Firms in Competitive Markets 14 Firms in Competitive Markets Economics P R I N C I P L E S O F N. Gregory Mankiw Having introduced the cost concepts in the previous chapter, we now begin to use those concepts to see how firms making production and pricing decisions in different market structures. In this chapter, we explore firm behavior under perfect competition. The next chapter covers the other extreme end of the competition spectrum – monopoly. The following two chapters cover the intermediate cases – oligopoly and monopolistic competition, respectively. Premium PowerPoint Slides by Ron Cronovich

In this chapter, look for the answers to these questions: What is a perfectly competitive market? 완전경쟁시장이란? What is marginal revenue? How is it related to total and average revenue? 한계수입이란? 총수입 및 평균수입과의 관계는? How does a competitive firm determine the quantity that maximizes profits? 경쟁기업은 이윤을 극대화하는 산출량을 어떻게 결정하나? When might a competitive firm shut down in the short run? Exit the market in the long run? 단기에서 경쟁기업은 언제 조업을 중단하나? 장기에서의 시장퇴출은? What does the market supply curve look like in the short run? In the long run? 단기에서의 시장공급공선은 어떤 모양? 장기에서는? 1

Introduction: A Scenario Three years after graduating, you run your own business. 졸업 후 3년이 지나 당신이 사업을 한다고 하자. You must decide how much to produce, what price to charge, how many workers to hire, etc. 당신은 얼마나 생산하고, 가격을 얼마로 메기고, 노동자를 얼마나 고용해야 할 지 등을 결정해야 한다. What factors should affect these decisions? 이 결정에 영향을 미치는 요인들은 무엇? Your costs (studied in preceding chapter) 비용 How much competition you face 경쟁 We begin by studying the behavior of firms in perfectly competitive markets. 완전경쟁시장에서의 기업 행동에 대한 공부로 시작해보자. FIRMS IN COMPETITIVE MARKETS 2

Characteristics of Perfect Competition 1. Many buyers and many sellers. 2. The goods offered for sale are largely the same. 3. Firms can freely enter or exit the market. Because of 1 & 2, each buyer and seller is a “price taker” – takes the price as given. “Firms can freely enter or exit the market” means there are no barriers or impediments to entry or exit. E.g., the government does not restrict the number of firms in the market. FIRMS IN COMPETITIVE MARKETS 3

The Revenue of a Competitive Firm Total revenue (TR) Average revenue (AR) Marginal revenue (MR): The change in TR from selling one more unit. TR = P x Q TR Q AR = = P ∆TR ∆Q MR = These revenue concepts are analogous to the cost concepts (TC, ATC, MC) in the previous chapter. FIRMS IN COMPETITIVE MARKETS 4

A C T I V E L E A R N I N G 1 Calculating TR, AR, MR Fill in the empty spaces of the table. Q P TR AR MR $10 n/a 1 $10 $10 2 $10 This easy exercise requires students to apply the definitions from the previous slide. It also demonstrates that MR = P for a competitive firm. (The table in this exercise is similar to Table 1 in the chapter.) 3 $10 4 $10 $40 $10 5 $10 $50 5

A C T I V E L E A R N I N G 1 Answers Fill in the empty spaces of the table. Q P TR = P x Q TR Q AR = ∆TR ∆Q MR = $10 $30 $20 $10 $0 n/a Notice that MR = P $10 1 $10 $10 2 $10 $10 3 $10 4 $10 $40 $10 5 $10 $50 6

MR = P for a Competitive Firm A competitive firm can keep increasing its output without affecting the market price. 경쟁기업은 시장가격에 영향을 미치지 않은 채 자신의 산출량을 증대시킬 수 있다. So, each one-unit increase in Q causes revenue to rise by P, i.e., MR = P. 그래서 Q 각 한 단위 증가는 수입을 P만큼 증가시킨다. 즉 MR=P다. MR = P is only true for firms in competitive markets. MR=P는 경쟁시장에 있는 기업들에게만 옳다. FIRMS IN COMPETITIVE MARKETS 7

