perfect competition - price takers

Principles of Microeconomics : Ch.14 First Canadian Edition

Perfect Competition - Price Takers

The individual firm produces such a small portion of the total market output that it cannot influence the price it charges for the product it sells.

The firm is a Price Taker in that it takes the market-determined price as the price it will receive for its output.


The Revenue of a Competitive Firm

Total Revenue for a firm is the market selling price times the quantity sold.

TR = (P x Q) Total revenue is proportional to the

amount of output. Graphically: Total revenue increases

at a constant rate, as each unit sold sells for a constant price.


$25

$20

$15

$10

$ 5

$

Quantity

Total Revenue

1 2 3 4 5

At a market price of $5, total revenueis ($5x1) = $5!

Total Revenue: Competitive Firm


Alternative Measurements of Revenue

Average Revenue:–Tells us how much revenue a firm

receives for the typical unit sold.

AR = TR ÷ Q–Average Revenue equals the Price of the

good, in Perfect Competition.


Alternative Measurements of Revenue

Marginal Revenue:–Tells us how much revenue a firm

receives for one additional unit of output.

MR = TR ÷ Q–Marginal Revenue equals the Price of the

good, in Perfect Competition. Graphically: Each unit sold will add

the same amount to total revenue, $5!


Total Revenue: Competitive Firm

$25

$20

$15

$10

$ 5

$

Quantity

Total Revenue

1 2 3 4 5

MarginalRevenue


Profit Maximization

$25

$20

$15

$10

$ 5

$

Quantity1 2 3 4 5

Total Cost


Profit Maximization

$25

$20

$15

$10

$ 5

$

Quantity

Total Revenue

1 2 3 4 5

Total Cost

$ MaximumProfit

at Q = 3 units!}


Profit Maximization

Maximum profits occur at a quantity that maximizes the difference (distance) between revenue and costs.


The Competitive Firm’s Cost Curves

Revisit of average cost curves:–The marginal-cost curve (MC) eventually

increases.

–The average-total-cost curve (ATC) is U-shaped.

–Marginal Cost crosses the Average-Total-Cost at the minimum ATC.

Graphically. . .


The Shape of Typical Cost CurvesC

ost

($’

s)

Quantity

MCATC

AVC


The Competitive Firm’s Profit- Maximizing Output

Add a line for the market price which is the same as the firm’s average revenue (AR) and its marginal revenue (MR).

Identify the level of output that maximizes profit.



Quantity

MCATC

AVC

P=MR=AR

QMax

Price



Quantity

MCATC

AVC

P=MR=AR

QMax

MaximumProfit

Price

P

ATC


The Competitive Firm’s Shut-Down Decision

Alternative levels of output produced because the firm is a price taker.

If the selling price is below the minimum average variable cost, the firm should shut-down!

The minimum loss would equal to the firm’s Total Fixed Cost.


Shut-Down! Costs are greater than market price

Quantity

MCATC

AVC

P=MR=AR

Loss in Excess of Fixed Costs

Q Don’t Produce!

Price


Short-Run Production Minimize Losses when MR = MC

Quantity

MCATC

AVC

P=MR=AR

Q short-run

Price

P

ATC

Losses are lessthan fixed costs


Quantity

MCATC

AVC

P=MR=AR

QMax

Price

PATC

Maximum EconomicProfit

Short-Run Production Maximize Profits when MR = MC


In the long-run the typical firm will operate where:MR = MCNormal Profit where Price = ATCMinimum ATC

Why? Due to Easy EntryDue to Intense Competition

Long-Run Production Normal Profits when MR = MC


Quantity

MC ATC

P=MR=AR

QLR

Price

Long-Run Production Normal Profits when MR = MC


The Competitive Firm’s Supply Curve

Short-Run Supply:

–Is the portion of its marginal cost curve that lies above average variable cost.

Long-Run Supply:

–Is the marginal cost curve above the minimum point of its average total cost curve.


Competitive Firm’s SR Supply Curve

Quantity

MCATC

AVC

P=MR=AR

Q1

P1

Price



Quantity

MCATC

AVC

P=MR=AR

Q3Q1 Q2

P1

P2

P3

Price



QuantityQ3Q1 Q2

P1

P2

P3

Price

Firms Short-Run Supply

Curve

}


The Firm’s Profit

Profit equals total revenue (TR) minus total costs (TC)–Profit = TR - TC

–Profit = ([TR ÷ Q] - [TC ÷ Q]) x Q

–Profit = (P - ATC) x Q


The Competitive Firm’s Decision To Produce, Shut-Down or Exit

In the short-run, a firm will choose to shut-down temporarily if the price of the good is less than the average variable cost.

In the long-run when the firm can recover both fixed and variable costs, the firm will choose to exit if the price is less than average total cost.


The Market Supply Curve

For any given price, each firm supplies a quantity of output so that price equals its marginal cost.

The quantity of output supplied to the market equals the sum of the quantities supplied by the individual firms.


The Market Supply Curve Firms will enter or exit the market until

profit is driven to zero. In the long-run, price equals the minimum of average total cost.

Because firms can enter and exit more easily in the long-run than in the short-run, the long-run supply curve is more elastic than the short-run supply curve.


Summary/Conclusion

If business firms are competitive and profit-maximizing, the price of a good equals the marginal cost of making that good.

If firms can freely enter and exit the market, the price also equals the lowest possible average total cost of production.

perfect competition - price takers

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