Chapter 12
What happens to the price and profit of the individual laptop produced in the short run?
They both rise.
Despite the fact that few firms sell identical products in markets where there are no barriers to entry, economists believe that the model of perfect competition is important because
it is a benchmark long dash —a market with the maximum possible competition long dash —that economists use to evaluate actual markets that are not perfectly competitive.
Economic profit is a firm's revenues minus all its costs
implicit and explicit.
minimum point on the marginal cost curve
is below the average variable cost of production. At this point, if a firm produces, it will suffer a loss that is greater than its fixed costs of production.
In a perfectly competitive industry with increasing average costs, the long-run supply curve will be
upward sloping.
TC
ATC x Q
VC
AVC x Q
Marginal revenue (MR)
The change in total revenue from selling one more unit of a product.
economic profit
accounting profit - opportunity cost of time
return should
be included in the firm's costs because it is the opportunity cost of not investing those funds elsewhere
market for cage-free eggs in 2015 was not in equilibrium
because farmers who were raising cage-free chickens were earning higher profits than farmers who were raising chickens using more traditional methods.
Constant-cost industries
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.
In the short run
it makes sense to operate as long as price is higher than variable costs.
You should continue running
the copy store as long as the revenue you earn covers your variable costs. The rent and interest and repayment on the loan are fixed costs that have been already paid and, therefore, should be ignored in the short run (until the year's lease is over).
What will happen in the laptop market in the long run?
Firms will enter the market.
p =
MR = AR
Productive efficiency
The situation in which a good or service is produced at the lowest possible cost.
allocative efficiency?
Allocative efficiency is when every good or service is produced up to the point where the marginal benefit for consumers the marginal benefit for consumers equals the marginal cost of producing it the marginal cost of producing it.
As production of laptop displays increases, firms in the industry can now enjoy economies of scale. In the short run, makers of laptop displays will what?
Be able to earn economic profit.
Does the market system result in allocation efficiency?
In the long run, perfect competition results in allocative efficiency because firms produce where price equals marginal cost.
Does the market system result in productive efficiency?
In the long run, perfect competition results in productive efficiency because firms enter and exit until they break even where price equals minimum average cost.
It is reasonable to expect game companies to continue to develop mobile games in the long run if they break even for two reasons
First, when a firm breaks even on a mobile game, it earns enough revenue to cover all its costs of production, including its investment in the game. Second, companies such as Proletariat may be able to earn short-run economic profits from future new games even if competition reduces its long-run profits to zero
What are the three conditions for a market to be perfectly competitive?
For a market to be perfectly competitive, there must be many buyers and sellers, with all firms selling identical products, and no barriers to new firms entering the market.
Assume the market for oranges is perfectly competitive. If the demand for oranges increases, will the market supply additional oranges?
If the demand for oranges increases, then the market will supply additional oranges because producers seek the highest return on their investments.
What is the relationship between a perfectly competitive firm's marginal cost curve and its supply curve?
A firm's marginal cost curve is equal to its supply curve for prices above average variable cost.
Don't firms also benefit from cost reductions because they are able to earn greater profits?
No. Because short-run profits encourage entry, firms earn zero economic profit in the long run.
TR
P x Q
How does perfect competition lead to allocative and productive efficiency?
Perfect competition leads to allocative and productive efficiency A. because prices reflect consumer preferences. B. because firms are motivated by profit.
How is the market supply curve derived from the supply curves of individual firms?
The market supply curve is derived by horizontally adding the individual firms' supply curves
The long-run supply curve is
a horizontal line equal to the minimum point on the typical firm's average total cost curve.
Accounting profit is a firm's
net income measured by revenue minus operating expenses and taxes paid.
price is below average total cost,
then existing firms will incur economic losses and some firms will exit.
In perfect competition, long-run equilibrium occurs when the economic profit is
zero
Marginal revenue
(MR) Change in total revenue from selling one more unit of a product.
price taker?
- A price taker is a firm that is unable to affect the market price. - A price taker is a buyer or a seller that is unable to affect the market price. Firms that are price takers face horizontal demand curves and have no market power.
Which of the following statements is true when the difference between TR and TC is at its maximum positive value?
- MR = MC - Slope of TR = Slope of TC
maximizing profits, MR
= MC is equivalent to P = MC
Price taker
A buyer or seller that is unable to affect the market price.
Sunk cost
A cost that has already been paid and cannot be recovered.
Long-run supply curve
A curve that shows the relationship in the long run between market price and the quantity supplied.
