2.11.2 perfect competition
Loss minimizing firm Short run: (digram)
- Demand is low so the price is below AC -AR is less than AC
Define Profit maximization rule (diagram)
•To maximize its total economic profits, a firm should produce at a level of output at which its MC equals to its MR. • for perfect competitor, the P=MR, so MC should equal P
What are explicit cost
Wages, interest, rent
What is long run equilibrium state
When all the firms in a perfectly competitive market are breaking even, a market is in its long run equilibrium state. No firms will wish to enter or exit a market in which firms are breaking even
Total losses if continue to operate
(ATC - AR) x Q
Total losses if continue to operate
(ATC - AVC) x Q
Profit-earning firm: short run (diagram)
- AR > AC •it is producing at MC=MR, but the price is greater than average total cost - the firm is earning economic profits - blue area: economic profit
Oligopoly Characteristics
- Few large dominant firms - change in one firms output has significant impact on the market price (price-makers) - products can be identical or differentiated (advertising) - significant barrier to entry
Profit-earning effects
- High demand= high price - absence of entry barriers → new firms will enter the market → increase in supply → decrease in price
allocative efficiency
- Is achieve if a market produces at the quantity where marginal benefits equals marginal cost - when P = MC
profit earning firm: long run
- New firms enter the market → price decreases → marginal revenue decreases to MR = ATC
4 characteristics of market structures
- Number of firms - price making abilities - type of product - entry barriers
Perfect competition diagram
- Price is determined by market supply and demand - price is the firm's MR - raise prices = no output - lower prices = not able to cover costs of production - demand for individual firm's output is perfectly elastic
Lost minimizing firm
- When the price is lower than the average total cost - minimize losses but earns no economic profit at all
Perfect Competition Characteristics
- very large number of firms - firme are so small, it cannot affect price (price takers) - identical products - no barriers to entry and exit
Productive efficiency
-Is achieved when firms produce at their minimum average total cost - firms are using resources to their maximum efficiency - MR = MC
The breaking even firm (diagram)
-Price of its output = the firms minimum average total cost -Covers all its explicit and implicit costs but earns no additional profit earned only a NORMAL PROFIT -No incentive to enter or exit the market
When should a firm continue to operate
AR > AVC
When should a firm shut down
AVC > AR
Break even condition
If AR = ATC
Shut down condition
If AVC > AR
Loss minimizing firm long run (diagram)
No barriers to entry → firms leave the market b minimize losses → supply decreases → price increases
What are implicit costs
Normal profit
What is a normal profit
Normal profit is the implicit, subjective value of each business owner's skill and time. This can vary amongst businesses