Download Competitive Markets Continued-Managerial Economics-Lecture Notes and more Study notes Managerial Economics in PDF only on Docsity! Lesson 26 COMPETITIVE MARKETS (CONTINUED) SHORT-RUN SUPPLY CURVE OF THE COMPETITIVE FIRM The rising portion of the firm's MC curve above the AVC curve or shut-down point is or represents the short run supply curve of the perfectly competitive firm (the heavier portion of the MC curve labeled s in the bottom panel of Figure 1. The reason for this is that the perfectly competitive firm always produces where P = MR = MC, as long as P > AVC. Thus, at P = $55, the firm produces 4.5 units (point N); at P = $45, Q = 4; at P = $25, Q = 3; and at P = $15, Q = 2.5. That is, given P, we can determine the output supplied by the perfectly competitive firm by the point where P = MC. Thus, the rising portion of the competitive firm's MC curve above AVC shows a unique relationship between P and Q, which is the definition of the supply curve. Figure 1 SHORT-RUN FIRM SUPPLY CURVE Example A competitive firm short-run supply curve is the marginal cost curve, so long as P > AVC. Given: TC = 361,250 + 5Q + 0.0002Q2 TR = 25Q MR = MC 25 = 5 + 0.0004Q Q = 50,000 docsity.com Since the firm is price taker: P = MR = $25 = TR – TC = 25(50,000) – 361,250 – 5(50,000) – 0.0002(50,000)2 = $138,750 MC = ATC 5 + 0.0004Q = 361,250 + 5Q + 0.0002Q2 Q Q = 42,500 It is clear that the point of minimum AVC is reached in the output range between 15,000 to 20,000, where AVC = 50,000 + 5Q + 0.0002Q2. The minimum point on the AVC occurs at Q = 15,811 and AVC = $11.32, and is found by setting MC = AVC and solving for Q: P = $25 MC = AVC 5 + 0.0004Q = 50,000+ 5Q + 0.0002Q2 Q Q = 15,811 LONG-RUN ANALYSIS OF A PERFECTLY COMPETITIVE FIRM In the long run all inputs and costs of production are variable, and the firm can construct the optimum or most appropriate scale of plant to produce the best level of output. The best level of output is the one at which price equals the long-run marginal cost (LMC) of the firm. The optimum scale of plant is the one with the short run average total cost (SATC) curve tangent to the long-run average cost of the firm at the best level of output. On one hand, if existing firms earn profits, more firms enter the market in the long run. This increases (i.e., shifts to the right) the market supply of the product and results in a lower product price until all profits are squeezed out. On the other hand, if firms in the market incur losses, some firms will leave the market in, the long run. This reduces the market supply of the product until all firms remaining in the market just break even. Thus, when a competitive market is in long run equilibrium all firms produce at the lowest point on their long-run average cost (LAC) curve and break even. This is shown by point E* in Figure 2. Figure 2 shows that at p = $25, the best level of output of the perfectly competitive firm is 4 units and is given by point E*, at which P = LAC. Because of free or easy entry into the market, all profits and losses have been eliminated, so that P = LMC = lowest LAC. Thus, for a competitive market to be in long run equilibrium, all firms in the industry must produce where P = MR = LMC = lowest LAC so that all firms break even. The perfectly competitive firm operates the scale of plant represented by SATC at its lowest point (point E*), so that its short run marginal cost (SMC) equals LMC also. docsity.com
