曼昆经济学原理英文版习题答案14章FIRMSINCOMPETITIVEMARKETS.doc

Chapter 14/Firms in Competitive Markets❖261
14

FIRMS IN
COMPETITIVE MARKETS

WHAT’S NEW IN THE SEVENTH EDITION:

There are no major changes to this chapter.

LEARNING OBJECTIVES:

By the end of this chapter, students should understand:

Ø what characteristics make a market competitive.
Ø how competitive firms decide how much output to produce.
Ø how competitive firms decide when to shut down production temporarily.
Ø how competitive firms decide whether to exit or enter a market.
Ø how firm behavior determines a market’s short-run and long-run supply curves.

CONTEXT AND PURPOSE:

Chapter 14 is the second chapter in a five-chapter sequence dealing with firm behavior and the organization of industry. Chapter 13 developed the cost curves on which firm behavior is based. These cost curves are employed in Chapter 14 to show how a competitive firm responds to changes in market conditions. Chapters 15 through 17 will employ these cost curves to see how firms with market power (monopolistic, monopolistically competitive, and oligopolistic firms) respond to changes in market conditions. The purpose of Chapter 14 is to examine the behavior of competitive firms—firms that do not have market power. The cost curves developed in the previous chapter shed light on the decisions that lie behind the supply curve in a competitive market.

KEY POINTS:

· 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.

· To maximize profit, a firm chooses a quantity of output such that marginal revenue equals marginal cost. Because marginal revenue for a competitive firm equals the market price, the firm chooses quantity so that price equals marginal cost. Thus, the firm’s marginal-cost curve is its supply curve.
· 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.

· In a market with free entry and exit, profit is driven to zero in the long run. In this long-run equilibrium, all firms produce at the efficient scale, price equals the minimum of average total cost, and the number of firms adjusts to satisfy the quantity demanded at this price.

· Changes in demand have different effects over different time horizons. In the short run, an increase in demand raises prices and leads to profits, and a decrease in demand lowers prices and leads to losses. But if firms can freely enter and exit the market, then in the long run the number of firms adjusts to drive the market back to the zero-profit equilibrium.

CHAPTER OUTLINE:

I. What Is a Competitive Market?

A. The Meaning of Competition
Remember that students have a difficult time understanding what a competitive market is. The use of the word “competition” in economics is much different from that in sports. This will lead students to often forget that these firms are generally unconcerned with the actions of their rivals.

1. Definition of competitive market: a market with many buyers and sellers trading identical products so that each buyer and seller is a price taker.

2. There are three characteristics of a competitive market (sometimes called a perfectly competitive market).

a. There are many buyers and sellers.

b. The goods offered by the sellers are largely the same.

c. Firms can freely enter or exit the market.

B. The Revenue of a Competitive Firm
Table 1

To help students understand price-taking behavior, use the example of common stock. Have your students assume that they inherited 100 shares of stock in a well-known company. Point out that these 100 shares may seem like a lot, but it is a very small proportion of the total number of shares outstanding. If the student wanted to know the value of a share, it could be obtained from a broker. At this market-determined price, the student could sell as few or as many shares as he or she wishes. At a price above this, no one would be willing to buy any. There is also no reason to charge a price below the current market price, because the student can sell any number of shares that he or she wishes at the current price.

1. Total revenue from the sale of output is equal to price times quantity.

Make sure that students realize that firms in perfect competition can only change their level of total revenue by varying their level of output because they have no ability to change the price.

2. Definition of average revenue: total revenue divided by the quantity sold.

3. Definition of marginal revenue: the change in total revenue from an additional unit sold.

You may want to make it clear that, by definition, average revenue is always equal to price. But marginal revenue is equal to price only for firms that operate in perfectly competitive markets.

