bài giảng kinh tế vi mô tiếng anh ch8 competitive market

1
Chapter 8
Competitive Firms and Markets
Key topics
1. competitive firm is a price taker
2. profit maximization
3. competition in short run (SR)
4. competition in long run (LR)
5. competitive firms earn zero LR profit
Major question facing a firm
"How much output should we produce?"
Optimal output
to pick profit-maximizing level of output, firm
must consider
• its cost function
• how much it can sell at a given price (demand)
• market structure
• number of firms in the market
• ease of enter and exit
• firm’s ability to differentiate its product from its rivals’
Why start with competition
• frequently observed market structure
• has desirable properties, so it is useful to
compare other market structure to
competition
Competition
• consumers believe that all firms sell
identical products
• firms freely enter and exit market
• buyers and sellers know the prices charged
by firms

• transaction costs are low
2
Price taking
• if all 4 conditions hold each firm is a price
taker: firm cannot affect market prices
• even if some of conditions don't hold, firms
may be price takers
• for example, if entry of new firms is limited
but there are many firms, no firm can
successfully raise its price
Meaning of “competitive firms”
• to most people: firms that are rivals for the
same customers
• to economists:
• firm is a price taker
• competitive firm ignores individual rival’s
behavior in deciding how much to produce
Why would a competitive firm be
a price taker?
• answer: it has no choice
• competitive firm faces a demand curve that
is horizontal at the market price
Figure 8.1 Residual Demand Curve
p, $ per
metal chair
93 4340 0 500527
q, Thousand metal
chairs per year
Q, Thousand metal
chairs per year

66
100
63
66
100
63
S
o
D
p, $ per
metal chair
(a) Firm (b) Market
D
r
Profit maximization
• economists assume that a firm maximizes
its profit
• competitive firm that did not profit
maximize would lose money and be driven
out of business
Profit
p = R – C
• firm's revenues, R
• its cost, C
• if profit is negative, p < 0, firm makes a loss
3
Business vs. economic profit
• business profit: revenue minus business cost
(only explicit cost)
• economic profit: revenue minus economic

cost (explicit + implicit cost: opportunity
cost)
• because explicit cost „
economic cost,
business profit „ economic profit
• we always use economic profit
Example: Own your own firm
• you pay explicit costs (wages, materials, )
• you do not pay yourself a salary
• you receive a business profit of $20,000 per
year
• your opportunity cost is $25,000,
• so you have an economic loss of $5,000
Profit function
p(q) = R(q) - C(q)
• profit varies with output
Two steps to maximizing profit
to maximize its profit, any firm (not just
competitive firms) must answer two questions:
• output decision: if the firm produces, what output
level, q*, maximizes its profit or minimizes its
loss?
• shut-down decision: is it more profitable to
produce q* or to shut down and produce no
output?
Figure 8.2 Maximizing Profit
π, Profit
∆
π > 0
∆

π
< 0
q* Quantity, q, Units
per day
Profit
1
1
π*
0
3 equivalent output rules
set output where
• p is maximized [peak of profit curve]
• marginal profit (extra profit from selling
one more unit of output, ∆p/∆q) = 0 [slope
of profit curve is flat]
• marginal revenue, MR, equals marginal
cost, MC: MR(q) = MC(q)
4
Why output rules are equivalent
• marginal revenue:MR = extra revenue from
selling one more unit of output: ∆R/∆q,
where ∆R is the change in revenue
• marginal profit(q) = MR(q) - MC(q)
• therefore, marginal profit = 0 implies MR =
MC
Interpreting output rules
• does it pay for a firm to produce one more
unit of output?
• If MR(q) > MC(q),
• firm's marginal profit is positive:

marginal profit(q) = MR(q) - MC(q) > 0,
• so it pays to increase output
Calculus
• Choose q to
max p(q) = R(q) - C(q)
• differentiate profit with respect to q and set
the derivative equal to zero:
0
ddRdC
MRMC
dqdqdq
π
=−=−=
Shut-down rules
• apply to all firms in SR and LR
• firm produces if it can make a profit
• should it shut down if it makes a loss?
answer: “it depends"
Equivalent shut-down rules
• Rule 1: firm shuts down only if it can
reduce its loss by doing so
• Rule 2: firm shuts down only if its revenue
is less than its avoidable cost
• by shutting down, firm eliminates avoidable
costs:
• variable costs
• fixed costs that are not sunk
Example 1
• R = $2,000
• VC = $1,000

