:

Paulos Ping Pong Balls is a firm that operates in a competitive

market. The ping pong balls sell for $3 per package.

Output Price TR TC MR MC Profit

0

1

2

34

5

6

78

9

3

3

3

33

3

3

33

3

0

3

6

912

15

18

2124

27

1.50

2.00

3.00

4.506.50

9.00

12.00

15.5019.50

24.00

---

3

3

33

3

3

33

3

---

0.50

1.00

1.502.00

2.50

3.00

3.504.00

4.50

-1.50

1.00

3.00

4.505.50

6.00

6.00

5.504.50

3.00

This firm will produce 6 units of output.

This firm will charge $3 per unit.


12/25

Recall that if the market price is less than the firms average variable

cost, the firm will temporarily shut down and produce q*=0.

- need to look at AVC vs P where MR = MC to determine

P

P*

q

D= MR

MC

q where

MR =

MC

AVC

AVC

*

q*=0


13/25

When the market price is greater than the average variable

cost at the quantity where MR = MC, then produce that

quantity.P

P*

q

D= MR

MC

q*

AVC

AVC

*


14/25

III. The Firms Profits Graphically

Recall that a firms profits depend on the relationship

between price and average total cost.

A competitive firm takes the market price as given, andwill compare this to the average total cost at the profit

maximizing level of output to determine its profits.

- at the quantity where MR = MC, compare the

price to the ATC


15/25

P

P*

q

D= MR

MC

q*

A. At q*, P > ATC

ATCATC*

profits

(P ATC)q > 0AVC


16/25

P

P*

q

D= MR

MC

q*

B. At q*, P = ATC

ATC

ATC* =

There is no profit area to illustrate

because profits are equal to zero.

(P ATC)q = 0

breaking even

AVC


17/25

P

P*

q

D= MR

MC

q*

C. At q*, P < ATC

ATC

ATC*

loss

(P ATC)q < 0AVC


18/25

Recap:

1) Competitive firms take the market price as given.

P = MR = D for the firm

2) Produce the level of output where MR = MC.

Double check that P > AVC at that quantity.

3) Compare the price to the ATC at that quantity to

determine profits or losses.

Note: graphically, Ill often leave off the AVC curve

and just have you focus on the ATC.


19/25

IV. Market Dynamics

Recall that when the market equilibrium changes, the

firms demand curve / marginal revenue changes as well.

This will affect the firms output and profits.


20/25


S

D

Q

P

P*

Q*

P

P*

q

D = MR

MCATC

Initially, Farmer Fran is earning a loss.

q*


21/25


S

D

Q

P

P*

Q*

P

P*

q

D2

P2

Q2

P2

D = MR

MCATC

Suppose that it is determined that soy helps promote hearth health.

Now Fran is earning a profit and is selling a higher output.

q*

D2 = MR2

q2


22/25


S

D

Q

P

P*

Q*

P

P*

q

D2

P2P3

Q2

P2

D = MR

MCATC

Because Fran is in a competitive industry earning positive profits,

wed expect other farmers to plant soybeans in the long run.

q*

D2 = MR2

q2

S3

Q3

P3D3 = MR3

q3


23/25

Long Run Equilibrium in a Competitive Market:

In the long run, firms in a competitive market will each

earn zero profits.

In order to earn zero profits, the price and average totalcost must be equal at q*.

This will occur at the point where:

MR = MC = ATCmin = P


24/25

V. Efficiency

We previously learned about the minimum efficient scale.- the quantity that minimizes average total cost

If a firm is producing at this level of output, we would

call the firmproductively efficient.- producing the level where ATC is minimized

If a competitive firm is breaking even, it is also being

productively efficient.- always in the long run

- sometimes in the short run


25/25

If theprice a firm charges is exactly equal to its

marginal cost, we call the firm allocatively efficient.

- a competitive firm is always allocatively efficient

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Principles of Microeconomics - Competitive Markets