A Competitive Industry
A Competitive Industry
• The General Rules
– Produce widgets until MC = P.
– If I cannot cover VC, shut down immediately
– If I cannot cover my VC + FC, start shedding
my fixed costs. Then shut down.
Lectures in Microeconomics-Charles W. Upton
A Competitive Industry
• The General Rules
A Competitive Industry
A Competitive Industry
• The General Rules
– Produce widgets until MC = P.
– If I cannot cover VC, shut down
immediately
– If I cannot cover my VC + FC, start shedding
my fixed costs. Then shut down.
– Produce widgets until MC = P.
– If I cannot cover VC, shut down immediately
– If I cannot cover my VC + FC, start
shedding my fixed costs. Then shut
down.
A Competitive Industry
A Competitive Industry
The Graphics of the Rule
Case A
Profit Maximization
where MC = P
Case B
Profit Maximization
where
ATC>p>AVC
For lack of a better
term, the standard
case
Make a gracious
exit from the
industry
A Competitive Industry
The Graphics of the Rule
Case C
Profit Maximization
where AVC>P
Case A
Profit Maximization
where MC = P
Case B
Profit Maximization
where
ATC>p>AVC
Leave -- Now!
For lack of a better
term, the standard
case
Make a gracious
exit from the
industry
Case C
Profit Maximization
where AVC>P
Leave -- Now!
A Competitive Industry
1
The Graphics of the Rule
Case A
Profit Maximization
where MC = P
Case B
Profit Maximization
where
ATC>p>AVC
For lack of a better
term, the standard
case
Make a gracious
exit from the
industry
The Graphics of the Rule
Case C
Profit Maximization
where AVC>P
Case A
Profit Maximization
where MC = P
Case B
Profit Maximization
where
ATC>p>AVC
Leave -- Now!
For lack of a better
term, the standard
case
Make a gracious
exit from the
industry
A Competitive Industry
A Competitive Industry
• Two cases:
Case C
Profit Maximization
where AVC>P
Leave -- Now!
A Competitive Industry
A Competitive Industry
• Two cases:
– When all firms have the same cost functions
– When firms have different cost functions
– When all firms have the same cost functions
– When firms have different cost functions
• We do the first case here; the second case in
a later lecture.
A Competitive Industry
A Competitive Industry
Identical Cost Functions
Identical Cost Functions
• In many cases, the assumption of identical
production functions and hence identical
cost functions make sense.
• In many cases, the assumption of identical
production functions and hence identical
cost functions make sense.
– Consider machine shop operators Smith and
Jones
A Competitive Industry
A Competitive Industry
2
Identical Cost Functions
Identical Cost Functions
• In many cases, the assumption of identical
production functions and hence identical
cost functions make sense.
• In many cases, the assumption of identical
production
functions
hence
identical
After
all, isand
there
a difference
cost functions
make
sense.
between McDonald’s and
– Consider machine shop operators Smith and
Jones
– Wilson, Brown and Green can also enter with
the same production function.
– Consider machineBurger
shop operators
King?Smith and
Jones
– Wilson, Brown and Green can also enter with
the same production function.
A Competitive Industry
A Competitive Industry
The Graphical Analysis
MC
The Graphical Analysis
MC
AC
AC
MC and AC curves
for all firms, both
actual and potential
A Competitive Industry
A Competitive Industry
The Graphical Analysis
MC
p1
The Graphical Analysis
MC
AC
p1
AC
At p1,
the firm
supplies
q1 units
p2
At p2,
the firm
supplies
q2 units
q1
q2 q1
A Competitive Industry
A Competitive Industry
3
The Graphical Analysis
MC
Industry Equilibrium
S = 10 MC
p1
AC
p1
p2
At pmin,
the firm
supplies
qmin units
p2
pmin
pmin
qmin q2 q1
With 10 firms,
supply curve is
10 times each
firm’s supply
curve
D
10qmin 10q2 10q1
A Competitive Industry
A Competitive Industry
Industry Equilibrium
Industry Equilibrium
S = 10 MC
S = 10 MC
p1
p1
p2
p2
pmin
D
P = p2
pmin
D
10qmin 10q2 10q1
10qmin 10q2 10q1
Industry Equilibrium
Industry Equilibrium
A Competitive Industry
A Competitive Industry
S = 10 MC
S = 10 MC
p1
p1
P2 >AC
p2
pmin
D
10qmin 10q2 10q1
A Competitive Industry
An Entry
Signal!
p2
pmin
D
10qmin 10q2 10q1
A Competitive Industry
4
Industry Equilibrium
Industry Equilibrium
S = 10 MC
p1
S = 10 MC
S = 12 MC
p2
p1
S = 12 MC
p2
p3
p3
pmin
D
With 12 firms,
supply curve
shifts;Dprice
drops.
pmin
10qmin 10q2 10q1
10qmin 10q2 10q1
Industry Equilibrium
Industry Equilibrium
A Competitive Industry
A Competitive Industry
S = 10 MC
p1Entry continues
until price drops
to
p2 pmin. Then no
p3 incentives to
enter or leave.
pmin
S = 10 MC
S = 12 MC
S = 20 MC
D
Supply curve
pLR
1
has η = ∞ at
p=pmin
p
S = 12 MC
2
S = 20 MC
p3
pmin
D
10qmin 10q2 10q1
10qmin 10q2 10q1
Industry Equilibrium
Industry Equilibrium
A Competitive Industry
A Competitive Industry
S = 10 MC
p1No matter what
the demand
curve,
firms
p2
p3 enter or leave
until
pmin
p=pmin
S = 12 MC
S = 20 MC
D
S = 10 MC
Suppose the
p1
demand
curve
shifts to D’.
10p2firms leave
the industry
S = 20 MC
pmin
D
D’
10qmin 10q2 10q1
A Competitive Industry
10qmin 10q2 10q1
A Competitive Industry
5
The U-Shaped AC Curve
The U-Shaped AC Curve
MC
AC
AVC
A Competitive Industry
• Common sense
suggests initially,
AC is downward
sloping.
MC
AC
AVC
A Competitive Industry
The U-Shaped AC Curve
• Common sense
suggests initially,
AC is downward
sloping.
• If it never sloped
upward, MC < AC.
Always. No
competitive firms.
A Competitive Industry
MC
End
AC
AVC
©2003 Charles
W. Upton
A Competitive Industry
6