• F = $3,000 (sunk)
• p = R - VC - F
= $2,000 - $1,000 - $3,000 = -$2,000
• firm does not shut down
5
Example 2
• R = $500
• VC = $1,000
• F = $3,000 (sunk)
• p = R - VC - F
= $500 - $1,000 - $3,000 = -$3,500
• firm shuts down
Short run vs. long run
• SR: firm compares its revenue to only its
avoidable (variable) cost - ignores sunk
fixed costs
• LR: all costs are avoidable
• firm can eliminate them by shutting down
• therefore, firm shuts down if LR profit is
negative: p < 0
SR competitive output decision
• because competitive firm is a price taker,
• market price, p, does not change if firm
increases output
• because competitive firm's revenue, R = pq,
• MR = p
• competitive firm maximizes profit by
setting output where MC = p
Figure 8.3 How a
Competitive Firm

Maximizes Profit
Cost, revenue,
Thousand $
284140
0
q me per year
2,272
4,800
426
1,846
100
–100
(a)
1
MR =
8
π* = $426,000
π*
π (q )
Cost, C Revenue
p, $ per ton
e
2841400 q , Thousand metric tons of lime per year
8
6.50
6
10
(b)
p = MR
π

* = $426,000
AC
MC
, Thousand metric tons of li
Solved problem
• specific tax of t is collected from only one
competitive firm
• how should that firm change its output level
to maximize its profit
• how does its maximum profit change?
Solved Problem 8.1
p, $ per umit
q
1
q
2
e
1
τ
τ
e
2
q, Units per year
p
p = MR
AC
1
MC
1
MC

2
= MC
1
+ τ
AC
2
= AC
1
+
τ
AC
2
(q
2
)
AC
1
(q
1
)
A
B
6
SR shut-down decision
• after choosing best output level
• firm decides whether to operate or shut
down
• shuts down if p < AVC
• (market price < minimum of its short-run
average variable cost curve)

• may operate even if p < 0 (p < AC)
Figure 8.4 The Short-Run Shutdown Decision
p, $ per ton
10050 140
q, Thousand metric tons of lime per year
AVC
AC
MC
p
a
e
b
0
5.14
5.50
6.00
6.12
5.00
A=$62,000
B =$36,000
SR competitive firm supply curve
• shift in market price traces out firm's supply
curve
• SR supply curve is MC above the minimum
of AVC curve
Figure 8.5 How the Profit-Maximizing Quantity Varies with Price
p, $ per ton
q
3
= 215 q

4
= 285q
1
= 50 q
2
= 140
e
1
e
2
e
3
e
4
p
2
p
1
p
3
p
4
0
q, Thousand metric tons of lime per year
6
7
8
5
AVC
MC

AC
S
Factor prices and SR firm supply
curve
• increase in factor prices causes the
production costs of a firm to rise, shifting
the firm's supply curve to the left
• if all factor prices double, costs double
• if only one factor price rises, costs rise less
than in proportion
Figure 8.6 Effects of an Increase in the Cost of Materials on the
Vegetable Oil Supply Curve
p, $ per ton
e
1
e
2
0 100 178145 q, Hundred metric tons of oil per year
7
8.66
12
AVC
1
MC
1
AVC
2
S
1
S

2
MC
2
p
7
Solved problem
interpret:
In the 1994-95 growing season, bad weather
caused the price of wine grapes to increase
substantially. A newspaper article stated
that the wine business is too competitive for
[wineries] to simply pass a 100% cost
increase directly to consumers.
SR market supply; identical firms
• market supply curve is horizontal sum of the
supply curves of all the individual firms
• maximum number of firms in a market, n, is fixed
in SR
• market supply curve at any price is n times the
supply of an individual firm
• larger n (more identical firms), the flatter (more
elastic) the SR market supply curve at each price
Figure 8.7 Short-Run Market Supply with Five Identical Lime
Firms
p, $ per ton
14050 175
q, Thousand metric tons
of lime per year
6.47 6.47
6

