What are the characteristics of a perfectly competitive market?
- Many buyers and sellers
- Firms are price-takers
- Homogeneous (=identical) goods
- Free entry and exit
- No externalities
- Perfect and complete information
- Economic agents are rational
Results of a competitive market: Equilibrium; maximum welfare
What is the goal of a competitive firm?
In the following analysis, we assume that:
Firms in perfectly competitive markets maximize their profits
(Profits = Total Revenues – Total Cost).
Firms produce in an efficient way (minimize the cost) and firms make the right decisions in order to maximize the economic profit.
Firms behave in a rational and consistent way and exploit all complete and certain information.
Long term vision more interesting: Maximizing the market value of the firm:
- market value includes the stream of profits that the firm earns over time
- direct interest of shareholders (long-term)
How do economists measure economic profit?
- Economic Profit = Total Revenues - Total Costs
- Total Costs include explicit costs and implicit (opportunity) costs
Total revenue of a firm: TR = Q*P
Accountants measure the accounting profit:
Accounting Profit = Total Revenues - Total Explicit Costs
What is marginal revenue and average revenue in a competitive firm?
- Marginal Revenue (MR): Change in total revenue from an additional unit sold
- For competitive firms, MR = Price
MR = deltaTR / deltaQ = P
Average Revenue: tells us how much revenue a firm receives for the typical unit
sold. For competitive firms, average revenue equals the price of the good
AR = TR/Q = P
What is the profit maximising condition for a competitive firm?
Short run!
- Marginal Cost (MC) = Marginal Revenue (MR)
- In a competitive market, MR = Price -> eine waagrechte Gerade
- Thus, MC = Price
Profit = Total Revenue - Total Cost
Price (P) > ATC at Q_MAX, the firm is earning economic profit.
Flächenhöhe = Differenz von P und ATC bei Qmax
Flächenbreite = 0 bis Qmax
What are the conditions for a firm to shut down in the short run?
- Continue production if revenue minus variable cost covers fixed costs
- Shut down if Total Revenue < Variable Costs (P < AVC)
- Shutdown point: Price equals average variable cost minimum (AVC)
What happens in the long-run supply curve of a competitive market?
- Firms enter or exit the market until profit is driven to zero -> P=ATC
- In the long run, Price = Minimum of Average Total Cost (ATC)
- The long-run market supply curve is horizontal until (von links her) this price
What is a non-profit organisation?
- Primary goal: Collective, public, or social benefit
- No profit distribution = non-distribution constraint: Profits are reinvested
- Examples: Schools, churches, consumer cooperatives
Enterprise foundations: Bosch, Bertelsmann, Carlsberg, Hershey, Rolex, Patagonia -> owned by foundations
Average Cost, Optimal Size, Market Structure
Perfect Competition: MC = AC (intersect)
Perfect competition is possible because firms have a U-shaped AC curve (= AC minimum exists). Many firms enter and exit the market, ensuring zero long-run profits.
No perfect Competition: MC will never reach AC
The AC and MC curves are downward-sloping, meaning:
* The firm experiences economies of scale.
* As production increases, the cost per unit decreases.
* This suggests a natural monopoly or oligopoly, not perfect competition.
The Demand Curve (D) intersects at a decreasing AC:
* If firms must produce large quantities to achieve low costs, small firms cannot survive.
* Perfect competition is impossible because firms must be large to minimize costs.
Break even point
The break-even point is the
price at which the firm makes
no profits (Revenue = Cost)
MR = min ATC (ganz unten im U shape)
Firm Behavior Under Perfect Competition
The profit maximizing condition is:
Marginal Cost (MC) = Marginal Revenue (MR)
In a competitive market MR = Price.
This condition implies that a firm’s marginal cost curve also describes its supply curve.
The Short Run: Market Supply with a Fixed Number of Firms:
For any given price, each firm supplies a quantity of output so that its marginal cost equals price.
The market supply curve reflects the individual firms’ marginal cost curves. -> dieselbe Steigung und Preise aber andere Quantity
The Long Run: Market Supply with Entry and Exit:
- Firms will enter or exit the market until profit is driven to zero.
- In the long run, price equals the minimum of average total cost.
- The long run market supply curve is horizontal at this price.
Alternative Theories:
Optimizing theories: Neoclassical
microeconomics, Managerial theories
Non-Optimizing theories: Behavioral theories
Optimizing theories: Neoclassical
microeconomics, Managerial theories
Non-Optimizing theories: Behavioral theories
Neoclassical
microeconomics
Firm organisation: Owner is also
manager
Goal: Profit maximisation
Example: wie bisher
Managerial theories
Firm organisation: Owners and manager
Goal: Management maximises the
own utility, subject to a
minimum profit constraint
necessary to satisfy the owners
Example: Baumol model: manager tries to maximise sales
revenue subject to profit
constraint
Behavioral theories
Firm organisation: Owners, managerand workers
Goal: Management tries to achieve a satisfactory profit, or
any other goal (e.g. welfare of the stakeholders in a
non-profit organization) rather than aiming to
maximise these goals.
Example: Simon model (1956): manager, due to the complexity
of calculations, uncertainties of future, different
interests within the organization and imperfection of
information is not aiming to reach an optimal decision, but he is satisfied with something less. Bounded rationality
Behavioral Theory of the Firm
Firm has several goals
Firm’s behavior is satisficing rather than maximizing
Search for levels of profits, sales, rate of growth that are
‘satisfactory’
Behavior characterized by ‘bounded’ or ‘limited’
rationality
Firm is an organization made up of individuals who
have different (and even conflicting) goals and
expectations of each other
Management must make decisions that are satisfactory
to all members of the company
