Ecomonics Firms in Competitive Markets

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?