ECON 2 Ch 9: Firms in a Competitive Market

Why would a producer decide to produce in a competitive market in which she will earn zero profit in the long run?

Because at zero profit, with her revenue, she can cover all her costs—explicit and implicit (opportunity cost).

profits

the profit motive drives firms to enter/exit an industry -when new firms enter the industry and the market supply curve shifts right, profits disappear in a perfectly competetive industry -when economic profits disapear, entry ceases and the market stabilizes -at the new equilibrium, the firms receive only normal profits

marginal revenue

the revenue associated with a one-unit increase in quantity sold MR = change in TR/ change in Q

SMARTWORK

SMARTWORK

Consider a profit-maximizing firm in the short run which chooses to remain open while it is losing money. Place the following values in order from lowest to highest to represent a firm in this situation

1. average variable cost 2. price 3. average total cost

characteristics of a perfectly competetive market

1. many buyers and sellers 2. standardized product 3. no barriers to entry 4. no market power 5. MC = price 6. perfect Information 7. zero economic profit

Which information would be enough to determine a firm's profit, given that Q = 10,000 units?

price, total cost (Price × Q equals total revenue, and profit = total revenue - total cost. Keep in mind, (price - average total cost) × Q is also profit, because ATC = TC ÷ Q, so TC = ATC × Q.)

the profit rectangle

(P-ATC) x Q -shaded area od the graph

The profit-maximizing rule leaves room for cases where it is both possible and reasonable for a firm to operate at a loss over the long run.

FALSE -Since all costs are variable in the long run, a firm can always set its profit to zero by ceasing operation (exit). There is no reason to produce in the condition denoted in the bottom line of the table.

INQUISITIVE

INQUISITIVE

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In the short run, some costs are fixed and the rest are variable. A firm will continue production only so long as it can cover at least its variable costs. Therefore, production will only occur when price, and therefore marginal revenue, equals or exceeds average variable cost. Where that condition is met, the marginal cost curve becomes the short-run supply curve, because it is only along this line that marginal cost equals marginal revenue

PPT NOTES

PPT NOTES

Suppose two cities are considering tearing down their stadiums to build new ones. In one city, the old stadium cost $5 million to build, while in the other city, the old stadium cost $50 million to build. If all else is equal, what can we say about how the costs of the old stadiums should affect the cities' decisions?

The cost to build the old stadium shouldn't be considered (because that is already lost)

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There are many sellers in a competitive market. Firms in this market sell very similar products, and each firm also has easy entry and exit to the market. Each firm is also considered a price taker

Of the four quantities shown, assuming the market price remains the same, select the output that leads to a normal profit or break-even point. (Keep in mind that this concept is different from the profit-maximizing output.)

When P* = ATC, TR = TC, which leads to a $0, or normal, profit.

In the short run, profits when a competitive firm shuts down are -$7750, and they are -$350 when the firm continues to produce. This firm will minimize losses in the short run by

continuing to produce -what are there fixed costs? = 7750

barriers to entry

include: -patents -control of essential factors of production -control of distribution outlets -well established brand loyalty -government regulation

Select the quantity on the graph that will maximize the profits for the perfectly competitive producing firm.

marginal revenue = marginal cost

market vs firm demand curve

market demand curve -downward sloping firm demand curve -horizontal -firm can charge one price for their product -no incentive to charge a lower price (=lower profits)

profits and losses

P > ATC = profits P < ATC = losses P = ATC means normal profits; zero economic profit

competition at work

few, if any, products are perfectly competitive but many industries function like a competitive model -agriculture markets -tshirt shops, retail food, printing, clothing, dry cleaning, beauty salons -price and profits In these industries are always under threat of expanded supplies brought to market by existing or new producers

profit maximization

profit = total revenue - total cost -producer must find the quantity where the difference between TR and TC is the highest

perfect competition examples

-wheat/agriculture markets -standardized product -easy entry/exit -no one firm's supply can effect the market price

In a perfectly competitive market, the long-run market supply curve tends to be horizontal or nearly so (very price sensitive). What is another way to state this fact?

-in the long run, the market will supply any amount of the good at the price where P = min ATC -Both supply and demand are more elastic in the long run than the short run, which corresponds to a leveling out of the supply and demand curves

characteristics of competetive markets

-many buyers and sellers -standardized product -low barriers to entry/exit -no market power

Which descriptions apply to the long-run equilibrium in a perfectly competitive market?

