Chapter 14 - Firms in Competitive Markets
What is a Competitive Market
The meaning of competition
A competitive market, sometimes called a perfectly competitive market, has two
characteristics:
1. There are many buyers and many sellers in the market.
2. The goods offered by the various sellers are largely the same
As a result of these conditions, the actions of any single buyer or seller in the market have a
negligible impact on the market price. Buyers and sellers in competitive markets must accept
the price the market determines and, therefore, are said to be price takers. There is also a
third condition thought to characterize perfectly competitive markets is that firms can enter
and exit the market freely.
The Revenue of a Competitive Firm
A firm in a competitive market, like most other firms in the economy, tries to
maximize profit, which equals total revenue minus total cost. There are five
things to remember when taking revenue into account. Quantity (Q), Price (P),
Total Revenue (TR = P x Q), Average Revenue (AR = TR/Q), and Marginal
Revenue (MR = ∆TR/∆Q).
Profit Maximization and the Competitive Firm’s Supply Curve
The goal of a competitive firm is to maximize profit, which equals total revenue minus total
cost.
A Simple Exam of Profit Maximization
Q TR TC Profit MR MC ∆ in Profit
0 0 3 -3
1 6 5 1 6 2 4
2 12 8 4 6 3 3
3 18 12 6 6 4 2
4 24 17 7 6 5 1
5 30 23 7 6 6 0
6 36 30 6 6 7 -1
7 42 38 4 6 8 -2
8 48 47 1 6 9 -3
The Marginal-Cost Curve and the Firm’s Supply Decision
, If the firm is producing at Q1, then it is making a profit because the MC is below the MR. If
the firm is producing at Q2, then the MC is above the MR and will be losing money and
making a loss. If the firm produces at Qmax, it will be maximizing its profit because the
marginal cost is equal to the marginal revenue if you increase or decrease production by 1,
the firm won't be maximizing its profits anymore. Three general rules to follow:
1. If marginal revenue is greater than marginal cost, the firm should increase its output.
2. If marginal cost is greater than marginal revenue, the firm should decrease its output.
3. At the profit-maximizing level of output, marginal revenue and marginal cost are
exactly equal.
These rules are the key to rational decision making by a profit-maximizing firm. Because the
firm’s marginal-cost curve determines the quantity of the good the firm is willing to supply at
any price, the marginal cost curve is also the competitive firm's supply curve.
The Firm’s Short-Run Decision to Shut Down
In certain circumstances, however, the firm will decide to shut down and not produce
anything at all. A shutdown refers to a short-run decision not to produce anything during a
specific period of time because of current market conditions. Exit refers to a long-run
decision to leave the market. The short-run and long-run decision differ because most firms
cannot avoid their fixed costs in the short run but can do so in the long run. Let’s consider
what determines a firm’s shutdown decision. If the firm shuts down, it loses all revenue from
the sale of its product. At the same time, it saves the variable costs of making its products.
Thus the firm shuts down if the revenue that it would get from producing is less than its
variable costs of production.
● Shutdown if TR<VC
What is a Competitive Market
The meaning of competition
A competitive market, sometimes called a perfectly competitive market, has two
characteristics:
1. There are many buyers and many sellers in the market.
2. The goods offered by the various sellers are largely the same
As a result of these conditions, the actions of any single buyer or seller in the market have a
negligible impact on the market price. Buyers and sellers in competitive markets must accept
the price the market determines and, therefore, are said to be price takers. There is also a
third condition thought to characterize perfectly competitive markets is that firms can enter
and exit the market freely.
The Revenue of a Competitive Firm
A firm in a competitive market, like most other firms in the economy, tries to
maximize profit, which equals total revenue minus total cost. There are five
things to remember when taking revenue into account. Quantity (Q), Price (P),
Total Revenue (TR = P x Q), Average Revenue (AR = TR/Q), and Marginal
Revenue (MR = ∆TR/∆Q).
Profit Maximization and the Competitive Firm’s Supply Curve
The goal of a competitive firm is to maximize profit, which equals total revenue minus total
cost.
A Simple Exam of Profit Maximization
Q TR TC Profit MR MC ∆ in Profit
0 0 3 -3
1 6 5 1 6 2 4
2 12 8 4 6 3 3
3 18 12 6 6 4 2
4 24 17 7 6 5 1
5 30 23 7 6 6 0
6 36 30 6 6 7 -1
7 42 38 4 6 8 -2
8 48 47 1 6 9 -3
The Marginal-Cost Curve and the Firm’s Supply Decision
, If the firm is producing at Q1, then it is making a profit because the MC is below the MR. If
the firm is producing at Q2, then the MC is above the MR and will be losing money and
making a loss. If the firm produces at Qmax, it will be maximizing its profit because the
marginal cost is equal to the marginal revenue if you increase or decrease production by 1,
the firm won't be maximizing its profits anymore. Three general rules to follow:
1. If marginal revenue is greater than marginal cost, the firm should increase its output.
2. If marginal cost is greater than marginal revenue, the firm should decrease its output.
3. At the profit-maximizing level of output, marginal revenue and marginal cost are
exactly equal.
These rules are the key to rational decision making by a profit-maximizing firm. Because the
firm’s marginal-cost curve determines the quantity of the good the firm is willing to supply at
any price, the marginal cost curve is also the competitive firm's supply curve.
The Firm’s Short-Run Decision to Shut Down
In certain circumstances, however, the firm will decide to shut down and not produce
anything at all. A shutdown refers to a short-run decision not to produce anything during a
specific period of time because of current market conditions. Exit refers to a long-run
decision to leave the market. The short-run and long-run decision differ because most firms
cannot avoid their fixed costs in the short run but can do so in the long run. Let’s consider
what determines a firm’s shutdown decision. If the firm shuts down, it loses all revenue from
the sale of its product. At the same time, it saves the variable costs of making its products.
Thus the firm shuts down if the revenue that it would get from producing is less than its
variable costs of production.
● Shutdown if TR<VC
