Chapter 14: Competitive Markets, Pages 290-293 I.

What Is A Competitive Market: Also called perfectly competitive market, competitive market has two primary characteristics, (1) many buyers & sellers in the market, and (2) the goods offered by sellers are essentially the same. a. Both buyers and sellers are price takers and have little impact on price because of the above factors. b. Gas and milk are price taker products. There are many consumers of both products and many suppliers that they have very little influence on the price. If one supplier increases their price, consumers will just go elsewhere. If one seller lowers the price, all others will follow eliminating any advantage for any of the sellers. Price is eliminated as a competitive edge for sellers. c. Another condition of competitive markets, is firms can easily enter and leave the market. The investment often is not large, the customer base is a constant, and the losses are not large. II. The Revenue of a Competitive Firm: Table 1 shows that a specific quantity of milk (Q) is sold at the market price (P). Total revenue (TR), will be PxQ.see Quantity 2 and at Table 1 Total, Average, and Marginal Revenue for a a price of $6 per gallon the TR is $12 at Q level 2. a. Because the quantity of milk produced in Table 1 Competitive Firm the price will not depend on the quantity produced and sold, but by the market conditions. Total revenue is proportional to the amount of output. b. Just as with cost analysis, the concepts of average and marginal are useful with revenue. c. The key questions answered by average and marginal prices are, what is the revenue for a gallon of milk and how much additional revenue will earned for each additional gallon produced. d. The last two columns in Table 1 have the answers. The average revenue (AR) is the total revenue divided by the quantity produced or (AR=TR/Q) and the marginal revenue (MR) is the change in total revenue divided by the change in quantity, or (MR=TR/Q). e. A key factor to remember: with all firms, and market conditions, the AR will always equals the price of the good, because dividing the total revenue by by the total quantity (TR/Q) will always yield the price per single output. (P=AR) f. Because the price is fixed by overwhelming market demand, for perfectly competitive firms only, marginal revenue (MR) will always equal the price (P)of the good.

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III. Profit Maximization & the Competitive Firms Supply Curve

a. The number one goal of a firm is to maximize profit. b. At quantity level 1, TR is $6, TC is $5, P is $1, Table 2 Profit Maximization: A Numerical Example MR is $6, MC is $2, P is $4. c. The profit maximizing level of production can be found by comparing the marginal cost (MC) with the marginal revenue (MR). d. The fifth and sixth columns in Table 2 compute MR & MC from the changes in TR & TC, and the last column shows the change in profit for each additional gallon produced e. Notice how the change in profit decreases with every quantity of production and the marginal cost increases at each quantity of production. f. As long as the MR exceeds MC, increasing the quantity produced raises profit. g. When MC=MR, profit maximization has been achieved. This occurs at quantity levels 4 and 5 with a profit of $7. h. A major point of economics can be illustrated by this concept..rational people think at the margin, what benefits me the most will drive my decision-making. I. If I stop production before MC=MR, I have not achieved my maximum profit, and if I produce beyond MC=MR, my profit will decrease, and I will also not achieve my goal of profit maximization.

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Page 293-295

IV. The Marginal-Cost Curve and the Firms Supply Decision: Figure 1 features the MC and ATC curves with
the MC crossing at the minimum ATC point (1). It also shows the perfectly elastic market price line, that of a price taker, which is also the average revenue line (AR), and the marginal revenue line (MR). The price is constant regardless of Q. a. We use Figure 1 to find the quantity of output that Figure 1 Profit Maximization for a Competitive Firm maximizes profit. Costs The firm maximizes Suppose the market price is P. and b. At Q1 MR1>MC1. There is still considerable growth profit by producing Revenue potential to reach maximum profit at Qmax, where MC=MR. the quantity at which MC marginal cost equals c. One can see visually that at Q1 and P the profit as marginal revenue. If the firm produces indicated by where Q1 crosses the ATC and intersects the P line MC Q , marginal cost is MC . is less than where Qmax crosses the ATC and intersects the Price ATC line. P = MR = MR P = AR = MR d. The Profit x Q at Qmax is much greater than Profit x Q at Q1. AVC e. Lessons Learned: (a) If MR is greater than MC, the firm If the firm should increase output to increase profit, (b) if MC is greater MC produces Q , than MR, the firm should decrease its output to increase marginal cost is MC . profit, (3) and at the profit maximizing level of output, MR=MC. TR
2

