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WHAT IS A COMPETITIVE
MARKET?
• A competitive market has many buyers and
sellers trading identical products so that each
buyer and seller is a price taker.
– Buyers and sellers must accept the price
determined by the market.
Price × Quantity
=
Quantity
= Price
© 2007 Thomson South-Western
The Revenue of a Competitive Firm
0 Q1 QMAX Q2 Quantity
© 2007 Thomson South-Western
Figure 2 Marginal Cost as the Competitive Firm’s Supply
Curve As P increases, the firm will
Price select its level of output
So, this section of the along the MC curve.
firm’s MC curve is MC
also the firm’s supply
curve.
P2
ATC
P1
AVC
0 Q1 Q2 Quantity
© 2007 Thomson South-Western
The Firm’s Short-Run Decision to Shut
Down
• A shutdown refers to a short-run decision not to
produce anything during a specific period of
time because of current market conditions.
• Exit refers to a long-run decision to leave the
market.
ATC
Firm
shuts
down if
P < AVC
0 Quantity
Costs
Firm’s long-run
supply curve MC = long-run S
Firm
enters if
P > ATC ATC
Firm
exits if
P < ATC
0 Quantity
Price
MC ATC
Profit
ATC P = AR = MR
0 Q Quantity
(profit-maximizing quantity)
© 2007 Thomson South-Western
Figure 5 Profit as the Area between Price and Average Total
Cost
(b) A Firm with Losses
Price
MC ATC
ATC
P P = AR = MR
Loss
0 Q Quantity
(loss-minimizing quantity)
© 2007 Thomson South-Western
THE SUPPLY CURVE IN A
COMPETITIVE MARKET
• The competitive firm’s long-run supply curve
is the portion of its marginal-cost curve that
lies above average total cost.
MC Supply
$2.00 $2.00
1.00 1.00
If the industry has 1000 identical firms, then at each market price, industry
output will be 1000 times larger than the representative firm’s output.
© 2007 Thomson South-Western
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.
MC
ATC
P = minimum Supply
ATC
Price Price
MC ATC
Short-run supply, S1
A Long-run
P1 supply P1
Demand, D1
S1 MC ATC
B
P2 P2
A Long-run
P1 P1
supply
D2
D1
0 Q1 Q2 0
Quantity (market) Quantity (firm)
S1
B ATC
MC
P2 S2
A C Long-run
P1 P1
supply
D2
D1
The increase in supply lowers market price. In the long run market
price is restored, but
market supply is greater.
© 2007 Thomson South-Western
Why the Long-Run Supply Curve Might
Slope Upward
• Some resources used in production may be
available only in limited quantities.
• Firms may have different costs.
• Marginal Firm
• The marginal firm is the firm that would exit the
market if the price were any lower.