The_Competitive_Firm

The Competitive FirmObjective1. Describe four models of market structure.2. List six characteristics of a perfectly competitive industry.3. Define the term price taker, and explain its significance to the competitivefirm.4. Graph total revenue and total cost to illustrate profit maximization.5. Graph total cost and total revenue, highlighting areas of losses and profits.6. State the profit maximizing rule.7. Graph marginal revenue and marginal cost, highlighting the profitmaximizing rate of output.8. Use the cost curves to graphically illustrate total profit.9. Explain the shutdown decision.10. Explain why a firm would operate in the short-run even if it is sufferinglosses.11. Graphically illustrate the shutdown point.I. Four market models will be explained in the next five lectures. These models areA. Competition involves a large number of firms, standardized product,and easy entry and exit by new or existing firms.B. Monopoly is the opposite of the competitive model. A monopoly hasone firm that is the sole producer of a good or service that has no closesubstitutes. The monopolist may exit the industry, but entry is blocked for other firms.C. Monopolistic competition is close to competition, except that theproduct is differentiated and there are fewer firms.D. An oligopoly is an industry that only has a few firms, and each isaffected by the price-output decisions of the others. Product can bedifferentiated or standardized.II. CompetitionA. As in all economic models, the assumed goal of the firm is to maximizeprofits.B. The characteristics of competition1. Many sellers. Because there are many sellers, a single sellerhas no impact on price.2. The products in a competitive market are homogeneous orstandardized; each seller’s product is identical to its competitor’s.3. Competitive producers have the access to the same resources,and no single firm affects resource prices.4. Individual firms must accept the market price; they are pricetakers and cannot influence price.5. Firms do not like being price takers. They work hard to improveproduct, plant efficiency, find good deals, etc., so that they can earnan economic profit.6. Freedom of entry and exit means that there are no significantobstacles preventing firms from entering or leaving the industry.C. Competition is an important economic model.1. The model helps analyze industries with characteristics similarto competition.2. The model provides an opportunity to examine decision makingusing the cost functions developed in the previous lectures.D. Competition provides a norm or standard against which to compareand evaluate the efficiency of the real world.III. Profit maximization in the short-run—the total revenue-total cost approachA. The assumed goal of the firm is to maximize profits.B. In the short-run the firm has a fixed resource and maximizes profits or minimizes losses by adjusting output to the level that maximizes profits.C. Profit maximization is illustrated using the total revenue-total cost approach or the marginal revenue-marginal cost approach.D. The total revenue-total cost approach is not preferred because it is too hard to dig out necessary information.E. Total revenue1. The total revenue curve shows the relationship between thequantity of output produced and total revenue.2. The price the firm receives for its product is the slope of the totalrevenue curve.3. It is inconvenient to calculate the slope to learn the price.4. In the graph, total revenue has a slope of $40.5. Price multiplied by quantity equals total revenue.6. At output level of 5.05, total revenue equals $202. It is read atpoint A or C on “The Total Revenue-Total Cost Approach” graph.7. The slope of the total revenue curve is also the marginalrevenue.F. Total cost1. The total cost curve shows the relationship between the quantityof output produced and total cost.2. The total cost curve yields the level of total cost given a selectedlevel of output.3. The slope of the total cost curve is marginal cost.4. At the output level of5.05, total cost is $147. It is read at pointB or D on the graph.G. Profit and loss1. Profit or loss is equal to total revenue less total cost.2. Profit is earned when total revenue exceeds total cost. It is thevertical distance between total revenue and total cost. On thegraph, it is the distance between points A and B, or C and D.3. Profit is maximized at the quantity where the slope of the totalrevenue and total cost curves are equal.4. This point is also the point where the vertical distance betweentotal revenue and total cost is the greatest.5. This occurs at the output level of 505. At this level of output,profit is $200-145=$55.6. Loss is earned when total cost exceeds total revenue.7. It is the vertical distance between total cost and total revenue.8. Breakeven points occur where total revenue equals total cost.9. Breakeven points define the beginning and end of profitablelevels of output. These points are labeled E and F.H. The profit curve1. Because profit information is difficult to read from the totalrevenue less total cost graph, some draw a profit curve.2. The profit curve is placed below the total revenue and total costcurves.3. Quantity is on the horizontal axis, and profit on the vertical.I. Changes in price1. We have to redraw the total revenue curve every time there is aprice change if we want to make decisions about the profitmaximizing output.2. Price increasesa) The breakeven points are wider apart, meaning that thereare more levels of output that result in profit.b) As the level of profits increase, and the profit maximizingoutput increases.3. Price decreases have the opposite affect on profits.J. Changes in cost1. We have to redraw the total cost curve every time there is a costchange if we want to make decisions about the profit maximizingoutput.2. Cost increasea) The breakeven points are closer together, meaning