Profit Maximization What Q maximizes the firm’s profit? 어떤 산출량이 기업의 이윤을 극대화하는가? To find the answer, “think at the margin.” 답을 찾기 위해서 “한계적으로 사고하라” If increase Q by one unit, 만약 Q가 한단위 증가하면, revenue rises by MR, 수입은 MR만큼 증가하고 cost rises by MC. 비용은 MC만큼 증가한다. If MR > MC, then increase Q to raise profit. 만약 MR>MC라면 이윤의 증대를 위해 Q을 늘여야 하고 If MR < MC, then reduce Q to raise profit. 만약 MR<MC라면 이윤의 증대를 위해 Q를 줄여야 할 것이다. FIRMS IN COMPETITIVE MARKETS 8

(continued from earlier exercise) Profit Maximization (continued from earlier exercise) At any Q with MR > MC, increasing Q raises profit. MR>MC인 어떤 Q에서도 Q가 늘면 이윤은 증가 Q TR TC Profit MR MC Profit = MR – MC $0 45 33 23 15 9 $5 5 7 1 –$5 $10 12 10 8 6 $4 –2 2 4 $6 1 10 10 2 20 At any Q with MR < MC, reducing Q raises profit. MR<MC인 어떤 Q에서도 Q가 줄면 이윤은 증가 10 (The table on this slide is similar to Table 2 in the textbook.) For most students, seeing the complete table all at once is too much information. So, the table is animated as follows: Initially, the only columns displayed are the ones students saw at the end of the exercise in Active Learning 1: Q, TR, and MR. Then, TC appears, followed by MC. It might be useful to remind students of the relationship between MC and TC. Then, the Profit column appears. Students should be able to see that, at each value of Q, profit equals TR minus TC. The last column to appear is the change in profit. When the table is complete, we use it to show it is profitable to increase production whenever MR > MC, such as at Q = 0, 1, or 2. it is profitable to reduce production whenever MC > MR, such as at Q = 5. 3 30 10 4 40 10 5 50 9

MC and the Firm’s Supply Decision Rule: MR = MC at the profit-maximizing Q. At Qa, MC < MR. So, increase Q to raise profit. At Qb, MC > MR. So, reduce Q to raise profit. At Q1, MC = MR. Changing Q would lower profit. Q Costs MC Qb P1 MR Qa Q1 This slide is similar to Figure 1 in the chapter. I’ve omitted the AVC and ATC curves (which appear in Figure 1 in the chapter) because they are not needed at this point. FIRMS IN COMPETITIVE MARKETS 10

MC and the Firm’s Supply Decision If price rises to P2, then the profit-maximizing quantity rises to Q2. The MC curve determines the firm’s Q at any price. Hence, Costs MC P2 MR2 Q2 P1 MR Q1 the MC curve is the firm’s supply curve. Q FIRMS IN COMPETITIVE MARKETS 11

Shutdown vs. Exit Shutdown: 조업중단 A short-run decision not to produce anything because of market conditions. 시장조건 때문에 단기적으로 생산을 중단하기로 결정 Exit: 퇴출 A long-run decision to leave the market. 시장을 떠나려는 장기적 결정 A key difference: 핵심적인 차이 If shut down in SR, must still pay FC. 단기에 조업을 중단하더라도 고정비용은 부담해야 If exit in LR, zero costs. 장기에 퇴출한다면 비용은 0 FIRMS IN COMPETITIVE MARKETS 12

A Firm’s Short-run Decision to Shut Down Cost of shutting down: revenue loss = TR Benefit of shutting down: cost savings = VC (firm must still pay FC) So, shut down if TR < VC Divide both sides by Q: TR/Q < VC/Q So, firm’s decision rule is: The shutdown rule, in plain English, says: If the cost of shutting down is less than the benefit, the firm should shut down. Shut down if P < AVC FIRMS IN COMPETITIVE MARKETS 13

A Competitive Firm’s SR Supply Curve The firm’s SR supply curve is the portion of its MC curve above AVC. Q Costs AVC If P > AVC, then firm produces Q where P = MC. MC ATC In edit mode, it looks like the text boxes are on top of each other. But in presentation mode, the text boxes display only one at a time. If P < AVC, then firm shuts down (produces Q = 0). FIRMS IN COMPETITIVE MARKETS 14