7
p, $ per ton
7
5
0
AVC
(a) Firm
MC
200
150
100
50 250 700
Q, Thousand metric tons
of lime per year
6
5
0
(b) Market
S
3
S
4
S
5
S
2
S
1
S
1

SR market supply; firms differ
• relatively low-cost firms enter first
• more (differing) firms, more kinks in supply
curve
Figure 8.8 Short-Run Market Supply with Two Different Lime
Firms
p, $ per ton
100 140 165 215 315 45025 50
S
2
SS
1
0
q, Q, Thousand metric tons of lime per year
6
7
8
5
SR competitive equilibrium
intersection of SR market supply curve and
market demand curve determines the SR
competitive equilibrium
8
Figure 8.9 Short-Run Competitive Equilibrium in the Lime Market
p, $ per ton
q
1
= 215q
2
= 50 Q

1
= 1,075Q
2
= 2500
q, Thousand metric tons
of lime per year
Q, Thousand metric tons
of lime per year
6.97
6.20
6
5
0
5
6
7
8
7
8
e
2
e
1
E
2
S
E
1
p, $ per ton
(a) Firm (b) Market

AVC
AC
D
2
S
1
D
1
A
C
B
Effect of a specific tax on SR
equilibrium
• specific tax t applied to all firms in market
• shifts the market supply curve up by t
• alters the SR equilibrium:
• lower equilibrium quantity
• higher equilibrium price
Figure 8.10 Short-Run Effect of a Specific Tax in the Lime Market
p, $ per unit
τ
τ
e
1
e
2
p
2
p
1

q
2
q
1
q, Units per year Q
2
=
nq
2
Q
1
=
nq
1
q , Units per year
AVC
AV
C
+
τ
MC + τ
MC
S
1
+ τ
S
+ τ
S
1
S

D
p
1
+
τ
(a) Firm
p, $ per unit
E
1
E
2
(b) Market
τ
τ
LR competitive profit
maximization
• LR output decision:
• set output at q* where
p = LR MC(q*)
LR shut-down decision
• operate only if revenue ‡ variable cost
• all costs are variable in the LR, so
• operate only if revenue ‡ cost
• or p ‡ AC (minimum of AC curve)
LR firm supply curve
• LR MC above the minimum of LR AC
curve (all costs are variable in LR)
• firm chooses its capital in LR, so LR supply
curve may differ from SR supply curve
9

Figure 8.11 The Short-Run and Long-Run Supply Curves
p, $ per unit
50 110 q, Units per year
25
24
28
35
20
0
p
SRAC
LRMC
LRAC
SRMC
SRAVC
B
A
S
SR
S
LR
LR market supply curve
• market supply curve = horizontal sum of
firms' supply curves in both SR and LR to
get more market output
• LR market supply differs from SR because
of differences in number of firms and input
prices
Number of firms
• in SR, each firm must produce more

because the number of firms, n, is fixed
• in LR, firms can produce more and/or more
firms can produce
Input prices
• to construct LR market supply curve, we need to
know how input prices vary with output
• as market expands or contracts, changes in factor
prices may shift firms' cost and supply curves
• LR effect of changes in input prices > SR effect
because market output can change more
dramatically in LR
LR market supply
• LR market supply curve is flat at the
minimum long-run average cost if
• free entry and exit
• an unlimited number of firms have identical
costs
• input prices are constant
• “many firms" = 10 firms in the vegetable oil
market
p, $ per unit
150
LRAC
LRMC
(a) Firm
q, Hundred metric tons of oil per year
10
S
1
0

p, $ per unit
(b) Market
Q , Hundred metric tons of oil per year
Long-run market supply
10
0
10
Role of entry and exit
• firm enters if it can make LR profit: p > 0
• firm exits to avoid a LR loss: p < 0
• entry and exit of firms determines number
of firms in a market in LR
• higher barriers to entry reduce number of firms
• in markets with free entry (no barriers or fixed
costs to entry): can have hit-and-run entry and
exit
Exit cost and shut-down decision
• if firms incur a cost to exit a market they
may not shut down in SR even if R < VC
• stay in operation for a while, to delay
incurring exit costs
Application: Steel trap
• for decades, many U.S integrated steel mills
(produce steel from iron ore) operated at
losses – why?
• U.S firms stopped being competitive in
1950s and 1960s: foreign firms
• had lower labor costs
• had modern plants
• found new sources of rich iron ore

