Module 8: Firms in Competitive Markets

• Perfectly Competitive Market

  • A market with:
  • Many buyers and sellers
  • Identical products are traded
  • Each buyer and seller is a price taker
  • There are no barriers to entry and exit
• Price Taking

  • Firms are “small” relative to the market and their actions cannot influence market price
• Free entry and exit

  • Firms can enter the market if it profits them and can exit the market if it experiences losses
• Total Revenue (TR)

  TR = P * Q

  Average Revenue (AR)

  AR = TR / Q

  Marginal Revenue (MR)

  MR = ∆TR / ∆Q
• The marginal cost curve is the supply curve
• Shutdown vs Exit

  Exit

  • Refers to a long-run decision to get out of the market

  Shutdown

  • Short-run decision not to produce anything during a specific period of time
  • A firm that shuts down does not earn any revenue and will not incur any variable cost but still has to pay the fix cost: TR=0, VC=0, FC>0
  • A firm shuts down if TR<VC
• Shut down condition: P < AVC

  • If the price per unit cannot cover for average variable cost per unit, it’s better for the firm to shut down
• Exit in the long-run

  • A firm exits the market in the long-run if profit < 0
  • Since Profit = TR - TC, this is equivalent to the condition that TR < TC
  • TR/Q < TC/Q
  • Average Revenue < Average Total Cost (ATC)
  • Hence, the firm’s long-run exit condition is P < ATC
• Long-run supply curve

  • Exit condition: P < ATC
  • If the price per unit cannot cover for the average total cost per unit, it’s better for the firm to exit the market
• Profit = (P - ATC) x Q

  • Profit > 0 if and only if P > ATC
  • Profit < 0 if and only if P < ATC
  • Profit = 0 if and only if P = ATC
• Short-run Market Supply Curve

  • The number of firms is fixed (that is, there are no additions of new firms)
• Long-run Market Supply Curve

  • There is entry or exit
  • Firms have same technology and markets for inputs
  • The cost curves of the firms are identical 

  If Profit is > 0, then there is entry in the long-run. If Profit is < 0 then there is exit in the long-run