1. Firms in
competitive Market

2. Market
 It is a social arrangement that allows buyers
& seller to discover information and carryout
voluntary exchange of goods or services.
 Mainly 4 kind of markets are there,
 Monopoly
 Oligopoly
 Monopolistic
 Perfect

3. Perfect Competition
 Meaning
 Characteristics
 Large no. of buyers & sellers
 Homogenous product
 Easy to enter & exit
 Perfect knowledge to both seller & buyer
 Perfect mobility
 Seller are price taker
 Straight horizontal line demand curve

4. Conti…
 As a result of these characteristics, the
perfectly competitive market has the
following outcomes:
 The actions of any single buyer or seller in
the market have no impact on the market
price.
 Each buyer and seller takes the market
price as given.
 Eg: Agricultural products (vegetables,
fruits, oils), copper, gold etc.

5. Conti…
Buyers and sellers must accept the
price determined by the market. No
single seller has market power (the
power to influence the market price).

6. Types of cost
 Fixed cost
 Variable cost
 Marginal cost
 Average cost
 Total cost
 E.g. Telephone bill

7. Conti…
Units FC VC TC MC AC
1 10 5 15 - 15
2 10 8 18 3 9
3 10 12 22 4 7.33
4 10 17 27 5 6.75
5 10 23 33 6 6.6

8. Relationship between AC & MC
Diagrammatic representation
Cost/Revenue
Output/Sales
MC
AC
Q1
X
Y
0

9. “Demand Faced By A Competitive
Firm” versus “Market Demand”
Price
QTY
(ones)
Pm
Demand faced by
one competitive firm
Market Demand
Price
QTY
(millions)

10. Price Determination
DS
D
S
300
100
5 20183
Price Demand Supply
100 18 3
200 10 10
300 5 20
Qty
Price
0
X
Y
200
10

11.  Marginal revenue the change in total
revenue that occurs as a result of a
1-unit change in sales..
 Marginal cost is the additional cost
from producing one more unit of
output.
Marginal Revenue & Marginal Cost

12. The Revenue of a Competitive Firm
 Revenue means total income generated
through selling of product.
 Revenue mainly of 3 kinds
 Total Revenue
 Average Revenue
 Marginal Revenue
 Total revenue for a firm is the market price
times the quantity sold.
TR = P  Q

13. Total, Average, and Marginal Revenue for a Competitive
Firm

14. Conti…
 Price is fixed of the
product in perfect
competition.
 So, Marginal revenue,
average Revenue and
price will be same for
competitive firm, that
can be represented by
straight line horizontal
curve.
0 Qty
Price
P= AR= MR
P
X
Y

15. Profit Maximization & competitive firm’s
supply curve
 The goal of a competitive firm is to
maximize profit.
 This means that the firm wants to
produce the quantity that maximizes the
difference between total revenue and
total cost.
P = TR - TC

16. Conti…

17. Figure 1 Profit Maximization for a Competitive Firm
Quantity0
Costs
and
Revenue
MC
ATC
AVC
MC1
Q1
MC2
Q2
The firm maximizes
profit by producing
the quantity at which
marginal cost equals
marginal revenue.
QMAX
P = MR1 = MR2 P = AR = MR

18. Conti…
 When MR > MC, profit is increasing, so
must produce more.
 When MR < MC, profit is decreasing, so
must produce less.
 When MR = MC, profit is constant, so this
is the point where profit is maximized.

19. Figure 2 Marginal Cost as the Competitive Firm’s
Supply Curve
Quantity0
Price
MC
ATC
AVC
P1
Q1
P2
Q2
This section of the
firm’s MC curve is
also the firm’s supply
curve.

20. Firm’s short-run decision to shut down
Shut-down
 It’s a decision not to
produce anything during
a specific period of time
because of current
market condition.
 Have to pay sunk cost,
that can not be ignored.
Exit from market
 It’s a long run decision
to leave the market
permanently.
 Not have to pay any
kind of cost at all
(fixed/variable)

21. Conti…
 Firm shuts down if the revenue that it would
get from production, less than its variable cost
of production.
Shut down if TR < VC
Shut down if TR/Q < VC/Q
Shut down if P < AVC
 Firm will lose money in shut down (paying
FC) but it would lose more money staying
open.

22. Figure 3 The Competitive Firm’s Short Run Supply
Curve
MC
Quantity
ATC
AVC
0
Costs
Firm
shuts
down if
P<AVC
Firm’s short-run
supply curve
If P > AVC, firm will
continue to produce
in the short run.
If P > ATC, the firm
will continue to
produce at a profit.