thatthere are fewer levels of output that result in output.b) The amount of profit earned at any level of outputdeclines.3. A cost decrease has the opposite affect of a cost increase.K. Hidden information1. The firm should shut down if its loss exceeds its fixed costs.2. By shutting down its loss will equal the fixed costs.IV. Profit maximization in the short-run—the marginal revenue-marginal cost approachA. This is the preferred short run approach for evaluating the firm anddetermining profit.1. It is easier to find important economic information.2. It is easier to manipulate if there are changes in price or cost.B. At least one resource is fixed, and at least one is variable.C. The firm has a fixed resource and maximizes profits or minimizeslosses by adjusting output.D. To understand profits, we must understand how the cost curvesdeveloped in the last lecture interact with demand. Demand from theViewpoint of a Competitive Seller1. As a price taker, the firm can sell as much output as it producesat the market price.2. The demand curve is a horizontal line beginning at the productprice. It is labeled P in the graph.3. At a price of $40.00, the firm can sell 2, 4, 6 units, or any otherquantity that it produces.4. The fact that the firm can sell as much as it likes at the marketprice makes the demand curve is a horizontal line.5. Horizontal demand is perfectly elastic.6. The demand curve is not perfectly elastic for the industry; itappears that way to the firm, because it must take the market price no matter what quantity it produces.E. Marginal revenue, price, average revenue, and total revenue1. Price is the marginal revenue at each unit sold.2. Total revenue is the price multiplied by the quantity sold. Forexample, at a price of $40, and 5.05 units are sold, total revenue is $202.3. Average revenue is the average price received by the firm. It istotal revenue divided by quantity sold. If total revenue is $202, and5.05 units are sold, the average revenue is $40.4. In the graph, total revenue is the area ABDC.5. The formula for the area of a rectangle is width multiplied byheight. The width is the quantity and the height is the price.6. For the competitive firm, demand, price, marginal revenue andaverage revenue are the same.F. Marginal cost, average total cost, average variable cost and total cost1. These curves are as described in the lecture, “Production.”2. To find the total cost at an output level, draw a vertical line fromthe output level to the average total cost curve. Then draw ahorizontal line to the price axis. The dollar amount is the averagetotal cost at the given output level. The total cost is the output level multiplied by the average total cost.3. In the graph, the output level is 5.05, and the average total costis $29. This makes the total cost $147.4. Total cost is the area EFDC.G. The profit maximizing rule1. The marginal revenue equals marginal cost (MR = MC) rulestates that the firm will maximize profits or minimize losses byproducing the output level at which marginal revenue equalsmarginal cost. They are equal when at the output level where thetwo curves intersect.2. In the graph, price intersects marginal cost at point B. Drawinga line down to the horizontal axes informs us that the profitmaximizing output is 5.05.3. Because I conveniently picked the profit maximizing output tocalculate total revenue ($202) and total cost ($147), we cancalculate profit at $55. It is the area ABFE on the graph.4. The profit per unit is the difference between that price ($40) andthe average total cost ($29) or $11. It is the distance BF or AE onthe graph.5. Three features of this marginal revenue = marginal cost rule areimportant.a) Rule assumes that marginal revenue must be equal to orexceed minimum-average-variable cost or firm will shutdown.b) The rule works for firms in any type of industry, not justpure competition.c) For the competitive firm, price = marginal revenue, so incompetitive industries the rule can be restated as the firmshould produce that output where price = marginal cost,because price = marginal revenue.V. Profit maximizing and cost minimizingA. Profit maximization. We have viewed profit maximization wheneconomic profit is greater than zero.B. Loss minimization1. Under certain conditions, the best a firm can do is minimize loss.2. Loss minimization is a type of profit maximization. It results in the largest profit a firm can earn. That profit just happens to be a negative number.3. Given the goal, how does the entrepreneur achieve it?4. The loss-minimizing case is illustrated when the price falls to $20.00. Marginal revenue does exceed average variable cost at relevant production levels. This means that total revenues cover all variable costs and some fixed costs. The firm loses less by producing compared to shutting down. Comparing price and marginal cost, the rule tells us to select output level of 4.0.5. At an output of 4.0, price is $20.00, making total revenue is $80. The total revenue is the area ABDC.6. At an output of 4.0, average total cost is $30.00, and total cost is $120. Total cost is the area EFDC.7. At an output level of 4.0, profit is $80.00-120.00=-$40.00. Profitis the area EFBA.C. Shut-down case1. If the price falls below $7.50, this firm should not produce.Marginal revenue will not cover average variable cost at any outputlevel. Therefore, the minimum loss is the fixed cost and productionof zero.VI. Determinants of supplyA. Short-run determinants1. The price of factor inputs.2. Technology3. Expectations for costs, sales, technology.B. The marginal cost curve above the AVC is the short-run supply curvefor a competitive firm.C. The supply curve is a curve describing the quantities of a good aproducer is willing and able to sell at alternative prices during a specifiedperiod of time.D. A change in supply occurs if any determinant of supply changes.。