chap 11 Flashcards
(22 cards)
Perfect competition
market in which
▪ Many firms sell identical products to many buyers.
▪ There are no restrictions to entry into the industry.
▪ Established firms have no advantages over new ones. ▪ Sellers and buyers are well informed about prices.
How Perfect Competition Arises
Perfect competition arises when
▪ The firm’s minimum efficient scale is small relative to market demand, so there is room for many firms in the market.
▪ Each firm is perceived to produce a good or service that has no unique characteristics, so consumers don’t care which firm’s good they buy.
- Price Takers
A price taker is a firm that cannot influence the price of a good or service.
– No single firm can influence the price—it must “take” the equilibrium market price.
– Each firm’s output is a perfect substitute for the output of the other firms, so the demand for each firm’s output is perfectly elastic.
Economic Profit and Revenu
The goal of each firm is to maximize economic profit, which equals total revenue minus total cost.
total revenue
equals price, P, multiplied by quantity sold, Q, or P ́ Q.
marginal revenue
A firm’s marginal revenue is the change in total revenue that results from a one-unit increase in the quantity sold.
The Firm’s Decisions
How to produce at minimum cost
2. What quantity to produce
3. Whether to enter or exit a market
The Firm’s Output Decision
A perfectly competitive firm chooses the output that
maximizes its economic profit.
– One way to find the profit-maximizing output is to look at the firm’s total revenue and total cost curves.
– At low output levels, the firm incurs an economic
loss—it can’t cover its fixed costs.
– At intermediate output levels, the firm makes an economic profit.
– At high output levels, the firm again incurs an economic loss—now the firm faces steeply rising costs because of diminishing returns.
Marginal Analysis and Supply Decision
The firm can use marginal analysis to determine the profit-maximizing output.
– Because marginal revenue is constant and marginal cost eventually increases as output increases, profit is maximized by producing the output at which marginal revenue, MR, equals marginal cost, MC.
marginal analysis that determines the profit-maximizing output
If MR > MC, economic profit increases if output
increases.
– If MR < MC, economic profit decreases if output increases.
– If MR = MC, economic profit decreases if output changes in either direction, so economic profit is maximized.
Temporary Shutdown Decision
f the firm makes an economic loss, it must decide whether to exit the market or to stay in the market.
– If the firm decides to stay in the market, it must decide whether to produce something or to shut down temporarily.
– The decision will be the one that minimizes the firm’s loss.
Economic loss calc
Economicloss=TFC+TVC-TR
=TFC +(AVC-P)xQ
The Shutdown Point
the price and quantity at which it is indifferent between producing the profit-maximizing quantity and shutting down.
The shutdown point is at minimum AVC.
– This point is the same point at which the
MC curve crosses the AVC curve.
– At the shutdown point, the firm is indifferent between producing and shutting down temporarily.
– At the shutdown point, the firm incurs a loss equal to total fixed cost (TFC).
The Firm’s Supply Curve
A perfectly competitive firm’s supply curve shows how the firm’s profit-maximizing output varies as the market price varies, other things remaining the same.
– Because the firm produces the output at which marginal cost equals marginal revenue, and because marginal revenue equals price, the firm’s supply curve is linked to its marginal cost curve.
short-run market supply curve
The short-run market supply curve shows the quantity supplied by all firms in the market at each price when each firm’s plant and the number of firms remain the same.
- A Change in Demand on a short-run market supply curve
An increase in demand brings a rightward shift of the market demand curve: The price rises and the quantity increases.
– A decrease in demand brings a leftward shift of the market demand curve: The price falls and the quantity decreases.
Profits and Losses in the Short Run
To see if a firm is making a profit or incurring a loss compare the firm’s ATC at the profit-maximizing output with the market price.
In part (a) price equals average total cost and the firm makes zero economic profit (breaks even).
– In part (b), price exceeds average total cost and the firm makes a positive economic profit.
– In part (c) price is less than average total cost and the firm incurs an economic loss—economic profit is negative.
Entry and Exit
New firms enter an industry in which existing firms
make an economic profit.
– Firms exit an industry in which they incur an economic loss.
A Closer Look at Entry
When the market price is $25 a sweater, firms in the
market are making economic profit.
– New firms have an incentive to enter the market.
– When they do, the market supply increases and the market price falls.
– Firms enter as long as firms are making economic profits.
– In the long run, the market price falls until firms are making zero economic profit.
A Closer Look at Exit
When the market price is $17 a sweater, firms in the
market are incurring economic loss.
– Firms have an incentive to exit the market.
– When they do, the market supply decreases and the market price rises.
– Firms exit as long as firms are incurring economic losses.
– In the long run, the price continues to rise until firms make zero economic profit.
Efficient Use of Resources
Resources are used efficiently when no one can be made better off without making someone else worse off.
– This situation arises when marginal social benefit equals marginal social cost.
- Choices
A consumer’s demand curve shows how the best budget allocation changes as the price of a good changes.
– So at all points along their demand curves, consumers get the most value out of their resources.
– If the people who consume the good are the only ones who benefit from the good, the market demand curve is the marginal social benefit curve.
– A competitive firm’s supply curve shows how the profit-maximizing quantity changes as the price of a good changes.
If the firms that produce the good bear all the costs of producing it, then the market supply curve is the marginal social cost curve.