23. The Firm’s Long-Run Decision to Exit or
Enter a Market
 In the long run, the firm exits if the
revenue it would get from producing is
less than its total cost. Equivalently, firm
exits (enters) if the profit is negative
(positive).
Exit if TR < TC
if TR/Q < TC/Q
if P < ATC

24. Conti…
 A firm enters the market if profit is
positive.
 Enter if TR > TC
if TR / Q > TC / Q
if P > ATC

25. Figure 4 The Competitive Firm’s Long-Run Supply
Curve
Copyright © 2004 South-Western
MC = long-run S
Firm
exits if
P < ATC
Quantity
ATC
0
Costs
Firm’s long-run
supply curve
Firm
enters if
P > ATC

26. Measuring profit in competitive firm
 Profit can be of three kind,
 Supernormal profit
AR > AC
 Normal profit
AR = AC
 Sub-normal profit (Loss)
AR < AC

27. Figure 5 Profit as the Area between Price and Average
Total Cost
(a) A Firm with Profits
Quantity0
Price
P = AR = MR
ATCMC
P
ATC
Q
(profit-maximizing quantity)
Profit

28. Figure 5 Profit as the Area between Price and Average
Total Cost
(a) A Firm with Profits
Quantity0
Price
P = AR = MR
ATCMC
P
(profit-maximizing quantity)
Q
ATC =

29. Figure 5 Profit as the Area between Price and Average
Total Cost
(b) A Firm with Losses
Quantity0
Price
ATCMC
(loss-minimizing quantity)
P = AR = MRP
ATC
Q
Loss

30. Supply curve in a competitive market
 Market supply equals the sum of the
quantities supplied by the individual
firms in the market.
 Market supply curve can be discussed
with two cases;
 Examine market with fixed no. of firms
 Examine market in which no. of firms
can change due to entry & exit.

31. The Short Run: Market Supply with a Fixed
Number of Firms
 For any given price, each firm supplies
a quantity of output so that its marginal
cost equals price.
 The market supply curve adds up the
individual firms’ marginal cost curves.

32. Figure 6: SR Market Supply with a Fixed Number of
Firms
(a) Individual Firm Supply
Quantity (firm)0
Price
MC
100
100
200
200
(b) Short Run Market Supply
Quantity (market)0
Price
Supply
100
100,000
200
200,000
SR

33. The Long Run: Market Supply with Entry and
Exit
 If in market, suppose everyone has
access to same technology for
producing the good & access to same
markets to buy the input into production.
 In such market entry & exit depend on
incentives facing the owners of existing
firms & entrepreneurs who could start
new firms.

34. Conti…
Entry
 Existing firms earning
profit.
 New entry expand no. of
firm in market.
 Expanded no. of firm lead
to increase quantity of
goods supplied.
 More supply lead to down
in price & profits.
Exit
 Firm in existing market
occurring lose.
 Exit of firm reduce the no.
of firm in market.
 Reduced market
decreased the quantity of
good supplied.
 Less supply lead to drive
up price & profits.

35. Figure 7 Market Supply with Entry and Exit
(a) Firm’s Zero-Profit Condition
Quantity (firm)0
Price
(b) Long Run Market Supply
Quantity (market)
Price
0
P = minimum
ATC
Supply
MC
ATC

36. Exercise: A Shift in Demand and Short Run &
Long Run Consequences
 An increase in demand raises price and
quantity in the short run.
 Firms earn profits because price now
exceeds average total cost.

37. Figure 8 An Increase in Demand in the Short Run and
Long Run
Firm
(a) Initial Condition
Quantity (firm)0
Price
Market
Quantity (market)
Price
0
DDemand, 1
SShort-run supply, 1
P1
ATC
Long-run
supply
P1
1Q
A
MC

38. Figure 8 An Increase in Demand in the Short Run and
Long Run
MarketFirm
(b) Short-Run Response
Quantity (firm)0
Price
MC ATCProfit
P1
Quantity (market)
Long-run
supply
Price
0
D1
D2
P1
S1
P2
Q1
A
Q2
P2
B

39. Figure 8 An Increase in Demand in the Short Run and
Long Run
P1
Firm
(c) Long-Run Response
Quantity (firm)0
Price
MC ATC
Market
Quantity (market)
Price
0
P1
P2
Q1 Q2
Long-run
supply
B
D1
D2
S1
A
S2
Q3
C

40. 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
firm’s average revenue and its marginal
revenue.

41. 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 firm’s marginal cost
curve is its supply curve.

42. Thanking you...