Chapter 9
P< AVC →Firm shuts down
A perfectly competitive firm shuts down in the short run if price is less than avenage variable cost (case 2):
The Theory of Perfect Competition
For the perfectly competitive firm, a price taker, price is equal to marginal revenue (P=MR), and therefore the firm's demand curve is the same as its marginal revenue curve
The Process of Moving from One Long-run Competitive Equilibrium Position to Another
The Industry is in long-run competitive equilibrium. All firms ean zero economic profit.
Which of the following conditions guarantee that a firm will achieve productive efficiency in the long run? Check all that apply.
The market for its product is perfectly competitive. And The market price is equal to the minimum long-run average cost.
If total revenue is Increasing at a constant rate, what does this condition imply about marginal revenue?
marginal revenue is positive and is constant
A perfectly competitive firm that seeks to elther maximize profit or minimize losses will produce the level of output at which
MR = MC
For a perfectly competitive firm, profit is maximized at an output level where MR=MC. Further, for a perfectly competitive firm, P=MR Therefore PMR=MC, which ensures that resource allocative efficiency is achieved.
MR=MC ——- P=MR—- P=MR=MC
The assumption of easy entry into and exit from the market in the theory of perfect competition implies that firms will tend to earn——————— in long-run equilibrium.
zero economic profit
Perfect Competition
A theory of market structure based on four assumptions: (1) There are many sellers and buyers; (2) the sellers sell a homogeneous good; (3) buyers and sellers have all relevant information; (4) entry into, and exit from, the market is easy.
Industry Adjustment to an Increase in Demand
An increase in market demand for a product can throw an industry out of long-run competitive equilibrium
Why is the Market Supply Curve Upward Sloping?
Because of the law of diminishing marginal returns, MC curves are upward sloping, and because MC curves are upward sloping, so are market supply curves
Which of the following is an assumption of perfect competition?
Each firm produces and sels a homogeneous product.
At what price does the perfectly competitive firm sell its product?
It sells at the price determined by the market. In other words, market demand and market supply determine the price of the good-say, $10-and then the firm takes this price as the price at whichit will sell its product,
Why is the Market Supply Curve Upward Sloping?
MC curves have an upward-sloping portion because the MPP of a variable input eventually declines. When that happens, the MC curve begins to rise
Assume the following for a perfectly competitive industry: (1) there is no incentive for firms to enter or exit the industry: (2) for some firms in the lindustry, short-run average total cost is greater than long-run average total cost at the level of output at which marginal revenue equals marginal cost; (3) all firms in the industry are currently producing the quantity of output at which marginal revenue equals marginal cost. Is the industry in long-run competitive equilibrium?
No, because of number 2.
What is resource allocative efficlency, and is the perfectly competitive firm resource allocative efficlent?
Resource allocative efficlency exists If firms produce the quantilty of output at which P = MC. The perfectly compettive firm is resource allocative efficlent. Proof: (1] The firm produces the quantity of output at which MR = MC. (2) In perfect compettion, P=MR. (3) Because P = MR and the firm produces the quantity at which MR=MC, it follows that P = MC. Hence, the firm Is resource allocative efficient.
Profit serves as an incentive for individuals to produce, prompting or encouraging certain behavior. Profit also serves as a signal by identifying where:
Resources can be most productively employed in producing goods and services that consumers want.
Marginal Revenue (MR)
The change in total revenue (TR) that results from sell- ing one additional unit of output (Q).
Marginal Revenue (MR):
The change in total revenue (TR) that results from selling one additional unit of output (Q)
Long-Run Competitive Equilibrium:
The condition in which P = MC = SRATC = LRATC Economic profit is zero, firms are producing the quantity of output at which price is equal to marginal cost, and no firm has an incentive to change its plant size
What does It mean to say the perfectly competitive firm Is a price taker?
The perfectly competitive firm takes the marketdetermined equilibrlum price as the price at which It sells Its product. The firm has no ability to control the price of the product It sells.
Short-Run (Firm) Supply Curve:
The portion of the firm's marginal cost curve that lies above the average variable cost curve
Short-Run (Firm) Supply Curve
The portion of the firm's marginal cost curve that lies above the average variable cost curve.
What quantity does the single perfectly competitive firm produce?
The quantily at which MR = MC.