Total Revenues and Total Costs Per Day ($)

Figure B 60 50 40 TR=PxQ 30 20 10 Losses TC

TC Losses

Q1

QMAX

Q2

Quantity
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Figure A: Profit Maximization

(MKT Price)

Profit maximization occurs where marginal revenue equals marginal cost. T.Output TC 0 10 MPr $5 5 5 5 5 5 5 5 5 5 5 5 TR $0 5 10 15 20 25 30 35 40 45 50 55 TP -$10 -10 -8 -5 -1 2 4 5 5 4 2 -1 ATC AVC MC *$5 MR *$5 5 5 5 5 5 5 5 5 5 5

Profits

ProfitMaximization

1 2 3 4 5

15 18 20 21 23 26 30 35 41 48 56

$15.00 $5.00 3 9.00 6.67 5.25 4.60 4.33 4.28 4.38 4.56 4.80 5.09 4.00 2 3.33 1 2.75 2 2.60 3 2.67 4 2.86 5 3.12 6 3.44 7 3.80 8 4.18

1 2 3 4 5 6 7 8 9 10 11 12 Q: Recordable DVDs per Day

Figure 2 Marginal Cost as the Competitive Firms Supply 6 Curve As P increases, the firm will select its level of output 7 Price
So, this section of the firms MC curve is also the firms supply curve. along the MC curve.

MC

8 9

P2

ATC

P1
AVC

10 11

* Placed between rows where quantities occur to indicate a change between one rate of output and the next.
Q1 Q2 Quantity
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V. Marginal Cost as the Competitive Firms Supply Curve: Because a P.C. firm is a price taker, its MR equals the market price. For any given price, the P.C. firms profit maximizing quantity of output is found by looking at the intersection of the price with the marginal-cost curve. In Figure 1 that quantity of output is Qmax. a. Figure 2 shows how a P.C. firm reacts to a price increase. When the price is P1, quantity produced is at Q1, where Price and Quantity meet on the MC curve. b. When the price rises to P2, MR is now higher than MC at the previous level of output, so the firm increases production. c. Because the firms marginal-cost curve determines the quantity of the good the firm is willing to supply at any price, the marginal-cost curve is also the perfectly competitive firms supply curve.

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V1. The Firms Short-Run Decision to Shut Down: A shut-

Figure 3 The Competitive Firms Short-Run Supply Curve

Costs down refers to short-run decision not to produce anything during a Firms short-run specific period because of market conditions. Exit is a long-run desupply curve MC If P > ATC, the firm will continue to cision to leave the market. produce at a profit. a. The difference is firms cannot avoid their fixed costs in ATC the short-run but can in the long-run, because they have none. If P > AVC, firm will b. A firm that shuts down temporarily has to pay its fixed AVC continue to produce costs but a firm that exits the market does not have to pay either cost in the short run. factor, fixed or variable. It can sell his fixed costs, land-machines. c. In the short-run, a firm that is losing money will want to Firm continue producing as long as their total revenue exceeds their vari- shuts able costs (TR>VC). Why? Because a firm can modify its variable down if P< AVC costs with layoffs and reducing non-essential expenses, but it is still Quantity 0 obligated to pay their fixed costs. d. Therefore, if a firm earns more than their variable costs, they will have less debt by being able to pay for their variable costs and have some left over to apply to their fixed costs. If TR is less than VC, (TR< VC), the firm shuts down. e. In the long-run, all costs are variable, therefore, a firm will better be able to manage its expenses and if it cannot make a profit it can just shutdown because its expenses are variable, therefore easy to eliminate while exiting an industry.

