Firms in Competitive

Markets
14
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 WHAT IS A COMPETITIVE
MARKET?
• 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 the market.

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 WHAT IS A COMPETITIVE
MARKET?
• 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.

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 WHAT IS A COMPETITIVE
MARKET?
• A competitive market has many buyers and
sellers trading identical products so that each
buyer and seller is a price taker.
• Buyers and sellers must accept the price determined
by the market.

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The Revenue of a Competitive Firm

• Total revenue for a firm is the selling price

times the quantity sold.
TR = (P  Q)

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The Revenue of a Competitive Firm

• Total revenue is proportional to the amount of

output.

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The Revenue of a Competitive Firm

• Average revenue tells us how much revenue a

firm receives for the typical unit sold.
• Average revenue is total revenue divided by the
quantity sold.

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The Revenue of a Competitive Firm

• In perfect competition, average revenue equals

the price of the good.
T o ta l re v e n u e
A v e ra g e R e v e n u e =
Q u a n tity

P ric e  Q u a n tity

Q u a n tity

 P ric e
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The Revenue of a Competitive Firm

• Marginal revenue is the change in total revenue

from an additional unit sold.
MR =TR/ Q

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The Revenue of a Competitive Firm

• For competitive firms, marginal revenue equals

the price of the good.

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Table 1 Total, Average, and Marginal Revenue for a
Competitive Firm

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 PROFIT MAXIMIZATION AND THE
COMPETITIVE FIRM’S SUPPLY CURVE
• 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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Table 2 Profit Maximization: A Numerical Example

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 Figure 1 Profit Maximization for a Competitive Firm

Costs
and The firm maximizes
Revenue profit by producing
the quantity at which
marginal cost equals MC
marginal revenue.
MC2

ATC
P = MR1 = MR2 P = AR = MR
AVC

MC1

0 Q1 QMAX Q2 Quantity

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 PROFIT MAXIMIZATION AND THE
COMPETITIVE FIRM’S SUPPLY CURVE
• Profit maximization occurs at the quantity
where marginal revenue equals marginal cost.

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 PROFIT MAXIMIZATION AND THE
COMPETITIVE FIRM’S SUPPLY CURVE
• When MR > MC => increase Q
• When MR < MC =>decrease Q
• When MR = MC =>Profit is maximized.

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Figure 2 Marginal Cost as the Competitive Firm’s Supply
Curve

Price
This section of the
firm’s MC curve is MC
also the firm’s supply
curve.
P2

ATC
P1
AVC

0 Q1 Q2 Quantity
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The Firm’s Short-Run Decision to Shut Down

• A shutdown refers to a short-run decision not to

produce anything during a specific period of
time because of current market conditions.
• Exit refers to a long-run decision to leave the
market.

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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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Figure 3 The Competitive Firm’s Short Run Supply Curve

Costs
Firm’s short-run
If P > ATC, the firm supply curve MC
will continue to
produce at a profit.

ATC

If P > AVC, firm will

continue to produce AVC
in the short run.

Firm
shuts
down if
P < AVC
0 Quantity

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The Firm’s Short-Run Decision to Shut Down

• The portion of the marginal-cost curve that lies

above average variable cost is the competitive
firm’s short-run supply curve.

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The Firm’s Long-Run Decision to Exit or
Enter a Market
• In the long run, 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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Figure 4 The Competitive Firm’s Long-Run Supply Curve

Costs
Firm’s long-run
supply curve MC = long-run S

Firm
enters if
P > ATC ATC

Firm
exits if
P < ATC

0 Quantity

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 THE SUPPLY CURVE IN A
COMPETITIVE MARKET
• The competitive firm’s long-run supply curve is
the portion of its marginal-cost curve that lies
above average total cost.

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Figure 4 The Competitive Firm’s Long-Run Supply Curve

Costs

MC
Firm’s long-run
supply curve

ATC

0 Quantity

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 THE SUPPLY CURVE IN A
COMPETITIVE MARKET
• Short-Run Supply Curve
• The portion of its marginal cost curve that lies
above average variable cost.
• Long-Run Supply Curve
• The marginal cost curve above the minimum point
of its average total cost curve.

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Figure 5 Profit as the Area between Price and Average
Total Cost

(a) A Firm with Profits

Price

MC ATC
Profit

ATC P = AR = MR

0 Q Quantity
(profit-maximizing quantity)
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Figure 5 Profit as the Area between Price and Average
Total Cost

(b) A Firm with Losses

Price

MC ATC

ATC

P P = AR = MR

Loss

0 Q Quantity
(loss-minimizing quantity)
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