U.S. firms slow to leave the
market
• not until late 1970s did Youngstown Sheet
& Tube and U.S. Steel Corporation at
Youngstown close
• next closing not until 1982
• firms continued to operate aging,
inefficient, and unprofitable plants
Big shut-down costs
• pay to dismantle mill and terminate contracts
• union contracts:
• workers severance pay
• supplemental unemployment benefits
• make payments to cover additional future pensions and
insurance benefits
• generally, union members eligible for pensions when
age + years of service = 75
• workers laid off due to plant closings are eligible for a
pension when age + years of service = 70
U.S. Steel Corp's closing costs
• in 1979 were $650 million ($415 million
labor related, or $37,000 per laid-off
worker)
• rose at least 45% since then
11
Pricing
• because they avoided shutting down since
1970s, U.S. steel mills sold at prices below
AC or AVC
• 1986:

• AVCof hot-rolled sheets per ton = $305
• AC= $406
• price = $273
Why LR market supply curve
slopes
• limited Entry
• firms have different costs
• input prices very with output
LR market supply; entry limited
• number of firms in a market is limited in LR
if
• government restricts
• scare resource
• only way to get more output is for existing
firms to produce more
• because individual firms' supply curves
slope up, the market supply curve slopes up
LR market supply; firms differ
• if firms differ:
• firms with relatively low minimum LR AC
enter the market at lower prices than others, so
• LR market supply curves slope up if firms
differ
• LR supply curve slopes up only if amount
that lower-cost firms can produce is limited
Application Upward-Sloping Long-Run Supply Curve for Cotton
0.71
Price, $ per kg
0 1 2 3
Iran

United States
Nicaragua, Turkey
Brazil
Australia
Argentina
Pakistan
4 5 6 6.8
Cotton, billion kg per year
1.08
1.15
1.27
1.43
1.56
1.71
S
LR market supply; input prices
vary with output
• nonconstant input prices:
• if market buys most of total sales of a factor,
factor price may vary with market output
• if price of an input rises when more is purchased,
the cost of producing the final good also rises:
• increasing-cost market
• LR supply curve slopes up
• in a decreasing-cost market, LR market supply
curve is slopes down
12
Figure 8.13 Long-Run Market Supply in an Increasing-Cost
Market
p, $ per unit

q
1
q
2
Q
1
= n
1
q
1
Q
2
= n
2
q
2
q , Units per year Q, Units per year
p
1
p
2
e
2
e
1
E
2
S
E
1

p, $ per unit
(a) Firm (b) Market
AC
2
MC
2
MC
1
AC
1
Figure 8.14 Long-Run Market Supply in an Decreasing-Cost
Market
p, $ per unit
q
1
q
2
Q
1
= n
1
q
1
Q
2
= n
2
q
2
q , Units per year Q, Units per year

p
1
p
2
e
2
e
1
E
2
S
E
1
p , $ per unit
(a) Firm (b) Market
AC
2
MC
2
MC
1
AC
1
Application: Slope of
manufacturing supply curves
• downward-sloping LR supply curves (3): prepared
feeds, aircraft, construction equipment
• upward-sloping LR supply curves (16), including:
tires, drugs, paints, electronic components, glass
• flat LR supply curves (7), including: plumbing and

heating products, floor coverings, fats, oils
• on average across all industries: LR supply curves
have only slight upward slope
• supply elasticity is 5.5 Þ 1% increase in price
leads to a 5.5% increase in quantity
LR competitive equilibrium
• intersection of LR market supply and demand
curves determines LR competitive equilibrium
• with identical firms, constant input prices, and free
entry and exit,
• LR market supply is horizontal at minimum LR
AC
• so equilibrium price = LR AC
• shift in demand curve affects only equilibrium
quantity and not equilibrium price
Figure 8.15 The Short-Run and Long-Run Equilibria for
Vegetable Oil
p, $ per ton
e
1
f
2
1000 150165
q , Hundred metric tons
of oil per year
11
10
7
MC
AVC

