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Microeconomics Ch. 12, 15
Terms in this set (35)
In perfectly competitive markets, firms are price takers long dash—they accept the market price as given, but not fixed.
That is, events in the market (a change in demand or a change in supply) might change market price, but the individual buyer or seller is unable to affect the market price.
A buyer or seller that is unable to affect the market price.
Perfectly competitive markets
many buyers and sellers, with all firms selling identical products, and no barriers to new firms entering the market.
Perfectly competitive firms
It cannot control price and are consequently price takers.
Economists assume that the objective of such firms is to maximize profit (total revenue minus total cost).
Therefore, to maximize profit, a firm should produce the quantity of output where the difference between total revenue and total cost is as large as possible.
Total revenue (TR)
It equals price multiplied by quantity:
Average revenue (AR)
It is total revenue divided by the quantity of the product sold:
Marginal revenue (MR)
It is the change in total revenue from selling one more unit of a product. More formally, it is the change in total revenue that results from a one-unit change in quantity, or:
equals TR minus TCProfit=TR−TC, and TR is price (P) times quantity (Q), we can write the following:
1. Profit equals TR minus TCProfit=TR−TC
2. Profit equals= (P×Q)−TC.
If we divide both sides of this equation by Q, we have:
where ATC is average total cost, because
TC/Q equals ATC.
This expression tells us that profit per unit (or average profit) equals price minus average total cost.
We obtain an expression for the relationship between total profit and average total cost by multiplying by Q:
Profit maximization in a perfectly competitive market
A firm maximizes profit at the level of output at which marginal revenue, (MR), equals marginal cost, (MC). In perfectly competitive markets, marginal revenue equals the market price, (P).
If the market price (P), of apples is $66.00 per crate, then the apple farmer will produce 77 hundred crates of apples, where (MR) = (MC) = (P).
Profit per unit of output:
P−ATC = profit per unit of output.
It equals profit per unit multiplied by the number of units produced:
Total profit is represented by the area of a rectangle which has a height equal to (P−ATC) and a width equal to Q, where this apple farmer's average total cost (of producing 77 hundred crates) is $30.00 per crate.
Production decision in the short run
If the firm produces, then it will produce an output level where price equals marginal cost.
If price is greater than average total cost, then the firm will make a profit.
If price is equal to average total cost, then the firm will break even.
If price is less than average total cost, then the firm will experience losses.
The $10.00 price is less than the average total cost of production, so the firm will experience losses.
Shut-down point in the short run:
In the short run, if price is greater than average variable cost, then the firm should continue to produce (because the firm would lose an amount less than fixed costs by shutting down).
However, if price is less than average variable cost, then the firm should stop production by shutting down.
The $10.00 price is less than average variable cost, so the firm should shut down.
The supply curve for a firm in a perfectly competitive market in the short run
that firm's marginal cost curve for prices at or above average variable cost.
A firm is breaking even when its total cost equals its total revenue.
Breaking even occurs when a firm earns zero economic profit.
A firm's revenues minus all its costs, implicit and explicit.
Because economic profit takes into account all of the wheat farmer's costs, she should continue to produce because she can cover all her implicit opportunity costs.
Entry and exit decisions:
In the long run:
If P > ATC, then new firms will enter the market. If new firms enter, then the market supply curve will shift to the right and decrease the market price.
If P < ATC, then existing firms will exit. If existing firms exit, then the market supply curve will shift to the left, and increase the market price.
Since firms are exiting the industry, market supply will decrease, increasing the market price.
Entry and exit decisions
Profits and losses provide signals to firms that lead to entry and exit in the long run.
For example, unless a firm can cover all its costs, it will shut down and exit the industry.
More precisely, new firms will enter if existing firms are making a profit and existing firms will exit if they are experiencing losses.
It have horizontal long-run supply curves. Any industry in which the typical firm's average costs do not change as the industry expands production will have a horizontal long-run supply curve.
