ECON Ch 12,15,5 Flashcards
(40 cards)
Price takers
Since there are many buyers and sellers and all firms sell identical products, firms in a perfectly competitive market are price takers– they are unable to affect the market price because they are tiny relative to the market and sell exactly the same product as everyone else.
Perfectly competitive markets
Many buyers and sellers
All firms sell identical products
There are no barriers to firms entering the market
Homogenous product
Firms are small – can’t influence the price!!!
Demand curve for perfectly competitive firm
Horizontal!
Whether you sell 6000 or 15000 wheat bushels, still the same price per bushel
Too small to affect the market price!
This price is determined by the overall intersection of market supply and market demand.
Marginal revenue
The change in total revenue from selling one more unit of a product
In competitive markets, how are price and marginal revenue related?
P = MR in a perfectly competitive market because the price of the next good sold will be equal to the price of the last good sold.
Profit
Total revenue - total cost
= P*Q - ATC * Q
= Q (P-ATC)
Profit maximizing point of a competitive firm
Table of marginal cost and marginal revenue
Produce up until MC = MR
or the last point where MC is still < MR
Profit maximizing decision is when MR = MC
But, in competitive markets, P = MR
so it is when Price = MC
- The profit maximizing level of output is where the difference between total revenue and total cost is greatest, and
- The profit maximizing level of output is also where MR = MC
These are true for every firm!
For perfectly competitive firms, since P = MR, - The profit maximizing level of output is also where P = MC
Illustrating profit on the graph
Since we get profit = (P-ATC) * Q, this is a rectangle with height (P-ATC) and length Q
Perfectly competitive firm maximizes profit when P= MR=MC, so when the MC curve intersects the demand curve. Get this quantity. Then look at where this quantity intersects the ATC curve. Subtract the MC and ATC values and multiply by the quantity to get the profit.
How to show/calculate loss or break even on a graph for perfectly competitive firm
Loss is negative profit.
Profit = Q* (P-ATC). Quantity can’t be negative, so it’s only at a loss when (P-ATC) < 0
P<ATC
If the price curve is never above the ATC curve, can’t make a profit. So the optimal point is still when MC=MR=P though.
Takes the smallest loss–> when the demand=MR=P curve intersects the MC curve. That’s the quantity. Multiple the quantity by the vertical distance at that quantity from the MR curve to the ATC curve.
Price and ATC relationship to tell if a firm makes profit or loss
If P> ATC, profit
P=ATC, break even
P<ATC, loss
Deciding whether to produce or shut down in the short run
In the short run, firms in perfectly competitive markets at a loss cannot raise price because price taker.
2 options:
1. Continue to produce
2. Stop production by shutting down temporarily
But, if a firm shuts down, still needs to pay fixed costs, but this is a sunk cost, so shouldn’t be taken into consideration.
Decide whether to just take the L with the fixed costs or produce and incur some variable costs, but obtain some revenue too.
Should only stop producing if:
Total revenue < variable cost
P* Q < VC (divide each side by Q)
P < AVC
So, if AVC > Price, shut down
If price >= AVC, then produce until MC=MR = price for perfectly competitive firms.
This means the marginal cost curve gives us they relationship between P and Q–> firms supply curve.
Competitive firm short run supply curve
Produces output at MR=MC
Since price = MR, firm produces where P=MC
So, supplies output according to its MC curve–> MC curve is the supply curve for the individual firm.
But, if the price is too low, below the minimum point of the AVC, shuts down.
Long run entry for perfectly competitive markets
Zero economic profit in the long run because:
If you are making profit, with free entry, new firms will be attracted. This increases supply (supply curve shifts right, causing lower price and greater quantity) This causes market EQ price to fall. Eq price falls until individuals make no economic profit. So, Price = ATC = MC at this point.
Long run exit for perfectly competitive firms
If the profit is negative, in the long run, firms exit. Supply curve shifts left, causes less supply and increased prices. Firms continue to leave until the price returns to the break even price of D=MR=P=MC=ATC
Long run competitive equilibrium
The situation in which the entry and exit of firms has resulted in the typical firm breaking even.
If firms are making an economic profit, additional firms enter the market, driving price down to break even level
If firms are making an economic loss, existing firms exit the market, driving the price up to the break even level
Expect the price to be driven down to the minimum point on the ATC curve.
Long run supply curve for perfectly competitive market
A curve that shows the relationship in the long run between market price and the quantity supplied
In the long run, the market supply and demand is equal at the price of the minimum of the ATC
So, long run supply curve is horizontal. Long run price is compeltelt determined by forces of supply. Number of suppliers adjusts to meet demand, at the lowest possible price.
Situation 1:
Increase in demand temporarily increases price and allows for profit, but this attracts new firms, increases supply, drives down price and eliminates profit. This supply is horizontal line with the original
Situation 2:
Decrease in demand temporarily decrease the price and causes firms to suffer losses which leads to some firms exiting, decreasing supply, driving up the price, eliminating economic losses, and having parallel supply to original. Horiztonal supplt curve!
Productive efficiency
Situation in which a good or service is produced at the lowest possible cost
Allocative efficiency
A state of the economy in which production represents consumer pref.
Produced until last unit provides MB=MC
Are perfectly competitive markets productively or allocatively efficient?
BOTH!
Productively because lowest cost to produce
Allocative because
1. Price represents MB
2. Perf comp firms produce until price = MC
3. Firms produce until last unit provides a MB = MC
Monopoly
A market structure consisting of a firm that is the only seller of a good or service that doesn’t have a close substitute.
1 seller.
Marginal revenue and price relationship for monopolies
Price isn’t equal to MR like it is for perf comp firms
As you produce form, the price per unit will decrease
This causes MR to decrease more than the price.
Draw the MR curve intersecting price (demand) curve at quantity of 1 and then going under the curve the rest of the way.
Monopolist maximizing profit decision
Also when MR=MC. this is the quantity.
The price is when you draw the vertical line from this quantity to intersect the demand curve.
Profit is difference between our price and the ATC curve at this quantity times the quantity.
Differences between perfectly competitive and monopolist
Many vs 1 firm
Free vs barriers to entry
For both, MR=MC for profit maximization
MR= price for competitive (no power). Power for monopolists–> MR<price
For comp, MC=P. for monopolist, MC<price
0 profit in long run vs profit because of the barriers for entry
For both, profit = (P-ATC)*Q
Inefficiency of a monopoly
Since MR is below demand, monopolies sell fewer at a higher price.
Consumer surplus is reduced to the area under the demand curve to the new price.
Producer surplus is increased to the trapezoid from the marginal cost to the new price.
Deadweight loss results. The middle triangle from the old quantity to the new quantity since the price is greater than the marginal cost, rather than equal.