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VI1. Short Run Losses: In Figure B, d1 shifts to d2 because supply or

demand changes. Price falls from $5 to $3. MC crosses between $5 & $6 and the firm is not profitable because cost is > than price. However, the firm is minimizing losses because MC + MR. VII1. The Short-Run Shutdown Price: The firm is sustaining economic losses in Figure B. 1. In the long-run it will go out of business. See the MC & ATC going up while price stays the same. 2. A firm is out of business when it sells its assets, it is shut down when it stops producing. 3. The cost of staying in business in the short-run is the total variable cost, it will disappear if you shut-down, your fixed costs continue rent, leases, etc. EXAMPLE: A price of $8 @ output of 100=$800 in TR. ATC per unit is $9 x 100 for a cost of $900, (AVC is $700 & FC is $200)=a loss of $100. If the firm continues to produce it has losses of $100, if it shuts down, it has losses of $200, the sum of the fixed costs.

9 8

Figure B: Short Run Losses

Price and Costs per Unit ($)

7 6 5 4 3 2 1 1 2 3 4 5 6 7 Recordable DVDs per Day 8 9 Losses

MC ATC d1

d2
P=MR=AR

1X. Calculating the Short-Run Break-Even Price: D1 touches min. point of the ATC=AR=P=MR, which means,
TR=TC, this is the Short-Run break-even price. It is also covering normal rate of return, implicit & explicit costs. X. Calculating the Short-Run Shutdown Price: The firm will produce where the MC intersects the demand curve. E1 or E2, but at E2 you are only Figure C: Short Run Shutdown/Break-even P. covering variable costs, not fixed costs. 9 1. At E2, the short-run shutdown price is where the price just covers AVC, just below the intersection of the MC and the AVC. Each unit sold 8 MC will addto its losses. You cannot even cover the fixed costs by continuing. 7 SR Break-even 2. This is only for the short run because the firm will be out of ATC point business already in the long-run. 6 AVC1
Price and Costs per Unit ($)

VI. The Meaning Of Zero Economic Profits: At E1 on Figure C,

the price is equal to ATC. Why produce with no profits? 1. Consider that a firm can have zero economic profits and still have positive accounting profits. 2. The ATC includes all economic costs. 3. At short-run break-even price they are zero while accounting costs are not.

5 4 3 2 1 Losses E2

d1 E1 AVC2
P=MR=AR

d2

SR Shutdown point
8 9

1 2 3 4 5 6 7 Recordable DVDs per Day

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The Firms Short-Run Decision to Shut Down (Figure 3)

Figure 3 The Competitive Firms Short-Run Supply Curve

1. What is a business shutdown? refers to short-run decision not to produce Costs anything during a specific period because of market conditions. Firms short-run supply curve 2. What is an Exit by a firm? is a long-run decision to leave the market. If P > ATC, the firm will continue to 3. What is the the difference between a shutdown and an exit? is firms cannot produce at a profit. avoid their fixed costs in the short-run but can in the long-run. A firm that shuts down temporarily has to pay its fixed costs but a firm that exits the market does not have to pay either cost factor, fixed or variable. 4. Why will a firm want to continue producing in the short-run when TR>VC? If P > AVC, firm will continue to produce a firm that is losing money will want to continue producing as long as their total in the short run. revenue exceeds their variable costs (TR>VC). Why? Because a firm can modify its variable costs with layoffs and reducing non-essential expenses, but it is still obligated to pay their fixed costs. Therefore, if a firm earns more than their variable Firm costs, they will have less debt by being able to pay for their variable costs and have shuts some money left over to pay towards fixed costs. down if P< AVC 5. What should a firm do if TR is less than VC, (TR< VC), and why? The firm 0 shuts down because its losses will be lower when it eliminates its variable costs. 6. Why is it easier and less painful for a firm to shut down in the long-run? In the long-run, all costs are variable, therefore, a firm will better be able to manage its expenses and if it cannot make a profit it can just shutdown because its expenses are variable, therefore easy to eliminate while exiting an industry.

