Class Meeting 2 - Perfect Competition Flashcards
(32 cards)
Perhaps the most important “sound bite” in economics is that __________.
incentives matter
Marginal Revenue
The increase in total revenue associated with a one unit increase in output.
Ex: The additional revenue on Ford’s statements associated with selling one more truck.
Marginal Cost
The increase in total cost associated with a one unit increase in output.
Ex: The additional cost on Ford’s statements associated with selling one more truck.
When Marginal Revenue is greater than Marginal Cost (MR > MC) . . .
increasing output causes revenue to rise more than costs rise, which increases profits.
- This is true for any market structure.
- In other words: MR > MC ⇒ +P*
As Marginal Cost increases . . .
new inputs become less productive (you get diminishing returns from inputs).
Average Cost
The total cost of making a single unit of product, calculated as:
AC = Total Manufacturing Cost / Number of Units Manufactured
If Marginal Cost is less than Average Cost (MC < AC), then Average Cost _____.
decreases
Think about it, if Marginal Cost is decreasing with every unit produced, then Average Cost has to decrease as units produced (output) increases, since AC = Total Mf Cost / # of Units Mf’d.
If Marginal Cost is greater than Average Cost (MC > AC), then Average Cost _____.
increases
Think about it, if Marginal Cost is increasing with every unit produced, then Average Cost has to increase as units produced (output) increases, since AC = Total Mf Cost / # of Units Mf’d.
If Marginal Cost is equal to Average Cost (MC = AC), then Average Cost __________.
is at its minimum point
At the point that the Marginal Cost of producing one more unit of output is equal to the Average Cost, the Average Cost and Marginal Cost are in equilibrium, and Average Cost is at its lowest point.
An easy way to remember how Marginal Cost affects Average Cost is the __________ analogy.
Driving Speed
If your Average Speed is 50 mph and you start driving above that, say 70 mph, your increase in Marginal Speed will drag up your Average Speed. If your Average Speed is 50 mph and you start driving below that, say 30 mph, your Marginal Speed will drag down your Average Speed.
Marginal Cost is _____ so long as the firm __________.
Once the firm __________, Marginal Cost __________.
constant; operates below capacity
reaches capacity; rises sharply
In other words, AC = MC when the firm is operating below capacity, after which point, AC rises less rapidly than MC.
In industries like electricity and film production, where Marginal Cost remains constant or even decreases with increases in output, the Marginal Cost of the first unit is _____, after which Marginal Cost __________ or _____ and Average Cost _____.
high; remains constant; decreases; decreases
The 4 Characteristics of Perfect Competition:
- Firms have NO control over price (they’re price takers).
- A homogenous product or “commodity” (like oil, corn, porkbelly) is being sold.
- NO barriers to entry (doesn’t mean cheap or free, just that other firms can enter).
- Increasing Marginal Cost is assumed (under the theory; not always true).
In a market with Perfect Competition, Marginal Revenue _____ Price, and because all firms produce up to where Marginal Revenue equal Marginal Cost, Price _____ Marginal Cost.
equals; equals
In Perfect Competition, MR = P = MC. Each firm is small compared to the market and can produce all it wants but can only sell at the market price. Additionally, firms will only produce until MR = MC, which also equals P in a perfectively competitive market. In other markets, price must be lowered to increase sales.
In a market with Perfect Competition, more competition (new firms entering the market) _____ the _____ to __________.
increases; Price; Marginal Cost
What’s the Difference Between Accounting Profit and Economic Profit?
Accounting Profit is the net income for a company, which is revenue minus expenses.
Economic Profit is similar to accounting profit, but it includes implicit costs like opportunity costs.
If a family owns a local fish store, they pay some or all of its accounting profit to themselves.
If the amount they earn is more than they could earn with the best alternative use of their time, their economic profit is _____ (they are earning rents).
If the amount they earn is less than they could earn with the best alternative use of their time, their economic profit is _____ (they are losing rents).
If the amount they earn is equal to what they could earn with the best alternative use of their time, their economic profit is _____ (they are not earning or losing rents).
positive;
negative;
zero
If firms in Perfect Competition are earning positive economic rents, it will attract __________ to the market.
new firms (entry into)
- This is possible because there are no barriers to entry in perfect competition.
When new firms enter a market in Perfect Competition, it (4 Effects) . . .
- Increases market supply.
- Drives down market price.
- Reduces economic profit (eventually to zero, where new entry stops).
If firms in Perfect Competition are earning negative economic rents, it will cause firms to __________ the market.
leave
When firms in Perfect Competition leave the market, it (4 Effects) . . .
- Decreases market supply.
- Increases market price.
- Increases economic profits (if they’re negative, they will get less so until an equilibrium of zero is reached).
In the long-run equilibrium, in Perfect Competition, firms will be operating on the __________ of the __________ curve.
minimum point; Average Cost
- Remember, MC = AC at the minimum point, and MC = MR = P in Perfect Competition, so in equillibrium (a.k.a. on the minumum point of the AC curve) AC = MC = MR = P.
Profit equals . . .
Profit = Total Revenue – Total Cost
Total Revenue = Price × Quantity Sold
Total Cost = (Price – Avg. Cost) × Quantity Sold
Economic Rent
The difference between what an owner of a factor of production (such as land, capital, or labor) receives and the opportunity cost (the best alternative use of resources for that owner).
- Economic rents are earned when Economic Profit > 0
- Positive economic rents mean success in business.
