Ch. 8: The Competitive Firm
The determinants of a firm's supply include:
-Price of factor inputs -Technology -Expectations -Taxes and subsidies ****All shift the MC upward or downward
In the long-run, firms must cover: In the short-run, firms continue to operate as long as:
-all costs, explicit and implicit or exit the industry (investment decision) -it's variable costs are covered
Perfectly Competitive Industry Characteristics:
1. Many firms - Lots of firms are competing for consumer purchases 2. Identical products - The products of the different firms are identical, or nearly so 3. Low entry barriers - Its relatively easy to get into the business
Monopoly
A firm that produces the entire market supply of a particular good or service
Perfect Compeition
A market in which no buyer or seller has market power
Firm vs Industry or Market
A market or industry consists of all firms operating in that type of business
Explicit Cost
A payment made for the use of a resource
The total revenue curve of a perfectly competitive firm is:
An upward sloping straight line
If a perfectly competitive firm wanted to maximize its total revenues, it would produce:
As much output as it is capable of
Where price doesn't cover average variable costs at any rate of output, production should:
Cease
Variable Costs
Costs of production that change when the rate of output is altered, such as labor and material costs
Fixed Costs
Costs of production that don't change when the rate of output is altered, such as the cost of basic plants and equipment
The market demand curve for a product is always:
Downward sloping (law of demand)
Shutdown Decision
Firms should shutdown only if total revenues < total variable costs If price drops below (or is equal to AVC), firm should shut down If total losses exceed total fixed cost by continuing production, he should cease production
Competitive Firm
Firms that have no market power
A firm's demand curve is perfectly ________ while market demand curve is _____________ _________________
Flat/Downward Sloping (law of demand)
The demand curve confronting a perfectly competitive firm is:
Horizontal (perfectly elastic)
Three possible scenarios for MC and price:
MC > p ---> If MC exceeds price, we are spending more to produce the extra unit than we're getting back: total profits will decline if we produce it p > MC ---> If an extra unit it bringing in more revenue than it costs to produce, it is adding to total profit. A competitive firm wants to expand rate of product whenever price exceeds MC p = MC ---> For perfectly competitive firms, profits are maximized at the rate of output where price equals marginal cost
Payroll taxes increase:
Marginal cost
For perfectly competitive firms, price equals:
Marginal revenue
Demand curve is:
Marginal revenue curve
Market equilibrium occurs when:
Marker supply crosses market demand
When price exceeds average variable cost but not average total cost, the profit maximization rule:
Minimizes losses
Various degrees of competition and different types of markets:
Perfect competition to imperfect competition and monopoly
Profit per Unit =
Price - ATC
Revenue =
Price x Quantity
If price exceeds average variable cost but is less than average total cost, a firm should, in the short run:
Produce at rate where price (MR) = MC
Profit Maximization
Produce at that rate or output where marginal revenue (p) equals marginal cost
Taxes affect average total cost and marginal cost curves as follows:
Profit taxes: affect neither Property taxes: affect only average total cost Payroll taxes: affect both average and marginal costs
Shutdown decision is a _______ _____ response
Short-run
The marginal cost curve is the:
Short-run supply curve for a competitive firm that lies above the average variable cost curve
Total Profits =
TR-TC and (p-ATC) x q --> Do from curve on graph
Price Takers
Take the price that the market sets
Market Power
The ability to alter the market price of a good or service
Marginal Revenue
The change in total revenue that results from one-unit increase in the quantity sold = Change in total revenue/Change in output
Investment Decision
The decision to build, buy, or lease plants and equipment; to enter or exit an industry -Long-run decision
Economic Profit
The difference between total revenues and total economic costs
Marginal Cost
The increase in total costs associated with a one-unit increase in production
Market Structure
The number and relative size of firms in an industry
Normal Profit
The opportunity cost of capital; zero economic profit -Normal rate of return
Shutdown Point
The rate of output where price equals minimum AVC
Production Decision
The selection of the short-run rate of output (with existing plants and equipment)
Economic Cost
The value of all resources used to produce a good or service; opportunity cost
Implicit Cost
The value of resources used, for which no direct payment is made
A perfectly competitive firm is one....
Whose output is so small in relation to market volume that its output decision have to perceptible impact on price
Profit
the difference between total revenue and total cost
Economic Profit =
total revenue - total economic cost (explicit costs + implicit costs)
Accounting Profit =
total revenue - total explicit costs