MC

ATC

AVC

Quantity
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Short Run Loss (Figure B)

7. What is the total revenue at d1? $5 x $7,500=$37,500 8. What is the total profit at d1? .50x7,500 = $3,750 9. What is the total cost at d1? $4.50x7,500=$33,750 10. A determinant occurs and d1 shifts to d2, what is the new TR? $3x5,500=$16,500 11. What is the total profit and/or loss at d2? 0 profit, loss of $26,125-$16,500=$9,625.00 12. What is the total cost at d2? $4.75x5,500=$26,125.00 13. Why is the firm not profitable? because TC is > than price 14. Why would E2 be the short run shutdown point? Because AVC is at or above d2 15. Why would production continue if TC produced a loss? If TR exceeded AVC production would continue in the short run. The cost of staying in business in the short-run is the total variable cost, it will disappear if you shut-down, your fixed costs continue rent, leases, etc. EXAMPLE: A price of $8 @ output of 100=$800 in TR. ATC per unit is $9 x 100 for a cost of $900, (AVC is $700 & FC is $200) =a loss of $100. 16. What in Figure B indicates this business will fail in the long run without corrective interventions? In the long-run it will go out of business. See the MC & ATC going up while price stays the same. 17. When is a firm is out of business? When it sells its assets. 18. When is a business shutdown? It is shut down when it stops producing.
The Meaning Of Zero Economic Profits

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Figure B: Short Run Losses

D=P=MR=AR

Price and Costs per Unit ($)

7 6 5 4 3 2 1 1 2 3 4 5 6 7 8 Recordable DVDs per Day (000) 9 E2 E1

MC ATC d1 AVC d2

19. At E1 on Figure B, the price is equal to ATC. Why produce with no profits? Consider that a firm can have zero economic profits and still have positive accounting profits. The ATC includes all economic costs. At short-run break-even price they are zero while accounting costs are not.

20. When a competitive firm doubles the amount it sells, what happens to the price of its output and its total revenue? The price of output stays the same because of perfect competitive market conditions and the fact the product is small in its production compared with the world market, and the total revenue output doubles.

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The Firms Short-Run Decision to Shut Down (Figure 3)

Figure 3 The Competitive Firms Short-Run Supply Curve

1. What is a business shutdown? refers to short-run decision not to produce Costs anything during a specific period because of market conditions. Firms short-run supply curve 2. What is an Exit by a firm? is a long-run decision to leave the market. If P > ATC, the firm will continue to 3. What is the the difference between a shutdown and an exit? is firms cannot produce at a profit. avoid their fixed costs in the short-run but can in the long-run. A firm that shuts down temporarily has to pay its fixed costs but a firm that exits the market does not have to pay either cost factor, fixed or variable. 4. Why will a firm want to continue producing in the short-run when TR>VC? If P > AVC, firm will continue to produce a firm that is losing money will want to continue producing as long as their total in the short run. revenue exceeds their variable costs (TR>VC). Why? Because a firm can modify its variable costs with layoffs and reducing non-essential expenses, but it is still obligated to pay their fixed costs. Therefore, if a firm earns more than their variable Firm costs, they will have less debt by being able to pay for their variable costs and have shuts some money left over to pay towards fixed costs. down if P< AVC 5. What should a firm do if TR is less than VC, (TR< VC), and why? The firm 0 shuts down because its losses will be lower when it eliminates its variable costs. 6. Why is it easier and less painful for a firm to shut down in the long-run? In the long-run, all costs are variable, therefore, a firm will better be able to manage its expenses and if it cannot make a profit it can just shutdown because its expenses are variable, therefore easy to eliminate while exiting an industry.

