Microeconomics Chapter 12

Long-Run Supply Affects

1. An increase in demand temporarily increases the price and allows firms to earn economic profits which attracts new firms to enter the industry, increasing supply, driving down the price, and eliminating economic profit 2. A decrease in demand temporally decreases the price and causes firm to suffer economic losses which leads some firms to exit the industry, decrease supply, driving up the price, and eliminating economic losses. No matter which instance happened, the price stays the same. It always returns to the long-run (break-even) level

Oligopoly

1. Number of firms: few 2. Type of product: Identical or differentiated 3. Ease of entry: Low 4. Examples of industries: Manufacturing computers and manufacturing automobiles

Monopolistic Competition

1. Number of firms: many 2. Type of product: Differentiated 3. Ease of entry: High 4. Examples of industries: Clothing stores and Restaurants

Perfectly Competition

1. Number of firms: many 2. Type of product: identical 3. Ease of entry: high 4. Examples of industries: Growing wheat, growing apples

Monopoly

1. Number of firms: one 2. Type of product: Unique 3. Ease of entry: Entry blocked 4. Examples of industries: First-class mail delivery and tap water

Market Structures

1. Perfectly competitive markets 2. Monopolistically competitive market 3. Oligopolies 4. Monopolies

Common Misconceptions to Avoid

1. While a perfectly competitive firm faces a horizontal demand curve, the market demand curve is still "normal" (downward-sloping). 2. In this chapter there are many supply curves described: the individual firm's supply curve, the market short-run supply curve, the market long-run supply curve; do not confuse these. 3. Remember that "zero economic profit" is an adequate level of profit to cover opportunity costs; it is not a bad outcome for a firm. 4. The reasons for shutting down in the short run and exiting the market in the long run are different: P<AVC for the short run, P<ATC for the long run.

Price takers

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.

Long-Run Supply Curve

A curve that shows the relationship in the long run between market price and the quantity supplied.This means that in the long run, the market will supply any demand by consumers at a price equal to the minimum point on the typical firm's average cost curve. Hence the long-run supply curve is horizontal at this price. In a perfectly competitive market, the long-run price is completely determined by the forces of supply. The number of suppliers adjusts to meet demand, at the lowest possible price.

Perfectly competitive market definition

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

Demand Curve for Perfectly Competitive Firm

A perfectly competitive firm faces a horizontal demand curve. By definition, a perfectly competitive firm is too small to affect the market price. Agricultural markets, like the market for wheat, are often thought to be close to perfectly competitive. Suppose you are a wheat farmer; whether you sell 6,000...or 15,000 bushels of wheat, you receive the same price per bushel: you are too small to affect the market price.

A Firm Experiencing a Loss

A situation that is even worse is when they cannot make a profit. Price is always lower than average total cost so it must make a loss. It makes the smallest loss possible by again following the MC=MR rule. No other level of output allows the firm's loss to be so small.

Long-run competitive equilibrium

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

Chapter 12

Firms in Perfectly Competitive Markets

Revenues for a perfectly competitive firm

For a firm in a perfectly competitive market, price is equal to both average revenue and marginal revenue. For this example, both revenues go up by $7 each time

Showing Marginal Revenue and Marginal Cost

For perfectly competitive markets, the marginal revenue is constant (horizontal line) and marginal cost is a curved line. The profit-maximizing point is when the two lines interest. The point should be marginal revenue is equal to marginal cost (or just less, if equal is not possible)

How Long-Run Competitive Equilibrium is achieved

If firms are making an economic profit, additional firms enter the market, driving down price to the break-even level. If firms are making an economic loss, existing firms exit the market, driving price up to the break-even level. Since the long-run average cost curve shows the lowest cost at which a firm is able to produce a given quantity of output in the long run, we expect price to be driven down to the minimum point on the typical firm's long-run average cost curve.

The Effect of Economic Losses

If the demand for an item falls, then the price will. For some businesses that price fall will cause them to no longer make a profit off that item. They have to reduce how many items they make to match up with the MC=MR. Some firms will exit the market

Showing revenue, cost, and profit

If we show total revenue and total cost on the same graph, the vertical difference between the two curves is the profit the firm makes. (Or the loss, if costs are greater than revenues.). At the profit-maximizing level of output, this (positive) vertical distance is maximized. The lines curve and intersect a couple times. It is good when the total revenue is above the total cost line

The Effect of Entry on Economic Profit

If you are one of the few businesses to be making a product, you will have high profit. The problem is that other firms and people will see that and want to make money too, so they will create their own business for it. This causes a shift to the left and a lower price per item. The market equilibrium falls as well. It falls until there is no incentive to enter the market.

Short-Run Market Supply Curve

Individual wheat farmers take the price as give...and choose their output according to the price. The collective actions of the individual farmers determine the market supply curve for wheat.

