FIRM IN THE

COMPETITIVE
MARKET
FIRM’S SHORT RUN DECISION TO SHUT DOWN

• A shut down refers to a short run decision not to produce anything during a specific period of time because of
current market condition.
• If the firm decides to shut down it loses all its revenue from sale of it product. At the same time it saves the
variable costs of making its products. But still pay the fixed cost.
• Shut down if TR < VC
• By dividing both sides by Q TR/ Q < VC/Q
• TR = P ×Q substitute in the equation P ×Q /Q < VC/Q
• VC /Q is nothing but Average Variable Cost

• From this we get P < AVC shut down condition

FIRM’S LONG RUN DECISION TO EXIT OR ENTER
THE MARKET
• If the firm decides to exit the market it will lose all revenue from sale of product, but now it
will save not only its variable cost of production but also its fixed cost.
• The firm exits the market if the revenue it would get from producing is less than its total costs.
• Exit if TR < TC
• Divide both sides by Q Exit if TR/Q < TC/Q
• TR = P ×Q substitute in above equation we get P ×Q /Q < TC/Q (ATC = TC/Q)

• From this we get P < ATC Exit condition If P > ATC Enter the market
 FIRM IN COMPETITIVE MARKET-DERIVING LONG RUN SUPPLY CURVE

• Profit Π = TR-TC , Profit = (TR /Q- TC/Q)×Q ; Π =(P-ATC)× Q

• P = ATC it is ZERO ECONOMIC PROFIT
• P > ATC POSITIVE ECONOMIC PROFIT
• P< ATC NEGATIVE ECONOMIC PROFIT or LOSS
• Short run – Number of firms are fixed : Long run- there is entry and exit of firms.
• Here there are three questions to be analysed.
• 1. Does the entry and exit of firms affect the other firm in the market?
• 2. How long entry and exit of firms continue and when does it stop?
• 3. The entry and exit of firms , does it affect the profit of firm?
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

Copyright © 2004 South-Western

THE SHORT RUN: MARKET SUPPLY WITH A
FIXED NUMBER OF FIRMS
POSITIVE ECONOMIC PROFIT P> ATC
NEGATIVE ECONOMIC PROFIT OR LOSS P < ATC
ECONOMIC PROFIT P >ATC
NEGATIVE ECONOMIC PROFIT OR LOSS P < ATC
WHY DO THE COMPETITIVE FIRM STAY IN THE
BUSINESS IF THEY MAKE ECONOMIC PROFIT?
• 1. Does the entry and exit of firms affect the other firm in the market?
• 2. How long entry and exit of firms continue and when does it stop?
• 3. The entry and exit of firms , does it affect the profit of firm?

• Zero economic profit is nothing but opportunity cost.

ZERO OPPORTUNITY COST OR OPPORTUNITY
COST
Mr.Plow’s Economic Profit and the Entry and Exit decision
Mr. Plow has made total Revenue = $25000
Explicit costs per year
Payment on the loan on his snow plow $7000
Gasoline 2000
Miscellaneous 1000
Implicit costs
Forgone salary 10000
The forgone income that the $50000 invested in 5000
the snow plow could have earned if invested else
where
Total cost 25000
MARKET SUPPLY WITH ENTRY AND EXIT