Break-even point:
A firm is breaking even when its total cost equals its total revenue. Since perfectly competitive firms produce where price equals marginal cost, this occurs when price equals the lowest point on the average total cost curve (where the marginal cost curve intersects the average total cost curve).
When are firms likely to be price takers?
A firm is likely to be a price taker when it represents a small fraction of the total market
Economic profit
A firm's revenues minus all its costs, implicit and explicit.
Perfectly competitive market
A market that meets the conditions of (1) many buyers and sellers, (2) all firms selling identical products, and (3) no barriers to new firms entering the market
Why are consumers so powerful in a market system?
Because it is consumers' demand that influences the market price and dictates what producers will supply in the market.
When are firms likely to enter an industry? When are they likely to exit?
Economic profits attract firms to enter an industry, and economic losses cause firms to exit an industry.
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. OK
Explain why it is true that for a firm in a perfectly competitive market that P = MR = AR.
In a perfectly competitive market, P = MR = AR because firms can sell as much output as they want at the market price. Your answer is correct.
What is the difference between a firm's shutdown point in the short run and its exit point in the long run?
In the short run, a firm's shutdown point is the minimum point on the average variable cost curve, while in the long run, a firm's exit point is the minimum point on the average total cost curve.
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 $24.00 price is greater than average variable cost, so the firm should continue to produce.
Would a firm earning zero economic profit continue to produce, even in the long run?
In long-run competitive equilibrium, a firm earning zero economic profit will continue to produce because such profit corresponds with positive accounting profit corresponds with positive accounting profit.
Because the price of laptops falls in the long run as output increases, what is true about this industry?
It is a decreasing-cost industry.
What is the relationship between price, average revenue, and marginal revenue for a firm in a perfectly competitive market?
Price is equal to both average revenue and marginal revenue.
productive efficiency?
Productive efficiency is when a good or service is produced at lowest possible cost.
Briefly discuss the difference between these two concepts
Productive efficiency pertains to production within an industry while allocative efficiency pertains to production across all industries.
Profit for a perfectly competitive firm can be expressed as
Profit equals=left parenthesis Upper P minus ATC right parenthesis times Upper Q (P−ATC)×Q, where P is price, Q is output, and ATC is average total cost. This is the correct answer.
Productive efficiency
The situation in which a good or service is produced at the lowest possible cost. The forces of competition will drive the market price to the minimum average cost of the typical firm. That is, in the long run, firms will enter and exit a competitive market until they break even (where price equals minimum average cost).
supply curve for a perfectly competitive firm in the short run?
The supply curve for a firm in a perfectly competitive market in the short run is that firm's marginal cost curve for prices at or above average variable cost.
Why are firms willing to accept losses in the short run but not in the long run?
There are sunk costs in the short run but not in the long run
Average revenue (AR)
Total revenue divided by the quantity of the product sold.
Profit
Total revenue minus total cost.
In the figure to the right, Sacha Gillette reduces her output from 8250 to 6250 dozen eggs when the price falls to $ 1.80. At this price and this output level, she is operating at a loss. What option does Gillette have in this situation?
Try to cut her costs of production to decrease the loss in the short run.
why it is true that for a firm in a perfectly competitive market, the profit-maximizing condition MR = MC is equivalent to the condition P = MC.
When maximizing profits, MR = MC is equivalent to P = MC because the marginal revenue curve for a perfectly competitive firm is the same as its demand curve.
If U.S. demand for beef continues to increase, in the long run, beef prices will
fall because the supply of beef will increase as new firms enter the industry.
Decreasing-cost industries
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.
Increasing-cost industries
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.
long-run supply curve shows
the relationship between market price and the quantity supplied. If market price is above average total cost, then existing firms will earn economic profit and new firms will enter the industry. If price is below average total cost, then existing firms will incur economic losses and some firms will exit.
Perfectly competitive market
A market that meets the conditions of: (1) many buyers and sellers, (2) all firms selling identical products, and (3) no barriers to new firms entering the market.
Allocative efficiency:
A state of the economy in which production represents consumer preferences. In particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it. Perfectly competitive markets are allocatively efficient because: 1. The price of a good represents the marginal benefit consumers receive from consuming the last unit of the good sold. 2. Perfectly competitive firms produce up to the point where the price of the good equals the marginal cost of producing the last unit. 3. Firms produce up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.
Allocative efficiency
A state of the economy in which production represents consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.
why firms don't maximize revenue rather than profit?
At the point where revenue is maximized, the difference between total revenue and total cost may not be maximized.
