Chapter 11 Perfect Competition
perfectly competitive model
assumes that the market is comprised of a large number of firms, and each firm is small relative to the entire market.
Marginal cost
MC = ΔTC/ΔQ = ΔTVC/ΔQ
shutdown point or shutdown price
minimum average variable cost is the short run shutdown point or shutdown price
marginal revenue (MR)
the addition to revenue from the sale of one more unit of output. MR = ΔTR/ΔQ
all
A firm is earning positive economic profit when it received revenue greater than all its opportunity costs, which include payments to the firm's owners who could have productively used their time, talent, and other resources elsewhere.
perfect information
Consumers are assumed to have perfect information regarding product price, quality, and availability in a perfectly competitive model.
perfectly competitive firm
A perfectly competitive firm must, in order to maximize profit, make three basic independent decisions: 1) How much output to supply (quantity of product) 2) How to produce that output (what production technique to use) 3) How much of each input to demand.
identical (homogeneous) products
All firms are producing identical (homogeneous) products in a perfectly competitive model, which makes the output of one firm in the market a perfect substitute for the output of every other firm in the market
P = MR
For an individual firm in perfect competition, Price = Marginal revenue.
perfectly elastic
In a perfectly competitive model, the firm's demand curve is horizontal, or perfectly elastic, at the prevailing market price.
Positive Economic Profit
P > ATC Price is greater than Average Total Cost
economic profit
Payment to owners and investors of at least a normal rate of return is included in total cost; when economic profit is zero, accounting profit is positive.
Profit
Profit = TR(total revenue) - TC(total cost) where TR (total revenue) = P (Price) * Q (Quantity)
always
The TR - TC and the Marginal Revenue = Marginal Cost Approaches both will always yield the same outcome when using the same set of data.
consumer sovereignty
consumer demand dictates output and employment levels in perfectly competitive markets.
short-run supply curve
for the perfectly competitive firm, the portion of the marginal cost curve that lies above the average variable cost curve (the shutdown price) serves as the firm's short-run supply curve because the firm maximizes profit, or minimizes losses, by producing at the output where MR = MC, or P = MC, as long as price is greater than average variable cost (P > AVC). The MC curve above the Shutdown price represents the firm's supply curve.
LRAC
long-run average cost curve.
Zero economic profit
owners are receiving a return equal to what they would earn in their next-best alternative opportunity. When price is equal to average total cost (ATC) at the output where MR (marginal revenue) = MC (marginal cost), the firm is earning zero economic profit, which is also sometimes referred to as a normal profit or breakeven. Economic profit is zero when the market price is equal average total cost, or when the demand line is tangent to the ATC curve at its minimum point. Zero economic profit = P(Price) = ATC (average total cost)
law of supply
predicted that firms will produce more output in reaction to an increase in product price
price-taker
the individual firm is small relative to the entire market and can sell all it can produce at the market price and thus is a price-taker in a perfectly competitive market.
perfect information
the model of perfect competition assumes that firms have perfect information and are free to enter an industry in the long run.
perfect competition
the typical firm in perfect competition earns zero economic profit (normal profit) in the long run equilibrium because new firms will enter the market to compete for above normal profit, driving economic profit to zero. Also because some firms will exit the market in response to below normal profit, driving economic profit to zero.
long-run equilibrium
the condition for a firm in long-run equilibrium in a perfectly competitive industry: P = MR = MC = ATC = minimum LRAC
negative economic profit
if price is less than average total cost at the output where marginal revenue is equal to marginal cost, then the firm has a negative economic profit and is incurring economic loss. The firm minimizes losses by producing at MR = MC when price is less than average total cost but price is greater than average variable cost. Negative economic profit: P < ATC but P > AVC
minimum efficient scale
one of the conditions for long-run equilibrium is that the firms in the market be at least at the minimum efficient scale, or the smallest scale necessary to achieve all economies of scale.
MR = MC
to make profits as large as possible in the short run (to maximize profits), a firm produces the quantity of output (Q) where MR = MC, given that MC increases as output increases. A profit-maximizing firm will continue to increase production as long as MR is greater than MC, or as long as profit increases when output increases, but will stop at the point where MR = MC. The easiest way to identify the short-run profit position of a firm is to compare price to average total cost at the output where MR = MC. Three possibilities: 1) Positive Economic Profit: price is greater than average total cost 2) Zero Economic Profit: price is equal to average total cost 3) Negative Economic Profit: price is less than average total cost
Freedom of entry
Perfect competition also assumes freedom of entry into the market and exit from the market in the long run because there are no barriers to entry.
price-takers
Individual firms are price-takers, which means the firm takes the price determined by the market forces of supply and demand.
all
to minimize losses by operating in the short run, a firm must cover all variable costs, so price must be above minimum average variable cost. As long as AVC < P < ATC, the firm is losing money, but would lose more if it did not produce and sell output because the firm would still have to pay fixed costs in the short run even if it did shut down.