principles of microeconomics - competitive markets
TRANSCRIPT
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Firms in Competitive Markets
Dr. Katherine Sauer
Principles of Microeconomics
ECO 2020
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Overview:
I.The Firms Marginal Revenue and DemandII. The Firms Output
III. The Firms Profits: Graphically
IV. Market Dynamics
V. Efficiency
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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
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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*
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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.
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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
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Market for Soybeans Farmer Frans Soybeans
S
D
Q
P
P*
Q*
D
P
P*
q
= MR
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Market for Soybeans Farmer Frans Soybeans
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
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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).
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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*
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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.
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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
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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
*
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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
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P
P*
q
D= MR
MC
q*
A. At q*, P > ATC
ATCATC*
profits
(P ATC)q > 0AVC
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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
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P
P*
q
D= MR
MC
q*
C. At q*, P < ATC
ATC
ATC*
loss
(P ATC)q < 0AVC
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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.
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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.
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Market for Soybeans Farmer Frans Soybeans
S
D
Q
P
P*
Q*
P
P*
q
D = MR
MCATC
Initially, Farmer Fran is earning a loss.
q*
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Market for Soybeans Farmer Frans Soybeans
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
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Market for Soybeans Farmer Frans Soybeans
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
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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
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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
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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