II. Profit Maximization and the Competitive Firm's Supply Curve

A. A Simple Example of Profit Maximization: The Vaca Family Dairy Farm
Table 2

Q
Total Revenue
Total Cost
Profit
Marginal Revenue
Marginal Cost
Change in Profit
0
$0
$3
$-3
----
----
----
1
6
5
1
$6
$2
$4
2
12
8
4
6
3
3
3
18
12
6
6
4
2
4
24
17
7
6
5
1
5
30
23
7
6
6
0
6
36
30
6
6
7
-1
7
42
38
4
6
8
-2
8
48
47
1
6
9
-3

1. In this example, profit is maximized if the farm produces four or five gallons of milk (see the fourth column).

2. The profit-maximizing quantity can also be found by comparing marginal revenue and marginal cost.

a. As long as marginal revenue exceeds marginal cost, increasing output will raise profit.

b. If marginal revenue is less than marginal cost, the firm can increase profit by decreasing output.

ALTERNATIVE CLASSROOM EXAMPLE:
Paulo’s Ping Pong Balls is a firm that operates in a competitive market. The ping pong balls sell for $3 per package. Fill in the following table with the class's help and discuss the profit-maximizing level of output:

Output
Price
Total Revenue
Total Cost
Profit
Marginal Revenue
Marginal Cost
0
$3
$0.00
$1.50
$-1.50
----
----
1
3
3.00
2.00
1.00
$3
$0.50
2
3
6.00
3.00
3.00
3
1.00
3
3
9.00
4.50
4.50
3
1.50
4
3
12.00
6.50
5.50
3
2.00
5
3
15.00
9.00
6.00
3
2.50
6
3
18.00
12.00
6.00
3
3.00
7
3
21.00
15.50
5.50
3
3.50
8
3
24.00
19.50
4.50
3
4.00
9
3
27.00
24.00
3.00
3
4.50

c. Profit-maximization occurs where marginal revenue is equal to marginal cost.

B. The Marginal-Cost Curve and the Firm's Supply Decision

1. Cost curves have special features that are important for our analysis.

a. The marginal-cost curve is upward sloping.

b. The average-total-cost curve is U-shaped.

c. The marginal-cost curve crosses the average-total-cost curve at the minimum of average total cost.
The graphs in this chapter often confuse students because they contain many different curves at the same time. Thus, the first time you draw the profit-maximizing decision of the firm, use only the marginal cost curve and the marginal revenue line. Then, after students feel comfortable with this, add average total cost (to teach students how to measure profit or loss). Last, add average variable cost to teach students about the short-run shutdown decision of a firm earning an economic loss. Point out that each of the short-run cost curves tells a different part of the story.

2. Marginal and average revenue can be shown by a horizontal line at the market price.

3. To find the profit-maximizing level of output, we can follow the same rules that we discussed above.
Figure 1

a. If marginal revenue is greater than the marginal cost, the firm should increase its output.

b. If marginal cost is greater than marginal revenue, the firm should decrease its output.

c. At the profit-maximizing level of output, marginal revenue and marginal cost are exactly equal.

4. These rules apply not only to competitive firms, but to firms with market power as well.

Activity 1—A Profitable Opportunity?

Type: In-class assignment
Topics: Profit maximization
Materials needed: None
Time: 15 minutes
Class limitations: Works in any size class

Purpose
This exercise reinforces the importance of marginal cost in decision-making. It shows average costs can be misleading.

Instructions
Tell the class, “As a recent graduate of this college you have landed a job in production management for Universal Clones, Inc. You are responsible for the entire company on weekends.”
“Your costs are shown below.”

Quantity Average Total Cost
500 200
501 201

Your current level of production is 500 units. All 500 units have been ordered by your regular customers.

“The phone rings. It’s a new customer who wants to buy one unit of your product. This means you would have to increase production to 501 units. Your new customer offers you $450 to produce the extra unit.”
a. Should you accept this offer?
b. What is the net change in the firm’s profit?

Common Answers and Points for Discussion
Most students will answer “yes.” Selling something for $450 when the average cost of production is $201 seems like good business. They are wrong.

The relevant comparison is marginal cost to marginal revenue. Marginal cost can be easily calculated as the change in total costs.

Quantity Average Total Cost Total Cost = Q ´ ATC
500 200 100,000
501 201 100,701

$100,701 – $100,000 = $701

Marginal cost in this example is $701. This is much higher than the marginal revenue of $450. The offer should not be accepted. It would result in a $251 loss.

Figure 2

5. If the price in the market were to change to P2, the firm would set its new level of output by equating marginal revenue and marginal cost.

