Chapter 11 Review Perfect Competition

Total Cost (TC)

average total cost ATC x quantity Q

the fact that all firms in a perfectly competitive industry are small relative to the industry and produce goods that are perfect substitutes leads to

each firm in the industry facing a perfectly elastic demand curve

the downward-slopping portion of a LRAC curve implies that

economies of scale exist over the range of the curve

if in the short run, perfectly competitive firms are earning positive economic profits, the adjustment to long-run equilibrium will include firms

entering the industry, causing market supply to increase and market price to decrease

If, in the short run, perfectly competitive firms are earning positive economic profits, the adjustment to long-run equilibrium will include firms ______ the industry, causing market supply to _____ and market price to _____.

entering, increases, decrease

firms operating in perfectly competitive markets

have no market power and are price takers

the demand curve for an individual seller in a perfectly competitive market is

horizontal (perfectly elastic) at the market-determined price

in a perfectly competitive market, the demand curve is

horizontal for the individual firm, while the demand curve is downward-sloping for the market

shutdown decision

if price < less than AVC average variable cost, economic profit is less than 0 and firm should shut down in the short un and pay total fixed costs (losses equal total fixed costs)

assume soybeans are produced in a perfectly competitive market, and the demand for soybeans increases. this leads to

increase in the price of soybeans and increase in the firms profit maximizing level of output

Firm as a price-taker

individual firms are price-takers which means the firm takes the price determined by the market forces of supply and demand. The firm must decide how much output to offer for sale, assuming the goal of the firm is to maximize profit, given the market price.

the marginal revenue curve for a perfectly competitive firm

is the same as the firm's demand curve

a decrease in market demand for output produced in a perfectly competitive industry

leads to a decrease in the individual firm's marginal revenue

a perfectly competitive firm producing where P = MR = MC > ATC in the short run is

making an economic profit greater than zero

Suppose at the profit-maximizing/loss-minimizing level of output P= $6, ATC= $7, and AVC= $5. A firm in this situation will

minimize its losses by continuing to produce where MR = MC in the short run

p= 6 atc= 7 and avc= 5

minimize its losses by continuing to produce where MR=MC in the short run AVC<P<ATC

the profit-maximizing rule is for firms to produce the amount of output at which

mr = mc

If firms in the market for yogurt are earning positive economic profit in the short run, and there are no barriers to entry into this market, economic theory

new entrants into the market will drive down the price of yogurt in the long run

the short-run supply curve for the perfectly competitive firm is the portion of the marginal cost curve MC that lies above the average variable cost AVC

the firm will maximize profits and minimize losses by producing the quantity where marginal revenue equals marginal cost if price is grater than average variable cost

zero economic profit

owners are receiving a reward equal to what they would earn in their next-best alternative opportunity. when price is equal to average total cost at the output where mr=mc the firm is earning zero economic profit, normal profit or breakeven market price is equal average total cost or when the horizontal demand line is tangent to the ATC curve at its minimum point

a firm is in the long-run equilibrium in a perfectly competitive market when

p = mr = mc = atc

a firm earns zero economic profit when

price is equal to average total cost

total revenue TR

P price x Q quantity

calculate total revenue

Price x Quantity

short profits and losses and long-run adjustments in a perfectly competitive market

-a short run economic profit or loss will lead to long-run industry changes -typical firm in perfect competition earns zero economic profit (normal profit) in long run equilibrium because new firms will enter the market to compete for above normal profit, driving economic profit to zero

assumptions of the model of perfect competition

-consumers have perfect information regarding production price, quality, and availability -output of one firm in the market is a perfect substitute for the output of every other firm in the market -the market consists of a large number of firms, and each firm is small relative to the entire market

all of the following are assumptions of the model of perfect competition

-firms in the market produce identical outputs -the demand curve facing the firm is perfectly elastic -the market consists of a large number of buyers and sellers entry into market in the long run is not restricted

Assumptions and characteristics of Perfect Competition

-the market is comprised of a large number of firms and each firm is small relative to the entire market -all firms are producing identical (homogenous) products, making the output of one firm in the market a perfect substitute for the output of every other firm in the market -there is freedom of entry into the market and exit from the market in the long run because there are no barriers to entry -consumers have perfect information regarding product price, quality, and availability -firms gave perfect information regarding market prices and opportunity costs

short run profit possibilities

1. positive economics p>atc 2. zero economic profit p=atc 3. negative economic profit p<atc

TFC (Total Fixed Cost)

AFC X Q average fixed cost x quantity

average fixed cost AFC

ATC - AVC average total cost - average variable cost

the shutdown price corresponds to the minimum point of the

Average variable cost AVC curve because losses greater than total fixed cost when price is greater than average variable cost AVC

Industry output is efficient when:

MB = MC for each firm

the total cost of producing 3 units of output is

TC = TVC + TFC

if a firm is a price-taker, it

sells its product at the price determined by the market

Market demand vs firm's demand

the firm's demand curve is horizontal or perfectly elastic. 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. if the firm raises its price above Pmkt=market price, its sales will fall to zero because demanders know they can buy the exact same product from another seller at the market price. There is no incentive for the firm to charge a price below market price because it can sell all it desires at the market price. Charging a price below market price is a violation of the profit-maximizing assumption

profit-maximizing output (where mr=mc)

the second approach to finding the profit-maximizing level of output to apply the marginal benefit equal to marginal cost the marginal benefit to the seller is the additional revenue received from the sale of another unit of output the addition to revenue from the sale of one more unit of output is called marginal revenue marginal revenue indicates how much total revenue changes when an additional unit of output is sold and is the change in total revenue divided by the change in output marginal cost is the addition to the firm's total cost when one more unit of output is produced marginal cost = change in total cost divided by change in output or change in total variable cost divided by the change in output

in a perfectly competitive market

there are many relatively small firms and each firm is a price-taker

the typical firm in a perfectly competitive industry earns only zero economic profit in the long run because

there are no barriers preventing new firms from entering the industry and competing away positive profits in the long run

a firm that chooses not produce in the short run suffers a loss equal to

total fixed cost

economic profit

total revenue minus total cost

positive economic profit

total revenue minus total cost is profit P > ATC average total cost as long as the market price is higher than the minimum point of the ATC curve, the firm will earn a positive economic profit. Raising the price causes the firm to produce a higher quantity and will also result in a higher profit

average variable cost

tvc/quantity output