Lecture Principles of microeconomics - Chapter 14: Firms in competitive markets

Firms in Competitive
Markets
Chapter 14
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The Meaning of Competition
A perfectly competitive market has 
the following characteristics:
There are many buyers and sellers in 
the market.
The goods offered by the various 
sellers are largely the same.
Firms can freely enter or exit the 
market.
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The Meaning of Competition
As a result of its characteristics, the 
perfectly competitive market has the 
following outcomes:
The actions of any single buyer or seller 
in the market have a negligible impact on 
the market price.
Each buyer and seller takes the market 
price as given. 

Thus, each buyer and seller is a price taker.
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Example of Competitive
Markets
Eggs vs. Nike 
Sneakers.
Pay attention to the 
difference between 
the two market 
structures.
Which brand names 
do you recognize?

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Revenue of a Competitive Firm
Total revenue for a firm is the selling 
price times the quantity sold.

TR = (P X Q)

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Revenue of a Competitive Firm
Marginal revenue is the change in 
total revenue from an additional unit 
sold.

MR = TR/

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Q


Revenue of a Competitive Firm

For competitive firms, marginal 
revenue equals the price of the 
good.

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Total, Average, and Marginal
Revenue for a Competitive Firm
Quantity
(Q)
1
2
3
4

5
6
7
8

Price
(P)
$6.00
$6.00
$6.00
$6.00
$6.00
$6.00
$6.00
$6.00

Total Revenue
(TR=PxQ)
$6.00
$12.00
$18.00
$24.00
$30.00
$36.00
$42.00
$48.00

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Average Revenue

(AR=TR/Q)
$6.00
$6.00
$6.00
$6.00
$6.00
$6.00
$6.00
$6.00

Marginal Revenue
∆TR / ∆ Q
(MR=                )
$6.00
$6.00
$6.00
$6.00
$6.00
$6.00
$6.00


Profit Maximization for the
Competitive Firm
The goal of a competitive firm is to 
maximize profit.
This means that the firm will want 
to produce the quantity that 
maximizes the difference between 
total revenue and total cost.

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Profit Maximization:
A Numerical Example
Price

Quantity

Total Revenue

Total Cost

Profit

(P)

(Q)
0

(TR=PxQ)
$0.00

(TC)
$3.00

(TR­TC)
-$3.00

$6.00

$6.00

1
2

$6.00
$12.00

$5.00
$8.00

$1.00
$4.00

$6.00
$6.00

$2.00
$3.00

$6.00
$6.00

3
4

$18.00
$24.00

$12.00

$17.00

$6.00
$7.00

$6.00
$6.00

$4.00
$5.00

$6.00
$6.00

5
6

$30.00
$36.00

$23.00
$30.00

$7.00
$6.00

$6.00
$6.00

$6.00

$7.00

$6.00
$6.00

7
8

$42.00
$48.00

$38.00
$47.00

$4.00
$1.00

$6.00
$6.00

$8.00
$9.00

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Marginal Revenue
∆ TR / ∆ Q
(MR=                )

Marginal Cost

MC= ∆ ΤΧ / ∆ Θ


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Profit Maximization for the
Competitive Firm...
Costs
and
Revenue

The firm maximizes 
profit by producing 
the quantity at which 
marginal cost equals 
marginal revenue.

MC

MC2
ATC
 P=MR1

 P = AR = MR
AVC

MC1

0

Q1

QMAX

Q2

Quantity


Profit Maximization for the
Competitive Firm
Profit maximization occurs at the 
quantity where marginal revenue 
equals marginal cost.

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Profit Maximization for the
Competitive Firm

When MR > MC

increase Q

When MR < MC

decrease Q

When MR = MC Profit is maximized.
The firm produces up to the point where
MR=MC
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The Interaction of Firms and
Markets in Competition
Price
And
Costs

Firm

Price

Market

S1

MC
A

a
$10

P=MR0

ATC
=$7

B

ATC

b
c

AVC

d

S2

P=MR1

D0
q4

q3

q2

q1
10 units

qF

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Q1

Q2

QM


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The Marginal-Cost Curve and the
Firm’s Supply Decision...
Costs
and
Revenue

This section of the 
firm’s MC curve is 
also the firm’s supply 
curve (long­run).

MC

 P2
ATC

 P1

AVC

0

Q1

Q2

Quantity


The Firm’s Short-Run Decision
to Shut Down
A shutdown refers to a short­run 
decision not to produce anything 
during a specific period of time 
because of current market 
conditions.
Exit refers to a long­run decision to 
leave the market.
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The Firm’s Short-Run Decision
to Shut Down
The firm considers its sunk costs 
when deciding to exit, but ignores 
them when deciding whether to shut 
down.
Sunk costs are costs that have 
already been committed and cannot 
be recovered.
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The Firm’s Short-Run Decision
to Shut Down
The firm shuts down if the revenue it gets 
from producing is less than the variable 
cost of production.

Shut down if TR < VC
Shut down if TR/Q < VC/Q
Shut down if P < AVC

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The Firm’s Short-Run Decision to
Shut Down...
Costs

Firm’s short­run 
supply curve.
If P > ATC, 
keep producing 
at a profit.

If P > AVC, 
keep producing 
in the short run.

MC

ATC
AVC

If P < AVC, 
shut down.
0
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Quantity


The Firm’s Short-Run Decision
to Shut Down
The portion of the marginal­cost 
curve that lies above average 
variable cost is the competitive 
firm’s short­run supply curve.

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The Firm’s Long-Run Decision
to Exit or Enter a Market
In the long­run, the firm exits if the 
revenue it would get from producing is 
less than its total cost.

Exit if TR < TC
Exit if TR/Q < TC/Q

Exit if P < ATC
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The Firm’s Long-Run Decision
to Exit or Enter a Market
A firm will enter the industry if such an 
action would be profitable. 

Enter if TR > TC
Enter if TR/Q > TC/Q
Enter if P > ATC

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The Competitive Firm’s LongRun Supply Curve...
Costs
MC = Long­run S
Firm enters 
if P > ATC
ATC
AVC
Firm exits
if P < ATC

0
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Quantity