It have upward-sloping long-run supply curves. Any industry in which the typical firm's average costs increase as the industry expands production will have an upward-sloping long-run supply curve.
It have downward-sloping long-run supply curves. Any industry in which the typical firm's average costs decrease as the industry expands production will have a downward-sloping long-run supply curve.
The situation in which the entry and exit of firms has resulted in the typical firm breaking even.
The market is initially in equilibrium when market supply equals market demand, where the price of peaches is $5.00 per basket. After the change in demand, the market supply curve will shift to the left until the market is again in long-run equilibrium at a price of $5.00.
Long-run supply curve:
A curve that shows the relationship between market price and the quantity supplied.
Since this is a constant-cost industry, the long-run industry supply curve will be horizontal at the $5.00 long-run equilibrium price.
Does the market system result in allocative efficiency?
In the long run, perfect competition
results in allocative efficiency because firms produce where price equals marginal cost.
Consumers are powerful in a market system.
If consumers want more oranges, the market system will supply them because an increased demand for oranges results in higher orange prices and a higher rate of return on investments.
For example, farmers who grow other products, trying to get the highest possible return on their investment, may begin growing oranges.
The situation in which a good or service is produced at the lowest possible cost.
The demand curve
faced by a perfectly competitive firm is horizontal at the market price. When the demand for X increases, the market demand for X will shift to the right, but the demand curve faced by a representative firm will shift up until it is horizontal at the new market price. Thus, when Farah claims that an increase in demand causes a rightward shift in the demand curve faced by each firm, she is confusing the demand faced by the firm with market demand.
Average Cost of Production
Since average cost of production at this level is $3.5, while market price is $5 per unit, the total profit earned by the firm is $(5-3.5)*2,000 = $3,000. When Jake thinks that the firm would have maximized profit at 2,500 units, he means that the marginal cost of production at that level would be equal to the marginal revenue of $5.
While Jake clearly thinks that increasing production further to 2,500 units would have been a good idea, Mathew also states that he expects the price to rise further, which means that the profit will be maximized at a production level even higher than 2,500 units of Y. Thus, both Jake and Mathew are most likely to agree that the firm should increase production from the current level.
To maximize profit, a monopoly produces output up to the point where the marginal revenue from selling the last unit of output is just equal to the marginal cost.
Marginal revenue equals marginal cost when the monopoly produces 10
The monopoly then charges the price indicated by the demand curve at the profit-maximizing level of output, 10
Consumers will demand 10
diamond necklaces if the price is $140.00
Profit equals price minus average total cost multiplied by the quantity sold:
Profit equals left parenthesis Upper P minus ATC right parenthesis times Upper Q
Profit is equal to the area of a rectangle with a height equal to the difference in the $140.00
price and the $70.00
average total cost of production and a base equal to 10
Equilibrium in a perfectly competitive market is determined by the intersection of the demand and supply curves.
Demand equals supply at 6
units of output.
Monopoly: To maximize profit, a monopoly produces output up to the point where the marginal revenue from selling the last unit of output is just equal to the marginal cost.
Marginal revenue equals marginal cost at 4
units of output.
Therefore, the monopoly produces 2
fewer units of output.
Equilibrium in a perfectly competitive market is determined by the intersection of the demand and supply curves. Demand equals supply at a price of $18.00
and at 18
units of output.
Monopoly: To maximize profit, a monopoly produces output up to the point where the marginal revenue from selling the last unit of output is just equal to the marginal cost. Marginal revenue equals marginal cost at 12
units of output. Consumers will demand 12
units of output if the price is $24.00
which is the monopoly's profit-maximizing price.
Consumer surplus: Measures the net benefit received by consumers from purchasing a good or service and is the area below the demand curve and above the market price.
Measures the net benefit to producers from selling a good or service and is the area above the supply curve and below the market price.
Is the sum of consumer and producer surplus.
By increasing price and reducing the quantity produced, the monopoly has reduced economic surplus by an amount equal to the area between the demand and supply curves for units of output no longer produced.
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