Which of the following assumptions contributes to a perfectly competitive firm being a price taker?
a. Each firm in the market supplies such a small part of the market that each firm has no influence over price. b. Firms sell a homogeneous product. C. Buyers and sellers have all relevant information about prices, product quality, and sources of supply.
The price at which a perfectly competitive firm sells its product is determined by
all sellers and buyers of the product, collectively.
In a perfectly competitive market, profit maximization—————— with resource allocative efficiency, which holds that————
consistent, P= MC.
market supply curve is the
horizontal sum of all the individual firms' supply curves.
The short-run industry or market supply curve is the
horizontal summation of the short-run supply curves for all the firms in the industry.
A Perfectly Competitive Firm
is a Price Taker
A profit-maximizing perfectly competitive firm will seek to produce the level of output at which
marginal revenue equals marginal cost.
Profits can be reduced in two ways:
through a rise in costs or a fall in price.)
Due to the law of diminishing marginal returns, marginal cost curves are———— and as a result market supply curves are————-
upward-sloping, upward-sloping
Marginal Revenue (MR):
- For a perfectly competitive firm, P = MR
TR < TVC →Firm shuts down
A perfectly competitive firm shuts down in the short run if total revenue is less than total variable costs (case 2):
Price Taker:
A seller that does not have the ability to control the price of the product it sells; the seller "takes" the price determined in the market
Price Taker
A seller that does not have the ability to control the price of the product it sells; the seller "takes" the price determined in the market.
The Process of Moving from One Long-run Competitive Equilibrium Position to Another
At a higher price and demand curve, firms in the industry are now earning positive economic profits.
Common Misconceptions about Demand Curves
Many think that all demand curves must be downward sloping, but this is not so
Firm A, one firm in a perfectly competitive industry, faces higher costs of production. As a result, will consumers end up paying higher prices?
No, because in a perfectly competitive industry, the more efficient firms with lower costs will drive firm A out of the market.
Do firms in a perfectly competitive market exhibit productive efficiency?
Productive efficiency, when P=Minimum ATC, is guaranteed in the long run. It is possible that a firm will produce its output at a unit cost higher than the lowest unit cost possible in the short run.
Profit Maximization Rule:
Profit is maximized by producing the quantity of output at which MR = MC
Theory and Real-World Markets
Therefore, the theory of perfect competition can be used to predict that market's behavior
P> AVC Firm produces
perfectly competitive firm produces in the short run as long as price is above aventge variable cost (cases 1 and 3):
Resource allocative efficiency occurs when a firm
produces the quantity of output at which price equals marginal cost.
That portion of the perfect competitive firm's———————- that is above its——————- is its————————
marglnal cost curve, AVC curve, supply curve
Constant-Cost Industry
An industry in which aver- age total costs do not change as (industry) output increases or decreases when firms enter or exit the indus- try, respectively
Decreasing-Cost Industry:
An industry in which average total costs decrease as output increases and increase as output decreases when firms enter and exit the industry, respectively
Decreasing-Cost Industry
An industry in which average total costs decrease as output increases and increase as output decreases when firms enter and exit the industry, respectively.
Increasing-Cost Industry:
An industry in which average total costs increase as output increases and decrease as output decreases when firms enter and exit the industry, respectively
Common Misconceptions over the Shutdown Decision
Even if price is below average total cost and a loss is being incurred, a firm should not necessarily shut down; the decision depends in the short run on whether the firm loses more by shutting down than by not shutting down
Why Does a Perfectly Competitive Firm Sell at the Equilibrium Price?
If it tries to charge a price higher than the market- established equilibrium, it won't sell any of its products
Why Does a Perfectly Competitive Firm Sell at the Equilibrium Price?
If the firm wants to maximize profits, it does not offer to sell at a lower price
The Marginal Revenue Curve of a Perfectly Competitive Firm is the Same as Its Demand Curve
The Marginal Revenue Curve of a Perfectly Competitive Firm is the Same as Its Demand Curve
Productive Efficiency:
The situation in which a firm produces its output at the lowest possible per- unit cost (lowest ATC)
Productive Efficiency
The situation in which a firm produces its output at the lowest possible per-unit cost (lowest ATC).
Why is the Market Supply Curve Upward Sloping?
We draw market supply curves upward sloping because they are the horizontal sum of firms' supply curves and firms' supply curves are upward sloping
In the theory of perfect competition, the firm faces a demand curve that is ——————-and the market demand curve is—————-
perfectly elastic, downward sloping
Profit from Two Perspectives
profit serves as an incentive for individuals to produce (2) it serves as a signal, identifying where resources are most welcome
In the short run, if a perfectly competitive firm's average variable cost curve lies above its demand curve at all levels of output, the firm should
shut down since price is less than average variable cost.
