CHAPTER

14

Firms in Competitive Markets

Economics
PRINCIPLES OF

N. Gregory Mankiw

© 2009 South-Western, a part of Cengage Learning, all rights reserved

 Types of market

Types of Numbers Enter in

  Market Example
product of sellers market

Agricultural
Perfect competition
1 products, Identical Many Free
(Cạnh tranh hoàn hảo)
stocks,…

Monopolistic Clothes,
2 Competition candies,  Differentiated Many Free
(Cạnh tranh độc quyền) shoes,…

Oligopoly Steel, car, Identical and

3 Some Restricted
(Độc quyền tập đoàn) oil,… Distinct

Monopoly Water,
4 Special One Blockade
(Độc quyền) energy,… 2
In this chapter,
look for the answers to these questions:
▪ What is a perfectly competitive market?
▪ What is marginal revenue? How is it related to total
and average revenue?
▪ How does a competitive firm determine the quantity
that maximizes profits?
▪ When might a competitive firm shut down in the
short run? Exit the market in the long run?
▪ What does the market supply curve look like in the
short run? In the long run?
3
 I. PERFECT COMPETITION
1. Definition
� A type of market where there are unlimited
suppliers and their products are identical

- Examples: Agricultural products ....

FIRMS IN COMPETITIVE MARKETS 4

 PERFECT COMPETITION
2. Characteristics

� Suppliers are price-taker

� No entry barrier
� No market power
� Symmetric information
� No non-price competition (no advertisement)
� Not necessary to choose supplier

FIRMS IN COMPETITIVE MARKETS 5

 PERFECT COMPETITION
3. Demand and marginal
revenue curves
P
� Demand curve: parallel to
horizontal axis
� Marginal curve: coinciding
with demand curve
P =MR=AR
P*
� → MR = P = AR

FIRMS IN COMPETITIVE MARKETS 6

 PERFECT COMPETITION
4. Maximizing profit
P
ΠMAX: MR=MC

MC
In perfect competition: MR = P

P=MR
⇒ ΠMAX in perfect competition: P*

P=MC

Q* Q

FIRMS IN COMPETITIVE MARKETS 7

 PERFECT COMPETITION
▪ 5. Break-even, shut down point

Π = TR – TC = Q (P - ATC)

❖ P> ATCmin → Π > 0 → profit

❖ P= ATCmin → Π = 0 → break-even point

❖ P< ATCmin → Π < 0 → loss

⮚ AVCmin< P < ATCmin → continue producing
⮚ P < AVCmin → shut down

FIRMS IN COMPETITIVE MARKETS 8

 PERFECT COMPETITION
5. Break-even, shut down
point P
P> ATCmin

MC
TR = P*AQ*O
ATC
Πmax
TC = OCBQ*
A
→ Π = P*ABC P*
P=MR
C
B

O
Q* Q

FIRMS IN COMPETITIVE MARKETS 9

 PERFECT COMPETITION
5. Break-even, shut
down point P

P= ATCmin
ATC
MC

TR = P*AQ*O
A P=MR
TC = P*AQ*O P*

⇒Π=0
⇒ Q*: break-even point

O
Q* Q

FIRMS IN COMPETITIVE MARKETS 10

 PERFECT COMPETITION
5. Break-even, shut down
point P
MC
P< ATCmin ATC

-Π B
C
TR = P*AQ*O
P=MR
TC = OCBQ* P*
A
→ - Π = P*ABC

O
Q* Q

FIRMS IN COMPETITIVE MARKETS 11

 PERFECT COMPETITION
5. Break-even, shut down
point P
AVCmin < P < ATCmin MC
ATC

B
TR = P*AQ*O C
AVC
TC = OCBQ* A
P*
* Continue: Lose - Π = P*ABC P=MR
* Stop: Lose FC = BCEF E F
⇒ FC > - Π
⇒ Continue producing

Q* Q

FIRMS IN COMPETITIVE MARKETS 12

 PERFECT COMPETITION
5. Break-even, shut down point
P < AVCmin P

MC
TR = P*AQ*O B ATC
C
TC = OCBQ*
* Continue: Lose - Π = P*ABC
AVC
* Stop: Lose FC = BCEF F
E
FC < - Π
P*
→ Stop producing A P=MR
(shut down point)

O
Q* Q

FIRMS IN COMPETITIVE MARKETS 13

 PERFECT COMPETITION
6. Supply curve
P

- Coinciding with MC, from

AVCmin MC

P=MR
P*

AVC

Q* Q

FIRMS IN COMPETITIVE MARKETS 14

 Entry & Exit in the Long Run

▪ In the LR, the number of firms can change due to

entry & exit.
▪ If existing firms earn positive economic profit,
▪ new firms enter, SR market supply shifts right.
▪ P falls, reducing profits and slowing entry.
▪ If existing firms incur losses,
▪ some firms exit, SR market supply shifts left.
▪ P rises, reducing remaining firms’ losses.

FIRMS IN COMPETITIVE MARKETS 15

 The Zero-Profit Condition
▪ Long-run equilibrium:
. The process of entry or exit is complete –
remaining firms earn zero economic profit.
▪ Zero economic profit occurs when P = ATC.
▪ Since firms produce where P = MR = MC,
the zero-profit condition is P = MC = ATC.
▪ Recall that MC intersects ATC at minimum ATC.
▪ Hence, in the long run, P = minimum LATC

FIRMS IN COMPETITIVE MARKETS 16

 PERFECT COMPETITION
7. Producer’s surplus (PS)
� The area below price line
and above marginal cost P

curve MC

PS = TR – VC
P=MR
= Π + FC P*

PS

Q* Q

FIRMS IN COMPETITIVE MARKETS 17

 EXERCISE
Total cost function of a perfect competition firm is:

TC = 0,5Q2 + 4Q + 288

a. At P = 50$, calculate Q* and ΠMAX

b. Calculate the break-even point of this firm

c. At P = 20$, should this firm close its business?

d. Show this firm’s supply curve

FIRMS IN COMPETITIVE MARKETS 18