The Irrelevance of Sunk Costs Sunk cost: a cost that has already been committed and cannot be recovered 매몰비용이란 이미 집행되었고 회수불가능한 비용을 말한다. Sunk costs should be irrelevant to decisions; 매몰비용을 의사결정과 연관짓지 말아야 한다. you must pay them regardless of your choice. 선택과 상관없이 그것들은 지불되어야 하니까. FC is a sunk cost: The firm must pay its fixed costs whether it produces or shuts down. 고정비용은 매몰비용이다. 기업은 생산을 하든, 조업중단을 하든 고정비용을 지불해야 한다. So, FC should not matter in the decision to shut down. 따라서 고정비용은 조업중단의 결정에서 고려되어서는 안된다. FIRMS IN COMPETITIVE MARKETS 15

A Firm’s Long-Run Decision to Exit Cost of exiting the market: revenue loss = TR Benefit of exiting the market: cost savings = TC (zero FC in the long run) So, firm exits if TR < TC Divide both sides by Q to write the firm’s decision rule as: The decision rule for whether to exit says: If the cost of exiting is greater than the benefit, the firm should exit. Exit if P < ATC FIRMS IN COMPETITIVE MARKETS 16

A New Firm’s Decision to Enter Market In the long run, a new firm will enter the market if it is profitable to do so: if TR > TC. Divide both sides by Q to express the firm’s entry decision as: Enter if P > ATC Similarly, a prospective entrant compares the benefits of entering the market (TR) with the costs (TC), and enters if the benefits exceed the costs. FIRMS IN COMPETITIVE MARKETS 17

The Competitive Firm’s Supply Curve The firm’s LR supply curve is the portion of its MC curve above LRATC. Q Costs MC LRATC FIRMS IN COMPETITIVE MARKETS 18

A C T I V E L E A R N I N G 2 Identifying a firm’s profit A competitive firm Determine this firm’s total profit. Identify the area on the graph that represents the firm’s profit. Q Costs, P MC ATC P = $10 MR 50 $6 Rather than tell students that profit equals (P – ATC) x Q, this exercise requires students to figure it out for themselves. If this exercise is too easy for your students, you can replace it with lecture slides that appear at the end of this file. 19

A C T I V E L E A R N I N G 2 Answers A competitive firm Q Costs, P Profit per unit = P – ATC = $10 – 6 = $4 MC ATC P = $10 MR 50 profit $6 The height of the rectangle is P – ATC, profit per unit. The width of the rectangle is Q, the number of units. The area of the rectangle = height x width = (profit per unit) x (number of units) = total profit. Total profit = (P – ATC) x Q = $4 x 50 = $200 20

A C T I V E L E A R N I N G 3 Identifying a firm’s loss A competitive firm Determine this firm’s total loss, assuming AVC < $3. Identify the area on the graph that represents the firm’s loss. Q Costs, P MC ATC $5 Students that didn’t figure out the answer to the previous exercise should be able to get this one. If this exercise is too easy for your students, you can replace it with lecture slides that appear at the end of this file. Note that the statement “assuming AVC < $3” is needed to prevent shut-down, i.e. to insure that the firm produces Q=30 instead of Q=0. 30 P = $3 MR 21

A C T I V E L E A R N I N G 3 Answers A competitive firm Q Costs, P Total loss = (ATC – P) x Q = $2 x 30 = $60 MC ATC $5 The height of the rectangle is ATC – P, loss per unit. The width of the rectangle is Q, the number of units. The area of the rectangle = height x width = (loss per unit) x (number of units) = total loss. 30 loss loss per unit = $2 MR P = $3 22

Market Supply: Assumptions 1) All existing firms and potential entrants have identical costs. 존재하는 모든 기업들과 잠재적 진입자들의 비용조건은 동일하다. 2) Each firm’s costs do not change as other firms enter or exit the market. 각 기업의 비용은 다른 기업들이 시장에 진입하거나 퇴출하더라도 변화하지 않는다. 3) The number of firms in the market is 시장에서 기업의 수는 fixed in the short run 단기에서 고정 (due to fixed costs) (고정비용 때문에) variable in the long run 장기에서는 변화 (due to free entry and exit) (자유로운 진입과 퇴출때문에) In the real world, there are many markets in which assumptions (1) and (2) do not hold. We make them here for simplicity. Later in the chapter, we will see how our results change if we drop either of these assumptions. Assumption (3) is more reasonable: In the real world, it is much easier for firms to enter or exit in the long run than in the short run. FIRMS IN COMPETITIVE MARKETS 23

