Market Structure Competition. Competitive Firm P0 P P 10,000,00050,000,000 P0 3010 D d IndustryFirm.
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Transcript of Market Structure Competition. Competitive Firm P0 P P 10,000,00050,000,000 P0 3010 D d IndustryFirm.
Market StructureCompetition
Competitive Firm
P0
PP
10,000,000 50,000,000
P0
P0
3010
D
d
Industry Firm
Competitive Firm
• A competitive firm can sell any quantity at the market price. The firm decides how much to produce but not the price. Competitive firms are “price takers”.
• A competitive firm (not the industry) faces an horizontal demand function.
• A competitive firm usually represents a small share of the entire industry.
Marginal Revenue-Competitive FirmPrice $50
Quantity Total Revenue
Price x Quantity
Marginal Revenue
1 50 50
2 100 50
3 150 50
4 200 50
Marginal revenue is constant at the level of the market price
Production Decision-The Firm
• The general rule to maximize profits was to produce up to the point in which marginal revenue equals marginal cost (conditional on profits>0).
• Marginal revenue is equal to price for a competitive firm. Therefore, a competitive firm produces a quantity at which price equals marginal cost.
The supply curve (firm) is equal to the marginal cost curve but…
Marginal Cost Curve
Quantity Marginal Cost
1 20
2 30
3 40
4 50
5 60
6 70
Supply Curve
Price Quantity
20 1
30 2
40 3
50 4
60 5
70 6
The supply curve-The Firm
$ pe
r bi
cycl
e
Q Q
$ pe
r bi
cycl
ed
d’
d’’
MC
S
The rule for a competitive firm is to produce up to the point where the marginal cost
equals the price. Which marginal costs? Long run marginal cost or short run marginal
costs?
The firm has a short run supply function and a long run supply function.
U-Shaped Marginal Cost
QQ1 Q2
50
S
MC
MR
Only the upward slopping part of the marginal cost is relevant for the
production decision.
“Shutdown Decision”
Profit=TR-TC=TR-FC-VC (TC=FC+VC)
If the firm “shuts down” it still pays the FCTherefore, the firm will operate if
TR-VC>0 or TR>VC TR=P*Q then TR>VC→P>AVC=VC/Q
The fix costs are irrelevant in the short run because the firm pays them even if it shuts down. Sunk cost are irrelevant
even in the long run. What is considered fix cost will depend on the length of period the firm is considering.
Putting Everything Together-The Short Run Supply Function (the FIRM)
QQ2
S
MCAC
AVC
The Supply of the Industry
SaSb
ScP
QQ1 Q2 Q1+Q2
Industry Supply
P0
The Supply of the Industry
SaSb
ScP
Q
Industry SupplyP0
P1
The Competitive Industry in the Short Run
S
P0
D
s
d
P
Q
P
qQ0 q0
The Industry The Firm
A Change in fixed costs
What is the effect in the short run?
The Competitive Industry in the Short Run- A Change in Variable Costs
S
P0
D
s
d
P
Q
P
qQ0 q0
s’S’
Q2 q2
P2 d’
The Industry The Firm
s’’
q2’
The Competitive Industry in the Short Run- A Change in Demand
S
P0
D
s
d
P
Q
P
qQ0 q0
D’
Q3 q3
P3 d’
The Planner’s ProblemSuppose a country wants to produce 1 million units of a good at the
minimum possible cost. You are told to tell “each firm” in the industry how much to produce to reach this goal.
How would you do this?
Suppose a firm is producing the last unit at a marginal cost of $5 and another firm is producing the last unit at a marginal cost of $3. You can tell the firm which is producing at a higher cost to produce one less unit and the firm producing at a lower cost to produce an additional unit. The level of output is maintained and you save $2 of cost. When every firm produces the last unit at the same marginal cost the total costs are at the minimum possible.
In a competitive equilibrium every firm produces at a point where marginal costs are equal to the price (and the price is equal for all of the firms). Hence, the market automatically produces at the lowest possible cost.
The Firm in the Long RunThe long run supply function (firm) is equal to the
long run marginal cost when the marginal cost is above the average costs.
Firms may exit the industry in the long run. They exit if profits are negative. Profits is Revenues minus OPORTUNITY costs.
TR-TC=P*Q-TC>0 →P>TC/Q=AC
The firm “breaks even” when the price is equal to the average cost
Break Even Price-The Firm
P*
S
AC
Break Even Price
MC
Q’
P**
Long Run and Short Run ResponsesRent Control-The Industry
S’ S
LRS
Q1 Q2 Q0=Q3 Q
P
P2
P1
Q0’
P0=P3
D
