Chapter 14 Blog

In this chapter, Mankiw begins to discuss how competitive markets work. One of the main details to keep in mind when analyzing a competitive market is that a firm in a competitive market is a price taker, which means that they must accept the price that the market determines for their good. Because of this, their revenue is directly proportional to the amount of output of the good it produces. The price that the good is sold for (determined by the market) is equal to the firm’s average revenue (total revenue divided by quantity sold) and its marginal revenue (the change in total revenue from one additional unit sold). In order to maximize profit, the main goal of any firm, a firm must choose a quantity of output where the marginal revenue equals the marginal cost. Because of the fact that marginal revenue is equal to the market price, the marginal cost curve is the supply curve for a competitive firm. One choice that a firm is able to make is to either shut down temporarily or exit the market. If a firm is unable to recover its fixed costs because the price of the good is less than the variable cost, it may choose to shut down temporarily (short run). In the long run, if the market price is less than the average total cost, a firm may choose to exit the market. Also in the long run, in a market where firms are free to exit and enter the market at will, profits will be driven to zero eventually.