The SR Market Supply Curve As long as P ≥ AVC, each firm will produce its profit-maximizing quantity, where MR = MC. P ≥ AVC인 한 각 기업은 자신의 이윤이 극대화되는 산출량, 즉 MR = MC인 산출량에서 생산. Recall from Chapter 4: At each price, the market quantity supplied is the sum of quantities supplied by all firms. 각 가격에서 시장 공급량은 모든 기업이 공급하는 양의 합계 FIRMS IN COMPETITIVE MARKETS 24

The SR Market Supply Curve Example: 1000 identical firms At each P, market Qs = 1000 x (one firm’s Qs) AVC One firm Q P (firm) Market Q P (market) MC S P3 P3 30 30,000 P2 P2 20 20,000 “Identical” means all firms have the same cost curves. Note: P1 is minimum AVC. At any price below P1, each firm will shut down, and market quantity supplied will equal zero. Hence, the market supply curve begins at price = P1 and Q = 10,000. P1 P1 10 10,000 FIRMS IN COMPETITIVE MARKETS 25

Entry & Exit in the Long Run In the LR, the number of firms can change due to entry & exit. 장기에 기업의 수는 진입과 퇴출 때문에 변화 If existing firms earn positive economic profit, 만약 기존 기업이 모두 양의 경제적 이윤을 얻고 있다면 new firms enter, SR market supply shifts right. 새 기업들이 진입하여 단기 시장공급곡선이 오른쪽으로 이동 P falls, reducing profits and slowing entry. 가격이 하락, 이윤이 줄고 진입이 둔화될 것 If existing firms incur losses, 만약 기존 기업들이 손실을 보고 있다면 some firms exit, SR market supply shifts left. 일부 기업이 퇴출, 단기 시장공급곡선이 왼쪽으로 이동 P rises, reducing remaining firms’ losses. 가격이 올라 남아있는 기업들의 손실이 줄어들 것이다. FIRMS IN COMPETITIVE MARKETS 26

The Zero-Profit Condition 무이윤 조건 Long-run equilibrium: 장기균형 The process of entry or exit is complete – remaining firms earn zero economic profit. 진입과 퇴출과정은 남아있는 기업들의 경제적 이윤이 0일 때 멈출 것이다. Zero economic profit occurs when P = ATC. 0의 경제적 이윤은 P=ATC일 때 발생 Since firms produce where P = MR = MC, the zero-profit condition is P = MC = ATC. 기업들은 P = MR = MC에서 생산하므로 무이윤조건은 P = MC = ATC. Recall that MC intersects ATC at minimum ATC. 한계비용은 평균비용의 최저점에서 평균비용곡선과 만나므로 Hence, in the long run, P = minimum ATC. FIRMS IN COMPETITIVE MARKETS 27

Why Do Firms Stay in Business if Profit = 0 Recall, economic profit is revenue minus all costs – including implicit costs, like the opportunity cost of the owner’s time and money. 경제적 이윤은 수입에서 기업주의 시간과 돈의 기회비용과 같은 암묵적 비용을 포함한 모든 비용을 뺀 것이라는 점을 기억하라. In the zero-profit equilibrium, 무이윤 균형에서 firms earn enough revenue to cover these costs 기업들은 이러한 비용들을 커버할 충분한 수입을 얻고 있으며 accounting profit is positive 이때의 회계적 이윤은 양의 값이다. Students often wonder why firms bother to stay in business if they make zero profit. The textbook gives a nice discussion of this, briefly summarized on this slide. FIRMS IN COMPETITIVE MARKETS 28

The LR Market Supply Curve In the long run, the typical firm earns zero profit. The LR market supply curve is horizontal at P = minimum ATC. One firm Q P (firm) Market Q P (market) MC LRATC P = min. ATC That the LR market supply curve is horizontal at P = min ATC will become more clear shortly, when students see the SR and LR effects of an increase in demand. long-run supply FIRMS IN COMPETITIVE MARKETS 29

