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Econ Unit 3: Chapter 12 - Perfect Competition
Terms in this set (81)
what four facts define Perfect Competition?
1. Many firms sell identical products to many buyers
2. There are no restrictions on entry into the market
3. Established firms have no advantage over new one
4. Sellers and buyers are well informed about prices
How does perfect competition arise?
when one firm's minimum efficient scale (the smallest output at which the long-run average cost reaches its lowest level) is small relative to he market demand for the good or service than there is room in the market for many firms
** [b/c more firms need to add more of the product to the market to feed the demand for the product..b/c that one firm will choose to produce only that small amount of output (less than the demanded output) because it is costing them the least!]
why do consumers not care which firm's good they buy in perfect competition?
because each firm produces a good that has no unique characteristics
In perfect competition, firms are considered _____________
a firm that cannot influence the MARKET price because its production is an insignificant part of the total market
a firm's goal is to maximize ________
economic revenue (total revenue - total cost)
What is Total cost?
the OPPORTUNITY COST of production, which includes normal profit
firm's Total Revenue:
of its output multiplied by the
number of units of output sold
(price x quantity)
The change in Total Revenue that results from a one unit increase in the
the total revenue curve graphs what?
The TR curve graphs the relationship between the total revenue and the quantity sold
what is unique about the total revenue curve?
it is a straight, upward-sloping line b/c every additional sweater sold brings in a constant amount of $25 ....which also tells us that the marginal revenue is always constant.
The marginal revenue curve is also what?
a firm's demand curve
In perfect competition, the firm's marginal revenue equals:
the market price
what is unique about the marginal revenue curve/ the market demand curve?
it is a horizontal line
a horizontal demand curve illustrates __________
perfectly elastic demand
the horizontal line does NOT mean that the market demand for the good is perfectly elastic: it means that:
the good sold is a perfect substitute for a good from other factories and its elasticity depends on the substitutability of the good for other goods and services
in perfect competition, what determines a firm's behavior/ the output that they will decide to produce?
the Market Price because it is a given!
to achieve its goal of maximizing economic profit, a firm much decide these 3 things:
1. how to produce at a minimum cost
2. what quantity to produce (that will maximize the firm's economic profit)
3. whether to enter or exit a market
how does a firm make the first decision: how to produce at a minimum cost?
by being on its long - run average cost curve (operating with the plant that minimizes long-run average cost)
what are the 2 revenue curves?
marginal revenue and total revenue
what do firm's use to make the 2nd decision: what quantity to produce to maximize their economic profit?
their cost curves and revenue curves (profit = R-C)
in low output levels, the firm incurs economic loss because:
because the firm can't cover its fixed costs
in too how output levels, the firm incurs economic loss because:
because it faces steeply rising costs because of diminishing returns
If Marginal Revenue > Marginal cost then:
economic profit increases as output increases
If Marginal Revenue < Marginal cost then:
economic profit decreases as output increases
If MR = MC then:
economic profit decreases if output changes in either direction, so economic profit is MAXIMIZED
why, if MR > MC, does economic profit increase as output increases?
because the revenue earned from producing one more unit of output is greater than the cost of producing it (and Profit = R-C......20- 10 = 10)
why, if MR < MC, does economic profit decrease as output increases?
because the revenue from selling one more unit is less than the cost of producing that unit (10-20 = -10)
a firm's profit-maximizing output is its quantity ______________
supplied at the market price
so a firm maximizes profit by producing the quantity at which.....?
marginal revenue (price) = marginal cost
if, at the quantity where MR=MC, the price is less than the average total cost, the firm will incur an economic loss, and maximum profit is a loss. The firm must then decide:
whether to stay in the market or exit the market
if the firm decides to stay in the market what must it decide?
whether to keep producing or to shut down temporarily
the decision that the firm makes - between whether to produce something or to shut down temporarily - is the best one that will _________________
minimize the firm's loss
How does the firm make the decision b/w temporary shut down or continuing to produce?
It will compare the loss from shutting down and the loss from producing and choose the option that minimizes loss. It will do all of this through the use of the economic loss equation!
a firm's economic loss =
total fixed cost + total variable cost - total revenue 0R
TFC + (AVC - P)Q
what is the economic loss of a firm that decides to shut down in the short run?
Total fixed cost
what is the economic loss of a firm that decides to continue producing?
The shutdown point is at?
minimum average variable cost
at a price below
minimum average variable cost
, the firm shuts down and produces no output..why?
because Total revenue = Price x Quantity! if the price is below a cost, they are losing.
what does a perfectly competitive firm's supply curve show?
