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Firms in Competitive Markets (Assumptions of the perfect competition model)
Firms in Competitive Markets
Assumptions of the perfect competition model
In the “perfect competition” model:
There are many buyers and sellers in the market, so an individual firm produces a very small portion of total market output, is a price taker, which means P = MR = AR
The goods offered by the various sellers are the same.
Firms can freely enter or exit the market.
Revenue of a competitive firm
Average revenue (AR)= total revenue (P x Q)/ the quantity sold (Q).
Average revenue =the price (P)
Marginal revenue (MR) is the change in total revenue from an additional unit sold.
A competitive firm is a price taker (i.e., price is fixed), so marginal revenue equals the price of the good.
So, for a competitive firm
AR = P = MR
Profit maximisation: a general rule
If marginal revenue > marginal cost, the firm should increase its output.
If marginal cost > marginal revenue, the firm should decrease its output.
If marginal revenue = marginal cost, the firm should choose that output because its profit is maximised.
Marginal cost curve as supply curve
The competitive firm’s profit-maximising quantity is found at the intersection of the price and marginal cost.
Given price, marginal costs determine how much the firm is willing to supply
So, Marginal cost curve is the firm’s supply curve.
The firm’s short-run decision to shut down
Shutdown停机: a short run decision to produce zero output for a period of time.
A firm will shut down if TR < VC or equivalently, P < AVC
The firm will lose money by shutting down due to fixed costs, but it will lose more by producing because its variable costs are not fully covered by revenue.
The competitive firm’s short run supply curve
is the portion of its marginal cost curve that lies above the average variable cost.
The firm’s long-run decision to exit or enter a market
The firm exits the market if it makes a loss in the long run, that is
TR < TC or equivalently P < ATC
The competitive firm’s long run supply curve is the portion of its marginal cost curve that lies above the average total cost.
Measuring profit for the competitive firm
profit
loss
Short-Run Industry Supply Curve
Short-run industry supply curve
Shows the quantity supplied by the industry at each price when the plant size of each firm and the number of firms remain constant.表示当每个公司的工厂规模和公司数量保持不变时，行业在每个价格上提供的数量
It is constructed by summing the quantities supplied by the individual firms.
Short run market supply
In the short run, the number of firms in the market is fixed.
The total quantity of market supply equals the sum of the quantities supplied by each individual firm.
Long run market supply
Entry and exit decisions
If firms already in the market are profitable then new firms will enter the market, increasing the quantity supplied and driving down prices and profits.
An increase in demand induces entry
Entry increases supply and restores long-run equilibrium
If firms in the market are making losses then some firms will exit the market, decreasing the quantity supplied and driving up prices and profits.
At the end of this process (in equilibrium)
firms that remain in the market must be making
zero economic profit, i.e., P = minimum ATC
The supply curve is horizontal at this price.
Why might the long-run supply curve slope upwards?
Some inputs are supplied in limited quantities.
e.g., farmland. As more people become farmers, the price of farmland is bid up, which raises the costs of all farmers in the market.
Firms may have different costs.
As demand increases, higher costs firms may enter the market.
The price in the market reflects the average total cost of the marginal firm, the lower-cost firms can earn profit even in the long run.