MC

ATC

AVC

Quantity
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Short Run Loss (Figure B)

7. What is the total revenue at d1? 8. What is the total profit at d1? 9. What is the total cost at d1? 10. A determinant occurs and d1 shifts to d2, what is the new TR? 11. What is the total profit and/or loss at d2? 12. What is the total cost at d2? 13. Why is the firm not profitable? 14. Why would E2 be the short run shutdown point? 15. Why would production continue if TC produced a loss? 16. What in Figure B indicates this business will fail in the long run without corrective interventions? 17. When is a firm is out of business? 18. When is a business shutdown?
Price and Costs per Unit ($)
9 8 7 6 5 4 3 2 1 1 2 3 4 5 6 7 8 Recordable DVDs per Day (000) 9 E2 E1 MC ATC d1 AVC d2 Figure B: Short Run Losses
D=P=MR=AR

The Meaning Of Zero Economic Profits

19. At E1 on Figure B, the price is equal to ATC. Why produce with no profits? Consider that a firm can have zero economic profits and still have positive accounting profits. The ATC includes all economic costs. At short-run break-even price they are zero while accounting costs are not.

20. When a competitive firm doubles the amount it sells, what happens to the price of its output and its total revenue? The price of output stays the same because of perfect competitive market conditions and the fact the product is small in its production compared with the world market, and the total revenue output doubles.

CH 14: Page 297-300

IX. Sunk Costs: A cost that has already been committed and cannot be recovered. a. A firm does not stop production because of fixed costs in the short run, but because of variable costs. b. A firm is obligated to its fixed costs because of contracts and/or other agreements, but a firm can eliminate variable costs. c. If a firm has $1 million in total costs with fixed costs of $300,000 and variable costs of $700,000 with a total revenue of $800,000, it makes economic sense to continue producing in the short-run. d. This is because you have enough revenue to pay for your variable costs and have $100,000 left over to apply to the fixed costs, or, to pay for your fixed costs and have $500,000 left over to pay part of your variable costs. e. If total revenue was less than the variable costs of $700,000, shutdown would be the best decision because now you cannot pay all of your variable costs or fixed costs. f. Two primary options left to save the business would be to slash your variable costs to $500,000, or less, without reducing total revenue, or a combination of renegotiating your fixed costs and reducing variable costs to reach profitability. Two other potential options would be to increase Figure 4 The Competitive Firms Long-Run Supply Curve total revenue via new customers or seek a merger with a comCosts Firms long-run petitor.
supply curve MC = long-run S

Firm X. The Firms Long-Run Decision to Exit or Enter a Marenters if ATC ket: A firms shutdown decision in the Long-Run is similar to P > ATC its exit decision. a. Remember, all fixed costs are variable in the long-run, Firm so a firm will shut down and exit the market if the revenue it exits if P < ATC would get from producing is less than the total costs. (TR<TC), (TR/Q<TC/Q, or(P<ATC) Quantity 0 b. In this case the firm exits the market because it will Figure 5 Profit as the Area between Price and Average Total save both its variable costs and its fixed costs. Cost c. A firm will enter the market if it can achieve a profit (a) A Firm with Profits by the price exceeding the average total cost. (P>ATC) Price d. In Figure 4, we see in the long-run that the supply MC ATC curve is the portion of its marginal cost curve that lies above Profit ATC. P e. If the price is lower than ATC, it will exit the market.

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ATC

P = AR = MR

XI. Measuring profit for the Competitive Firm: Remember, profit equals total revenue minus total cost. (P=TR-TC) a. Other ways to determine profit are: (TR/Q - TC/Q) x Q or, (P - ATC) x Q Quantity 0 Q b. Panel A of Figure 5 shows a firm earning a profit. (profit-maximizing quantity) c. The shaded rectangle is P-ATC and the width is Q. Figure 5 Profit as the Area between Price and Average Total d. So, the profit is (P-ATC) x Q. If P was $50, ATC was $45, Cost (b) A Firm with Losses and Q was 1 million, the profit would be $5 million. e. Panel B of Figure 5 shows a firm with losses. It can also be Price seen as minimizing losses because MC=MR, which is the maximum revenue attainable given this production scenario. MC ATC f. The shaded rectangle shows ATC-P with a width of Q. g. This is a loss because the ATC is above the Price indicating ATC costs are more than revenues. P P = AR = MR h. So, the loss is (ATC - P) x Q. Loss i. So, the loss is (ATC P) x Q. If P was $50, ATC was $55, and Q was 1 million, the loss would be $5 million.