How the firm's profit-maximizing output varies as the market price varies, always ABOVE the minimum average variable cost
what is the firms supply curve made up of?
the marginal cost curve at all prices above minimum average variable cost
when price exceeds minimum average variable cost, the firm maximizes profit by:
producing output where MC=MR (price)
when price is less than minimum average variable cost, th firm maximizes profit by:
temporarily shutting down and producing no output
when the price is equal to the minimum average variable cost (MR=AVC), the firm maximizes profit by:
1) temporarily shutting down and producing no output
2) producing output at which Average Variable Cost is a minimum
so, a single firm in isolation in a perfectly competitive market, will make its profit-maximizing decision bases on what?
the market price....which it takes as a given ((but how is the market price determined??)
to determine the competitive market supply curve, you have to sum....?
all the quantities supplied by all the firms in the market
what determines the short run equilibrium
the short run market supply and the market demand
**good to know: in short-run equilibrium, although the firm produces the profit maximizing output (MR=MC), it does not necessarily end up making an economic profit. It might do so, but it might alternatively break even or incur an economic loss
To see if a firm IS making a profit OR incurring a loss what should you compare ?
the firm's ATC at the profit-maximizing output with the market price.
using the formula (p-atc) x Q which is same as TC-TR
comparing what's inside the parenthesis
if the market price ends up equalling average total cost, what does that mean?
the firm breaks even...and the entrepreneur makes NORMAL PROFIT
if the market price end up exceeding average total cost what does that mean?
the firm makes an economic profit
if the market price is less than the average total cost what does that mean?
the firm incurs an economic loss
***In the short-run equilibrium, a firm might make profit, incur loss, or break even. This is not the same for long-run equilibrium. In the long-run equilibrium only one of them is true. The reason is that in the long-run, firms can ____________
enter of exit the market
entry and exit of firms in the market change the _____________________
market supply...(less firms, less output being produced)
if market supply is changed from the entry or exiting of firms: what does this mean for the market price?
it changes the market price in some way!
If firms enter a market, supply increases and the market supply curve shifts rightward. The increase in supply lowers the market price and eventually eliminates the _____________ of each firm. When _______________ reaches zero, entry stops.
why do firms exit a market
they exit because they are incurring an economic loss
If firms exit a market, supply decreases and the market supply curve shifts leftward. The market price rises and ___________________ incurred by the remaining firms decreases. eventually ________________ is eliminated and exit stops
economic profit induces entry which eliminates the ________
loss induces exit, which eliminates the
when profit and loss have been eliminated and entry and exit have stopped, a competitive market is said to be in ________________
Long-run equilibrium (S*)
what changes demand?
changes in tastes
what changes costs?
chanages in technology
before something increases demand, where are firms producing?
in long-run equilibrium (where ATC=P)
how much are they making at long run equilibrium?
zero economic profit
In the MARKET, an increase in demand shifts the demand curve rightward. The price rises and the quantity supplied rises. For the FIRM, how does it maximize its profit now (with the rise in market price)?
It maximizes its profit by increasing output and producing at the point where the new market price equals MC (AKA: MR=MC)
With economic profit occurring, what does this bring and what happens in the market?
firms enter the market and short-run supply increases and shifts rightward
what does the increase in supply do to the market price and how to individual firms respond?
lowers the price; firms decrease their output, moving down along their marginal cost/supply curve until they get to the profit-maximizing point where MR=MC
after the supply curve shifts and the market price has returned to its original level, how much is each individual firm producing and how much is being produced in the MARKET at the new
each individual firm produces the same quantity as before the increase in demand;
Market output is higher because more firms are producing it.
what are three things that A DECREASE in demand brings
lower price, economic losses, and exit
when firms exit the market what happens to supply?
decreases supply. supply curve shifts leftward
if a new technology is being used to a firm, what does it do to the firm's production costs? (in terms of ATC)
lowers their production costs (lowers ATC)
who makes an economic profit with new technology?
the first firms to use it
as more firms begin to use the new technology what happens to supply and price?
supply increases and price falls
since there are positive economic profits being made, new firms enter, but firm continuing to use the old technology incur economic loss and: _____-
when enough firms have entered the market what happens to supply and price?
market supply increases to a level that lowers the price to equal minimum average total cost
in the end, a new long-run equilibrium is reached, where more is being produced in market at a lower price. and individual firms are producing a different quantity with new technology at lower price. so technological change brings only temporary gains to producers, but the lower prices and better products are permanent gains for _____________
resources are used efficiently if?
if it is not possible to make someone better off without making someone else worse off
the gains from trade is?
the sum of consumer surplus and producer surplus (total surplus)
when the market for a good or service is in equilibrium, it means that the gains from trade are _____________
when firms in perfect competition are away from long-run equilibrium, either ___________ or _________ moves the market toward the best situation
exit or entry
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