APPLIES -economic profit is zero -firms outside the market have no incentive to enter -no exit or enter signals are being set -firms in market have no incentive to exit (In equilibrium, being in the market and being out of it are equally attractive, as reflected by economic profit being zero. Accounting profit must be positive) DOES NOT APPLY -accounting profit is zero (Accounting profit must be positive. It does not factor in certain costs, such as opportunity costs) -firms will raise their prices to increase profits (In competitive markets, firms are price takers and do not choose the selling price.)

calculating profits using ATC

Profit = (Price - ATC) * quantity -price -ATC gives us the profit per unit profit per unit (P-ATC) -vertical distance between the price and ATC curves at the profit maximizing quantity

READING NOTES

READING NOTES

Fill in the blanks to complete the passage about short-run operating loss.

In the short run, a profit-maximizing firm should operate even when it is losing money, so long as the market price is above average variable cost. In this situation, continued operation enables a firm to cover all of its variable cost and some of its fixed cost with any remaining revenue (If the company can cover some of its fixed cost, it will do better by producing than by shutting down in the short run. This is because the firm must still pay all of its fixed costs in the short run. This situation is described in the middle section of the table.)

fill in blanks about positively sloped long run market supply curves

In the simplest kind of case, the long-run market supply curve is perfectly horizontal. However, more realistically it may slope upward, if increasing the quantity supplied leads to increased production costs, due to shortages in either material or labor.

profit maximizing rate of output

MC = MR price = MR in perfect competition (profit maximizing quantity) production decision -price > MC means increase output -price = MC means maintain output (because profits are maximized) -price < MC means decrease output even if the profits are the same between two levels, most firms will produce at a higher level because: 1. the firm increases its consumer base 2. it denies rivals an additional sale 3. provides a cushion when the economy slumps 4. corporate size may mean prestige and power

Initially, you produce 100 boxes of jelly beans per time period. Then a new customer calls and places an additional order for jelly beans, requiring you to increase your output to 101 boxes. She offers you $1.75 for the additional box. Should you produce it?

No, because $1.75 is less than the marginal cost.

Which statements are true in the long run for a company operating with negative economic profit and positive accounting profit?

TRUE -operation is sustainable but not advisable (With negative economic profit, the rational thing for the firm to do is exit the market.) -firm will most likely exit the market (Negative economic profit indicates better opportunities elsewhere, outside the market.) NOT TRUE -operation is not sustainable (With positive account profit, the firm could continue to operate) -the firm will most likely stay in the market (Negative economic profit is a signal to exit.)

profits in perfect competition

competitive firms are powerless to stop the forces of a competitive market because individual firms cannot reduce output to affect the market price -no barriers to entry: as long as it is easy to enter an industry or for existing producers to expand production, economic profits wont last long

marginal cost

cost of producing one more unit of output MC = change in TC / change in Q

profit maximizing rule

never produce a unit of output that costs more to produce than it brings in (MC = MR) -maximize total profits not profit per unit

A firm is experiencing a loss of $5,000 per year. The firm has fixed costs of $8,000 per year

operate in the short run and shut down in the long run

calculating marginal revenue

price = marginal revenue in perfect competition -price is constant -a one unit increase in sales increases total revenue by the amount of the price -firm demand curve = marginal revenue curve

shutdown point

price = minimum AVC on the graph -only shut down if continuing production exceeds fixed costs; this happens only when total revenue is less than total variable cost P < ATC (continue to produce) price = min AVC (continue to produce; losing an amount equal to fixed costs) price < min AVC (shut down)

The following options describe costs incurred by owners of a given business. Identify which would be considered a sunk cost for a firm that is considering exiting a market.

sunk cost -four wedding cakes for carlos's cakes shop (Cakes are the final good and can be sold, but the costs or ingredients (like sugar, flour, and eggs) in the cake cannot be resold) - a large new billboard sign displaying shantel's shoes for shantel's shoe shop (Unless Shantel knows someone else with the same name who sells shoes and likes her sign, Shantel is unlikely to sell her sign to another firm.) -the cost of taking two online photography classes by Phillipe of Philipe's photography shop (once philipe takes the online classes, what he paid is not a recoverable cost) NOT a sunk cost -fireworks from fridays firework display (they can be resold) -the cost of two riding lawn mowers

short run production decision

the selection of the short run rate of output with existing plant and equipment -short run = some fixed inputs/costs

Which of the following conditions are true when a firm is maximizing its profits?

true: -selling additional units will reduce profits (Beyond the optimal point, marginal costs exceed marginal revenue, and profits will decrease as each unit costs more than the revenue earned from selling it.) -revenue gained from the next unit sold equals the cost of producing it (marginal revenue (MR) = marginal cost (MC).) NOT true - total revenue is maximized / total number of units sold is maximized (Total revenue is maximized only when marginal revenue is equal to zero, which is typically at a high level of production. Producing so many units also increases total costs. This can decrease profits or potentially create a loss)