MICROECONOMICS - CHAPTER 12

The profit-maximizing level of output is

also where P = MC.

Productive efficiency

is a situation in which a good or service is produced at the lowest possible cost.

Suppose a firm in a perfectly competitive market is making a loss. It would like the price to be higher, but it is a price-taker, so it cannot raise the price. That leaves two options:

1. Continue to produce, or 2. Stop production by shutting down temporarily

The rules we have just developed for profit maximization are:

1. The profit-maximizing level of output is where the difference between total revenue and total cost is greatest; and 2. The profit-maximizing level of output is also where MR = MC.

perfectly competitive market: one in which

1. There are many buyers and sellers; 2. All firms sell identical products; and 3. There are no barriers to new firms entering the market.

Long-run supply curve:

A curve that shows the relationship in the long run between market price and the quantity supplied.

Once we have determined the quantity where MC=MR, we can immediately know whether the firm is making a profit, breaking even, or making a loss. At that quantity,

If P > ATC, the firm is making a profit If P = ATC, the firm is breaking even If P < ATC, the firm is making a loss

Profit is maximized by producing as long as

MR>MC; or until MR=MC, if that is possible.

Revenue for a perfectly competitive firm is easy: the firm receives the same amount of money for every unit of output it sells. So:

Price = Average Revenue = Marginal Revenue

We assume that all firms try to maximize profits—including perfectly competitive ones. Recall that:

Profit = Total Revenue - Total Cost

Long-run competitive equilibrium:

The situation in which the entry and exit of firms has resulted in the typical firm breaking even.

The firm's shut down decision is based on its variable costs; it should produce nothing only if:

Total Revenue < Variable Cost (P x Q) < VC Dividing both sides by Q, we obtain: P < AVC So if P < AVC, the firm should produce 0 units of output.

Allocative efficiency

is 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.

Marginal revenue (MR)

is the change in total revenue from selling one more unit of a product.

Average revenue (AR)

is total revenue divided by the quantity of the product sold

price-takers

they are unable to affect the market price. This is because they are tiny relative to the market, and sell exactly the same product as everyone else.