6. Because the firm's marginal cost curve determines how much the firm is willing to supply at any price, it is the competitive firm's supply curve.

C. The Firm's Short-Run Decision to Shut Down

1. In certain circumstances, a firm will decide to shut down and produce zero output.

2. There is a difference between a temporary shutdown of a firm and an exit from the market.

a. A shutdown refers to a short-run decision not to produce anything during a specific period of time because of current market conditions.

b. Exit refers to a long-run decision to leave the market.

c. One important difference is that, when a firm shuts down temporarily, it still must pay fixed costs. If a firm exits the industry in the long run, it has no costs.

3. If a firm shuts down, it will earn no revenue and will have only fixed costs (no variable costs).

4. Therefore, a firm will shut down if the revenue that it would earn from producing is less than its variable costs of production:

Shut down if TR < VC.

5. Because TR = P x Q and VC = AVC x Q, we can rewrite this condition as:

Shut down if P < AVC.

6. We now can tell exactly what the firm will do to maximize profit (or minimize loss).

a. If the price is less than average variable cost, the firm will produce no output.

b. If the price is above average variable cost, the firm will produce the level of output where marginal revenue (price) is equal to marginal cost.

If:
The Firm Will:
P ≥ AVC
Produce output level where MR = MC
P < AVC
Shut down and produce zero output

7. Therefore, the competitive firm's short-run supply curve is the portion of its marginal revenue curve that lies above average variable cost.

Figure 3

8. Spilt Milk and Other Sunk Costs

a. Definition of sunk cost: a cost that has been committed and cannot be recovered.

b. Once a cost is sunk, it is no longer an opportunity cost.

c. Because nothing can be done about sunk costs, you should ignore them when making decisions.

9. Case Study: Near-Empty Restaurants and Off-Season Miniature Golf

a. In making a decision of whether to open for lunch, a restaurant owner must weigh revenue with variable costs. (Much of the cost of running a restaurant is somewhat fixed.)

b. The same criteria would apply to a decision of whether a miniature golf course in a summer resort community should stay open during other seasons. The course should only be open if revenue exceeds variable costs.

D. The Firm's Long-Run Decision to Exit or Enter a Market

1. If a firm exits the market, it will earn no revenue, but it will have no costs as well.

2. Therefore, a firm will exit if the revenue that it would earn from producing is less than its total costs:

Exit if TR < TC.

3. Because TR = P x Q and TC = ATC x Q, we can rewrite this condition as:

Exit if P < ATC.

4. A firm will enter an industry when there is profit potential, so this must mean that a firm will enter if revenues will exceed costs:

Enter if P > ATC.
Figure 4

5. Because, in the long run, a firm will remain in a market only if P ≥ ATC, the firm's long-run supply curve will be its marginal cost curve above ATC.

If:
The Firm Will:
P > ATC
Enter because economic profits are earned
P = ATC
Not enter or exit because economic profits are zero
P < ATC
Exit because economic losses are incurred

E. Measuring Profit in Our Graph for the Competitive Firm

1. Recall that Profit = TR –TC.

2. Because TR = P x Q and TC = ATC x Q, we can rewrite this equation:

Profit = (P – ATC) x Q.

Figure 5

3. Using this equation, we can measure the amount of profit (or loss) at the firm's profit-maximizing level of output (or loss-minimizing level of output).
Students always want to use the point of minimum average total cost when finding profit on the graph. Remind them to always find the average total cost of the profit-maximizing level of output.

Keep reminding students that economic profits and losses are different from accounting profits and losses. Point out that economic cost includes the cost of all resources, including a “normal return or profit” to compensate the firm’s owner for the risks and other efforts put into the business.

III. The Supply Curve in a Competitive Market

A. The Short Run: Market Supply with a Fixed Number of Firms
Figure 6

1. Example: a market with 1,000 identical firms.

2. Each firm's short-run supply curve is its marginal cost curve above average variable cost.

3. To get the market supply curve, we add the quantity supplied by each firm in the market at every given price.

B. The Long Run: Market Supply with Entry and Exit
Figure 7

1. If firms in a market are earning profit, this will attract new firms.

a. The supply of the product will increase (the supply curve wil