Ecomonics Firms in Competitive Markets

Please complete questions 1-5 in the questions for review section and #3 in the problems and applications section

296 PARTV FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY

• 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 mar-
ginal cost. Because marginal revenue for a com-
petitive 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

competitive market, p. 280
average revenue, p. 281

~What is meant by a competitive firm?
‘~.)Explain the difference between a firm’s revenue

and its profit. Which do firms maximize?
(~Draw the cost curves for a typical firm. For a

given price, explain how the firm chooses the
level of output that maximizes profit. At that
level of output, show on your graph the firm’s

, ~ total revenue and total costs.
~Under what conditions will a firm shut down

temporarily? Explain.

1. Many small boats are made of fiberglass, which
is derived from crude oil. Suppose that the price
of oil rises.
a. Using diagrams, show what happens to the

cost curves of an individual boat-making
firm and to the market supply curve.

b. What happens to the profits of boat makers
in the short run? What happens to the
number of boat makers in the long run?

2. You go out to the best restaurant in town and
order a lobster dinner for $40. After eating half

will choose to exit if the price is less than average
total cost.

• In a market with free entry and exit, profits are
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.

marginal revenue, p. 282
sunk cost, p. 286

~ftnder what conditions will a firm exit a
-market? Explain.

6. Does a firm’s price equal marginal cost in the
short run, in the long run, or both? Explain.

7. Does a firm’s price equal the minimum of
average total cost in the short run, in the long
run, or both? Explain.

8. Are market supply curves typically more
elastic in the short run or in the long run?
Explain.

of the lobster, you realize that you are quite full.
Your date wants you to finish your dinner because
you can’t take it home and because “you’ve
already paid for it.” What should you do? Relate

t;:”‘ your answer to the material in this chapter.
0Bob’ s lawn-mowing service is a profit-maximizing,

competitive firm. Bob mows lawns for $27 each.
His total cost each day is $280, of which $30 is a
fixed cost. He mows 10 lawns a day. What can you
say about Bob’s short-run decision regarding
shutdown and his long-run decision regarding exit?