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Lecture Business economics - Lecture 10: Firms in Competitive Markets

In this chapter we examine the behavior of competitive firms, such as your local gas station. After completing this chapter, students will be able to learn what characteristics make a market competitive, examine how competitive firms decide how much output to produce, examine how competitive firms decide when to shut down production temporarily,. | Review of the previous lecture Because a competitive firm is a price taker, its revenue is proportional to the amount of output it produces. The price of the good equals both the firm’s average revenue and its marginal revenue. To maximize profit, a firm chooses the quantity of output such that marginal revenue equals marginal cost. This is also the quantity at which price equals marginal cost. Therefore, the firm’s marginal cost curve is its supply curve. In the short run, when a firm cannot recover its fixed costs, the firm will choose to shut down temporarily if the price of the good is less than average variable cost. Review of the previous lecture In the long run, when the firm can recover both fixed and variable costs, it will choose to exit if the price is less than average total cost. In a market with free entry and exit, profits are driven to zero in the long run and all firms produce at the efficient scale. Changes in demand have different effects over different time . | Review of the previous lecture Because a competitive firm is a price taker, its revenue is proportional to the amount of output it produces. The price of the good equals both the firm’s average revenue and its marginal revenue. To maximize profit, a firm chooses the quantity of output such that marginal revenue equals marginal cost. This is also the quantity at which price equals marginal cost. Therefore, the firm’s marginal cost curve is its supply curve. In the short run, when a firm cannot recover its fixed costs, the firm will choose to shut down temporarily if the price of the good is less than average variable cost. Review of the previous lecture In the long run, when the firm can recover both fixed and variable costs, it will choose to exit if the price is less than average total cost. In a market with free entry and exit, profits are driven to zero in the long run and all firms produce at the efficient scale. Changes in demand have different effects over different time horizons. In the long run, the number of firms adjusts to drive the market back to the zero-profit equilibrium. Lecture 10 Firms in Competitive Markets Instructor: Prof.Dr.Qaisar Abbas Course code: ECO 400 The Long Run: Market Supply with Entry and Exit 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. The long-run market supply curve is horizontal at this price. Market Supply with Entry and Exit The Long Run: Market Supply with Entry and Exit At the end of the process of entry and exit, firms that remain must be making zero economic profit. The process of entry and exit ends only when price and average total cost are driven to equality. Long-run equilibrium must have firms operating at their efficient scale. Why Competitive Firms Stay in Business If They Make Zero Profit? Profit equals total revenue minus total cost. Total cost includes all the opportunity costs of the firm. In the zero-profit equilibrium, .