(a) Firm
AC
p , $ per ton
F
1
E
1
F
2
E
2
1,5000 2,000 3,300 3,600
Q, Hundred metric tons
of oil per year
11
10
7
(b) Market
D
1
S
SR
S
LR
D
2
f
Solved problem
• If government starts collecting a lump-sum
franchise tax of L each year

• all firms are identical
• free entry and exit,
• how do the long-run market and firm
equilibria change?
13
Solved Problem 8.3
p, $ per unit
q
1
q
2
Q
1
= n
1
q
1
Q
2
= n
2
q
2
q , Units per year Q, Units per year
p
1
p
2
p
1

p
2
e
2
e
1
E
2
S
2
S
1
D
E
1
p, $ per unit
(a) Firm
(b) Market
MC
AC
1
AC
2
+ q/
LR competitive profit is zero
with free entry
• LR supply curve is horizontal if
• firms are free to enter the market
• firms have identical cost
• input prices are constant

• all firms in market operate at minimum LR
AC
• profit-maximizing firm stays in business if
it earns zero LR profit
LR profit = zero when entry is
limited
• if some firms in a market make SR p > 0
due to a scarce input,
• other firms bid for scarce input (factor
receives rents),
• which drives up the price of the factor until
all firms earn p = 0 in LR
Figure 8.16 Rent
p, $ per bushel
q *
π* = Rent
q, Bushels of tomatoes per year
AC (including rent)
AC (excluding rent)
MC
p*
Rent
• extra, opportunity value of a scarce input
• payment to the owner of an input beyond the
minimum necessary for the factor to be supplied
• people with unusual abilities earn staggering rents
(Tiger Wood)
• Rolling Stones earned $121.2 million, from their
1994 concert tour; compare 1993 gross national
product of

• Grenada (100,000 people): $215 million
• Kiribati: $51.1 million
• Bhutan: $234 million
Competitive firms must
maximize profits
• competitive market with free entry:
• profits are driven to zero in LR
• any firm that did not profit maximize would
make losses
• thus, firms that survive in a competitive
market must profit maximize
14
1 Competition
• competitive firms are price takers
• markets are likely to be competitive if
• firms sell identical products
• firms can enter and exit freely
• buyers and sellers know the prices charged by firms
• transaction costs are low
• competitive firm faces a horizontal demand curve
at the market price
2 Profit maximization
• firms maximize economic profit = revenue minus
economic (opportunity) cost
• business profit ‡ economic profit
• quantity where profit is highest:
• marginal profit is zero
• MR = MC
• To maximize profit, all firms make two decisions:
• determine the quantity where its profit is highest

• decide whether to produce or shut down
3 Competition in SR
• competitive firm maximizes profit by setting qso
that p = SR MC
• it shuts down if p < minimum AVC
• competitive firm's SR supply curve: its MCcurve
above the minimum of its AVC
• with identical firms, SR market supply curve is
flat at low output levels and upward sloping at
larger levels
• SR competitive equilibrium is determined by the
intersection of the market demand curve and the
SR market supply curve
4 Competition in LR
• output set where p = LR MC
• shuts down if p < minimum LR AC
(because all costs are variable in LR)
• thus, firm's supply curve is LR MC above
min LR AC
• LR firm supply curve differs from SR curve
because firm can vary formerly fixed
factors
Competition in LR (cont.)
• LR market supply curve is horizontal if
• all firms are identical
• entry and exit is easy
• input prices are constant
• LR market supply curve is flat at minimum AC
• LR supply curve slopes if
• firms differ

• entry is difficult or costly, or
• input prices vary with output,
5 Competitive firms earn zero
profits in LR
• competitive firms may make profits or
losses in SR
• in LR, economic profit = 0
• prices of scarce inputs adjust to ensure that
competitive firms make zero long-run
profits
• only competitive firms that maximize profit
can survive