SR & LR Effects of an Increase in Demand A firm begins in long-run eq’m… …but then an increase in demand raises P,… …leading to SR profits for the firm. …driving profits to zero and restoring long-run eq’m. Over time, profits induce entry, shifting S to the right, reducing P… One firm Market Q P (market) Q P (firm) S1 MC ATC S2 Profit D2 B P2 P2 Q2 D1 A C P1 long-run supply P1 This slide replicates Figure 8 from the textbook. In edit mode, the text boxes in the top part of the slide appear to be on top of each other. But in slide-show mode, the text boxes display one at a time. If students did not previously understand why the LR market supply curve is horizontal, this slide may help. Q1 Q3 FIRMS IN COMPETITIVE MARKETS 30

Why the LR Supply Curve Might Slope Upward 왜 장기 공급 곡선이 우상향할 수 있는가? The LR market supply curve is horizontal if 장기공급곡선은 다음과 같은 경우라면 수평선이다. 1) all firms have identical costs, and 모든 기업의 비용이 동일하고 2) costs do not change as other firms enter or exit the market. 다른 기업이 시장에 진입하거나 퇴출하더라도 비용은 변화하지 않는다. If either of these assumptions is not true, then LR supply curve slopes upward. 만약 이러한 가정들이 사실이 아니라면 장기공급곡선은 우상향할 수 있다. Here are two of the assumptions we made previously, when we began the process of deriving the LR market supply curve. FIRMS IN COMPETITIVE MARKETS 31

1) Firms Have Different Costs 기업들의 비용조건이 다른 경우 As P rises, firms with lower costs enter the market before those with higher costs. 가격이 상승함에 따라 비용이 낮은 기업부터 높은 기업 순으로 진입 Further increases in P make it worthwhile for higher-cost firms to enter the market, which increases market quantity supplied. 가격이 계속 상승하면 비용이 더 높은 기업들도 시장에 들어오게 되고 이는 시장의 공급량을 증대시킨다. Hence, LR market supply curve slopes upward. 따라서 장기 시장공급곡선은 우상향하게 된다. At any P, 어떤 가격에서건 For the marginal firm, 한계기업에게는 P = minimum ATC and profit = 0. 가격은 평균비용의 최저와 같고 이윤은 0 For lower-cost firms, profit > 0. 저비용 기업의 이윤은 0보다 크다. The marginal firm is the firm that would exit the market if the price were any lower. 32

2) Costs Rise as Firms Enter the Market 기업들이 시장에 진입함에 따라 비용이 상승하는 경우 In some industries, the supply of a key input is limited (e.g., amount of land suitable for farming is fixed). 일부 산업에서는 핵심 투입요소의 공급이 제한되어 있다(예컨대 농사짓기에 적합한 땅의 양은 고정되어 있다). The entry of new firms increases demand for this input, causing its price to rise. 새로운 기업의 진입은 이러한 투입요소에 대한 수요를 증대시켜 가격을 상승시킨다. This increases all firms’ costs. 이는 모든 기업의 비용을 증대시킨다. Hence, an increase in P is required to increase the market quantity supplied, so the supply curve is upward-sloping. 따라서 공급을 늘이기 위해서는 가격이 상승해야 하며, 공급곡선은 우상향 하게 된다. Another example: There’s a limited amount of beachfront property. An expansion of the beach resort industry will bid up the price of such property, and raises costs in the industry. FIRMS IN COMPETITIVE MARKETS 33

CONCLUSION: The Efficiency of a Competitive Market Profit-maximization: MC = MR Perfect competition: P = MR So, in the competitive eq’m: P = MC Recall, MC is cost of producing the marginal unit. P is value to buyers of the marginal unit. So, the competitive eq’m is efficient, maximizes total surplus. In the next chapter, monopoly: pricing & production decisions, deadweight loss, regulation. Recall from Chapter 7: a competitive market equilibrium is efficient. This chapter has shown why: P = MR under perfect competition, so P = MC in the competitive market equilibrium. Reviewing these concepts now sets the stage for the next few chapters, where firms with market power set their price above marginal cost, leading to market inefficiencies and a potential role for government intervention. FIRMS IN COMPETITIVE MARKETS 34

CHAPTER SUMMARY For a firm in a perfectly competitive market, price = marginal revenue = average revenue. If P > AVC, a firm maximizes profit by producing the quantity where MR = MC. If P < AVC, a firm will shut down in the short run. If P < ATC, a firm will exit in the long run. In the short run, entry is not possible, and an increase in demand increases firms’ profits. With free entry and exit, profits = 0 in the long run, and P = minimum ATC. 35