Economic profit:
A firm's revenues minus all its costs, implicit and explicit.
Break-even point:
Breaking even occurs when a firm earns zero economic profit.
What determines entry and exit of firms in a perfectly competitive industry in the long run?
In a perfectly competitive industry in the long run, new firms will enter if existing firms are making a profit and existing firms will exit if they are experiencing losses.
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 entering entering the industry, market supply will increase, decreasing decreasing the market price
How should firms in perfectly competitive markets decide how much to produce?
Perfectly competitive firms should produce the quantity where the difference between total revenue and total cost is as large as possible.
The supply curve for a firm:
Tells us how many units of a product the firm is willing to sell at any given price. The marginal cost curve for a firm in a perfectly competitive market tells us the same thing. The firm will produce at the level of output where price equals marginal cost. Therefore, a perfectly competitive firm's marginal cost curve is also its supply curve. However, if a firm is experiencing losses, it will shut down if its total revenue is less than its variable cost. That is, if price drops below average variable cost, the firm will have a smaller loss if it shuts down and produces no output. So, the firm's marginal cost curve is its supply curve only for prices at or above average variable cost.
Suppose the market for cotton is perfectly competitive and that input prices increase as the industry expands. Characterize the industry's long-run supply curve
The cotton industry's long-run supply curve will be upward sloping because the long-run average cost of production will be increasing.
Shutdown point
The minimum point on a firm's average variable cost curve; if the price falls below this point, the firm shuts down production in the short run.
Shutdown point
The minimum point on a firm's average variable cost curve; if the price falls below this point, the firm shuts down production in the short run.
Economic loss
The situation in which a firm's total revenue is less than its total cost, including all implicit costs.
Long-run competitive equilibrium
The situation in which the entry and exit of firms has resulted in the typical firm breaking even.
Which of the following terms best describes a state of the economy in which production reflects consumer preferences?
allocative efficiency
Long-run equilibrium in perfect competition results in
allocative efficiency & productive efficiency
profit begins to decline
at output levels below the point where revenue is maximized; therefore, a firm maximizing revenue produces too much output.
Profit is maximized
at the output level where marginal revenue equals marginal cost.
If game companies can only break even on the mobile games they develop, in the long run, we would expect them to
continue to develop mobile games because they can cover all costs of production if they break even.
What dynamics best describe the factors at play in this market? Market entry for visual effect companies is relatively
easy, so firms can expect to earn zero economic profit in the long run.
In a perfectly competitive industry with constant costs, the long-run supply curve will be
horizontal
The lure of short-run economic profits should result
in an increase in the number of farmers who raise cage-free chickens. This will increase the supply of cage-free chickens, resulting in a higher quantity produced and a lower price.
reason for studying the model of perfect competition is important because
it is a benchmark long dash —a market with the maximum possible competition long dash —that economists use to evaluate actual markets that are not perfectly competitive.
the increase in total revenue that results from selling one more unit of output is
marginal revenue
As described in the chapter opener, the market for cage-free eggs in 2015 was
not in equilibrium because farmers who were raising cage-free chickens were earning higher profits than farmers who raised chickens using more traditional methods.
As the demand for cage-free eggs increases
other things equal, the price would increase. However, as the price increases and firms earn higher profits, the industry supply curve will shift to the right as the number of farmers who raise cage-free chickens rises. If this is a constant-cost industry, the price will decrease in the long run to what it was prior to the increase in demand.
perfectly competitive market,
price is determined by the intersection of market demand and supply. An individual corn farmer has no ability to affect the market price for corn. Therefore, the demand curve for one corn farmer is a horizontal line equal to the market price.
Which of the following terms best describes the result of the forces of competition driving the market price to the minimum average cost of the typical firm?
productive efficiency
find economic profit
subtract the opportunity cost of her time and the funds she is using from her accounting profit.
In the long run in the market for cage-free eggs, we would expect
the equilibrium price to decrease and the equilibrium quantity to increase, as more firms enter.
If output is increased
the loss would rise since the marginal cost of the additional output would be greater than the marginal revenue.
In perfect competition
the market demand curve is downward sloping while demand for an individual seller's product is perfectly elastic.
market price is above average total cost
then existing firms will earn economic profit and new firms will enter the industry.
demand curve is horizontal for a firm
then its marginal revenue curve is horizontal as well.
firm uses its own funds to finance its operations
there is an implicit cost to those funds because the firm could have invested them elsewhere. Therefore, it is correct to include the opportunity cost of the firm's funds that it used to develop and receive approval for the drug.
