Firm Behavior And Industry Organization Because A Company
Firm Behavior And The Organization Of Industry Because A Competitive
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 marginal cost. Because marginal revenue for a competitive 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 will produce at the point where price equals minimum average total cost, and firms will enter or exit the industry based on the profitability conditions.
Sample Paper For Above instruction
The behavior of firms within competitive markets and the organization of industries are foundational concepts in microeconomics that help explain how prices and outputs are determined. A perfectly competitive firm operates as a price taker, meaning it has no influence over the market price and must accept the prevailing price. This fundamental characteristic ensures that the firm’s total revenue is directly proportional to the quantity of goods it sells, as the price remains constant regardless of the individual firm’s output level.
Given this context, the firm’s revenue per unit—also called average revenue—is equal to the market price. Additionally, because the firm is a price taker, its marginal revenue—the additional revenue gained from selling one more unit—also equals the market price. This simplifies profit maximization, as the firm will aim to produce the quantity where marginal revenue equals marginal cost (MR=MC). When MR=MC, the firm maximizes its profit—or equivalently, minimizes its loss in the short run.
This equilibrium condition, MR=MC, leads to the firm’s supply curve being its marginal cost curve above the average variable cost (AVC). Specifically, the firm will produce at the level where the price equals the marginal cost and the marginal cost curve intersects the average total cost (ATC) at its minimum in the long run. In the short run, the firm may continue operating even if it is incurring losses—provided it can cover its variable costs—since fixed costs are sunk costs that do not influence current production decisions.
When the market price falls below the average variable cost, the firm will choose to shut down temporarily rather than continue producing at a loss—because doing so would increase total losses. Conversely, in the long run, if the firm cannot cover its total costs, it will exit the industry altogether. This process of entry and exit drives the industry toward a long-run equilibrium where firms earn zero economic profit, as prices settle at the minimum of the average total cost curve. At this point, the quantity supplied by all firms matches the quantity demanded at this price, stabilizing the industry.
Changes in market demand influence the short-term and long-term behavior of firms and industries differently. An increase in demand raises prices and profits temporarily, encouraging firms to expand production or new firms to enter the market. However, in the long run, the entry of new firms increases supply, driving prices back down to the point where firms earn zero economic profit. Conversely, a decrease in demand leads to falling prices and potential industry exit in the long run.
The elasticity of market supply curves also varies over time. In the short run, supply is less elastic because firms face fixed plant capacities and cannot easily adjust production. Over the long run, supply becomes more elastic as firms can enter or exit the industry, and existing firms can adjust their capacity, leading to a more responsive supply curve.
References
- Varian, H. R. (2014). Intermediate Microeconomics: A Modern Approach. W.W. Norton & Company.