Identifying Whether a Firm Can Make a Profit

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 1. If P > ATC, the firm is making a profit 2. If P = ATC, the firm is breaking even 3. If P < ATC, the firm is making a loss

Average total cost and profit equation

Profit= (P- ATC) x Q

Responses of Perfectly Competitive Firms to Losses

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. If the firm shuts down, it will still need to pay its fixed costs. The firm needs to decide whether to incur only its fixed costs, or to produce and incur some variable costs, but obtain some revenue. The firm's fixed costs should be treated as sunk costs, costs that have already been paid and cannot be recovered, because even if they haven't literally been paid yet, the firm is still obliged to pay them.

Marginal revenue

The change in total revenue from selling one more unit of a product

Table with costs

The cost of the item will change as you go, but the revenues will not. With costs you can calculate profits by subtracting total cost from total revenue.

Maximum Profit with MC and ATC

The difference between price and average total cost equals profit per unit of output. Total profit equals profit per unit of output, times the amount of output the area of the green rectangle on the graph (P-ATC) x Q. It is not where the MC and ATC lines intersect

If P<AVC

Then the MC = MR rule should guide production: produce the quantity where MC = MR. For a perfectly competitive firm, this means where MC = P. So the marginal cost curve gives us the relationship between price and quantity supplied: it is the firm's supply curve!

Supply Curve of a Firm in the Short Run

The firm's shut decision is based on its variable costs; it should produce nothing only if: Total revenue < variable cost, (PxQ)<VC. Dividing both sides by Q, we obtain P<AVC. So if P<AVC, the firm should produce 0 units of output.

Price takers an perfectly competitive markets

The first (many buyers and sellers) and second (all times sell identical products) conditions imply that perfectly competitive firms are price-takers. This is because they are tiny relative to market, and sell exactly the same product as everyone else. Perfectly competitive markets are rare

Profit Maximization

The goal of all firms. We assume that all firms try to maximize profits-including perfectly competitive ones.

Increasing-Cost and Diminishing-Cost Industries

The horizontal curve is applied to items that are easily replaceable, but what if they're not? 1. If some factor of production cannot be replicated, additional firms may have higher costs of production. Example: If certain grapes grow well only in certain climates, then the cost to produce additional grapes may be higher than for existing firms. 2. On the other hand, sometimes additional firms might generate benefits for other firms in the market, leading additional firms to have lower costs of production.Example: Cell phones require specialized processors. As more firms produce cell phones, economies of scale in processor-production reduce cell phone costs.

Rules for Profit Maximization

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. 2. The profit-maximizing level of output is also where MR = MC. However neither of these rules require the assumption of perfect competition; they are true for every firm!For perfectly competitive firms, we can develop an additional rule, because for those firms, P = MR; this implies: 3. The profit-maximizing level of output is also where P = MC.

How is the firm's demand curve determined?

There are thousands ofindividual wheat farmers. Their collective supply, combined with the overall market demand for wheat, determines the market price of wheat in the first panel. The individual farmer takes this market price as his or her demand curve: the second panel. When looking at the two graphs, the individual only produces 15,00 bushels while the market equilibrium is 2.25 billion bushels. The individual has very little affect on the price of the item

Average revenue

Total revenue divided by the quantity of the product sold

Profit equals

Total revenue- total cost. Revenue for a perfectly competitive firm is easy to analyze: the firm receives the same amount of money for every unit of output it sells. So Price = Average Revenue = Marginal Revenue

Economic Profit Leads to Entry of New Firms

Unfortunately for Sacha, the profits in the carrot farming business will not last. Why? Additional firms will enter the market, attracted by the profit. Perhaps: Some farms will switch from other produce to carrots, or People will open up new farms. However it happens, the number of firms in the market will increase, increasing supply; this will in turn lower the price Sacha can receive for her output.

Are Perfectly Competitive Markets Efficient?

We have shown that in the long run, perfectly competitive markets are productively efficient. But they are allocatively efficient also: 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 good. 3. Therefore, firms produce up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it. Productive and allocative efficiency are useful benchmarks against which to measure the actual performance of other markets.

Reinterpreting Marginal

We know we should produce at the level of output where marginal cost equals marginal revenue (MC=MR). We have been calling this the profit-maximizing level of output. But what if the firm doesn't make a profit at this level of output, or at any other? In this case, we would want to make the smallest loss possible. Note that sometimes a loss may be unavoidable, if we have high fixed costs. It turns out that MC=MR is still the correct rule to use; it will guide us to the loss-minimizing level of output.

A Firm Breaking Even

When ATC exceeds MC, the only choose is to break even. Obtaining a profit is not possible. MC=MR

Profit Maximization Calculated

With costs, you can also calculate marginal revenue and marginal cost for the firm. Profit is maximized by producing as long as MR>MC; or until MR=MC, it that is possible. MR must be more to gain a profit

Productive Efficiency

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

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.