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The firm would then exit the market.

Q (loss-minimizing quantity)

Quantity
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Page 295-299

The Firms Short-Run Decision to Shut Down (Figure 3) 1. What is a business shutdown? 2. What is an Exit by a firm? 3. What is the the difference between a shutdown and an exit? 4. Why will a firm want to continue producing in the shortrun when TR>VC? 5. What should a firm do if TR is less than VC, (TR< VC), and why?

Figure 3 The Competitive Firms Short-Run Supply Curve

Costs If P > ATC, the firm will continue to produce at a profit. Firms short-run supply curve MC

ATC If P > AVC, firm will continue to produce in the short run.

AVC

Firm shuts down if P< AVC 0 Quantity

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6. Why is it easier and less painful for a firm to shut down in the long-run? Short Run Loss (Figure B) 7. What is the total revenue at d1? 8. What is the total profit at d1?
9

Figure B: Short Run Losses

D=P=MR=MC=AR

9. What is the total cost at d1?

Price and Costs per Unit ($)

8 7 MC ATC d1 AVC d2 E2 6 5 4 3 2 1 1 2 3 4 5 6 7 8 Recordable DVDs per Day (000) 9

10. A determinant occurs and d1 shifts to d2, what is the new 11. What is the total profit and/or loss at d2? 12. What is the total cost at d2? 13. Why is the firm not profitable? 14. Why would E2 be the short run shutdown point? 15. Why would production continue if TC produced a loss?

TR?
E1

16. What in Figure B indicates this business will fail in the long run without corrective interventions? 17. When is a firm is out of business? . 18. When is a business shutdown? The Meaning Of Zero Economic Profits 19. At E1 on Figure B, the price is equal to ATC. Why produce with no profits?

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Figure 6 Short-Run Market Supply

(a) Individual Firm Supply Price Price

(b) Market Supply

MC $2.00 $2.00

Supply

1.00

1.00

100

200

Quantity (firm)

100,000

200,000 Quantity (market)

If the industry has 1000 identical firms, then at each market price, industry output will be 1000 times larger than the representative firms output.

The Short Run: Market Supply with a Fixed Number of Firms

1. 2. 3. 4. 5. 6.

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For any given price, each firm supplies a quantity of output so that its MC equals price. When the demand increases so does the price, as seen in panel a. The market supply curve reflects the individual firms marginal cost curves. As long as the price is above the AVC, each firms marginal cost curve is its supply curve because the firm will increase production. To derive the market supply curve, we add the quantity supplied by each firm in the industry. Since there are 1,000 firms, as seen inn panel b, on average, the average quantity supplied by the market is 1,000 times the QS by each firm. Figure 1 Economists versus Accountants Figure 7 Long-Run Market Supply
How an Economist Views a Firm How an Accountant Views a Firm

(a) Firms Zero-Profit Condition Price Price

(b) Market Supply

Economic profit Accounting profit

MC ATC P = minimum ATC Supply

Revenue

Implicit costs Total opportunity costs

Revenue

Explicit costs
0 Quantity (firm) 0 Quantity (market)

Explicit costs

The Long Run Market Supply With Entry & Exit 1. Firms will enter or exit the market until profit is driven to zero. 2. In the long run, price equals the minimum of ATC. 2007 Thomson South-Western 3. The long run market supply is horizontal at this price. 4. At the end of the process of entry and exit, firms that remain must be making zero economic profit 5. The process of entry and exit ends only when price and ATC are driven to equality. Why do competitive firms stay in business if they make zero profit? 6. Profit equals TR -TC, TC includes the implicit opportunity costs of the firm. 7. In the zero-profit equilibrium, the firms revenue compensates the owners for the time and money they expend to keep the business going via the implicit costs. Remember, implicit costs reduce the taxable profit on paper, but in fact the business makes a profit while paying taxes only on the TRTC. 8. The firm which only has accounting costs to claim, and has a profit on paper, will pay a profit tax and the firm with 0 economic profit will pay no taxes.
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A Shift in Demand in the Short Run and Long Run
An increase in demand raises price and quantity in the short run. Firms earn profits because price now exceeds average total cost. A. Because firms can enter and exit in the long run but not in the short run , the response of a market to a change in demand depends on the time horizon. B. In panel a the equilibrium point is A, the quantity sold is Q1 and the price is P1. C. A massive increase in demand shifts D1 to D2 in panel b and the short-run equilibrium moves from point A to point B, Q1 rises to Q2 and P1 rises to P1. D. All of the existing firms respond to the higher price by producing more. E. Because each firms supply curve reflects its marginal-cost curve, how much they increase production is determined by the marginal-cost curve. F. In the new short-run equilibrium, the price exceeds the ATC so firms are making a positive profit.
Figure 8 An Increase in Demand in the Short Run and Long Run
(a) Initial Condition Market Price Price Firm

MC Short-run supply, S1 A P1 Long-run supply Demand, D1 0 Q1 Quantity (market) 0 P1

ATC

Quantity (firm)

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A market begins in long run equilibrium.

And firms earn zero profit.

Figure 8 An Increase in Demand in the Short Run and Long Run The higher P encourages firms to produce
An increase in market demand raises price and output.
(b) Short-Run Response Market Price Price MC P2 D2 D1 Q1 Q2 Long-run supply P1 ATC Firm

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more and generates short-run profit.

P2 P1

B A

S1

0 G. Over time, the profit in this market encourages new firms to enter. H. As the number of firms grows, the short-run supply curve shifts to the right from S1 to S2 in panel c. I. The shift causes the price to fall to equal the ATC on the P1 demand curve, with zero economic profits, but at the new long-run equilibrium the quantity produced has increased to D3. H. New firms will stop entering the market at the lower equilibrium price.

Quantity (market)

Quantity (firm)

Figure 8 An Increase in Demand in the Short Run and Long Run

Profits induce entry and market supply increases.
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(c) Long-Run Response Firm Price S1 C S2 Long-run supply MC P1 Price Market

P2 P1

B A

ATC

D2 D1

available only in limited quantities. production, the increase in demand for the resource raises cost to firms, the Some resources used in production may be The result is a have different costs. Firms may long-run market supply curve that is upward sloping. allonly inwhich creates a new higher price. available limited quantities. B. Why the Long-Run Supply Curve Might 2. Firms may have different costs.- The marginal firm exits Marginal Firm The marginal Slope Upwardfirm is the firm that would exit the the market if the Price were any lower. Marginal Firm

Why the Long-Run Supply Curve Might 1. Some resources used in production may be A. As more firms use a specific resource in their Slope Upward

Why the Long-Run Supply Curve Might Slope Upward

Q1

Q2

Q3

Quantity (firm)

Quantity (market)

The increase in supply lowers market price.

In the long run market price is restored, but market supply is greater.
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market because each worker has a different productivity The in terms of the speed ofthat would exit the better use A. Costs varyif the price were any lower. level marginal firm is the firm their production, Some resourcesmistakes inproduction may be firms with lower costs arewere any lower. enter the market than of time, and fewer used in the workplace. Those market if the price more likely to those with only costs. available higher in limited quantities. B. For the firms with higher costs to be profitable if they enter the market, prices must rise. The higher demand and Firms may have differentthe profit margins some new firms need to remain in the market. quantity supplied will provide costs. Marginal Firm FACT: Because firms can enter and exit more easily in the long run than in the short run, the long-run supply curve is typically more elastic firm thethe firm that would exit the The marginal than is short-run supply curve.
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market if the price were any lower.

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Summary
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 firms average revenue and its marginal revenue.

Summary
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 firms marginal cost curve is its supply curve.

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Summary
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. 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.
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Summary
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.
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