The Process of Moving from One Long-run Competitive Equilibrium Position to Another
(7) This lowers the demand and marginal revenue curves for firms. Older firms, which made up the industry before market demand increased (back in box 2). cut back output.
The Process of Moving from One Long-run Competitive Equilibrium
(5) Other firms (currently not in the Industry) view the positive economic profits as an incentive to join the industry.
Long-Run (Industry) Supply (LRS) Curve:
A graphic representation of the quantities of output that an industry is prepared to supply at different prices after the entry and exit of firms are completed
The Demand Curve for a Perfectly Competitive Firm
Horizontal
Increasing-Cost Industry
An industry in which average total costs increase as output increases and decrease as output decreases when firms enter and exit the industry, respectively.
Constant-Cost Industry:
An industry in which overage total costs do not change as (industry) output increases or decreases when firms enter or exit the industry, respectively
True or False: The perfectly competitive firm's entire marginal cost curve is its short-run supply curve.
False — Therefore, the perfectly competitive firm's short-run supply curve is the portion of the firm's marginal cost curve that lies above the average variable cost curve.
How do we know f the perfectly competitive firm Is earning profit or Incurring a loss?
If P> ATC for the firm, then it is earning profit. If P< ATC for the firm, then It is Incurring a loss.
Assume an increasing-cost industry that is Initially in long-run competitive equilibrlum. An increase in demand will cause a(n).——————- In prices and profits and, as a result, firms will the ———————-industry, causing the market supply curve to shift—————-
Increase, enter, rightward
The demand curve is the same as the marginal revenue curve for a perfectly competitive firm because
Price is equal to marginal revenue
Profit Maximization Rule
Profit is maximized by producing the quantity of output at which MR = MC.
Resource Allocative Efficiency
The situation in which firms produce the quantity of output at which price equals marginal cost:P = MC.
Why is the Market Supply Curve Upward Sloping?
They are upward sloping because the supply curve for each firm is the portion of its marginal cost (MC) curve that is above its average variable cost (AVC) curve -and this portion of the MC curve is upward sloping
TR>TVC Firm produces
We can summarize the same information in terms of total revenue and total variable costs. A perfectly competitive firm produces in the short run as long as total revenue is greater than total vari- able costs (cases 1 and 3):
A perfectly competitive firm will continue to increase its production as long as marginal
revenue is greater than marginal cost.
In the short run, a perfectly competitive firm should continue to produce as long as it can cover its variable costs. Which of the following conditions describes this rule?
P>AVC
The term price taker can apply to buyers as well as sellers. A price-taking buyer is one who cannot influence price by changing the amount he or she buys. In which of the following scenarios would you most likely be a price taker? Check all that apply.
A can of soda costs $1 at the store. A smartphone costs $200 regardless of the service plan you purchase with
Long-Run (Industry) Supply (LRS) Curve
A graphic representation of the quantities of output that an industry is prepared to supply at different prices after the entry and exit of firms are completed.
Perfect Competition:
A theory of market structure based on four assumptions: (1) There are many sellers and buyers; (2) the sellers sell a homogenous good; (3) buyers and sellers have all relevant information; (4) entry into, and exit from, the market is easy
Long-Run Competitive Equilibrium
The condition in which P = MC SRATC = LRATC. Economic profit is zero, firms are producing the quantily of output at which price is equal to marginal cost, and no firm has an incentive to change its plant size.
Theory and Real-World Markets
The four assumptions are also approximated in some real-world markets; in them, the number of sellers may not be large enough for every firm to be a price taker, but the firm's control over price may be negligible; the amount of control in that market may be so negligible that the firm act as if it were a perfectly competitive firm
Short-Run Market (Industry) Supply Curve:
The horizontal sum of all existing firms' short-run supply curves
Short-Run Market (Industry) Supply Curve
The horizontal sum of all existing firms' short-run supply curves.
Productive and resource allocative efficiency
The market price of a good equates the marginal cost of production and the marginal value that consumers attach to a unit of the good. Because the price also reflects the opportunity cost of the resources employed to produce the last unit, consumers will value the last unit they purchase at least as much as they would value any other good that those resources could have produced. These characteristics of perfectly competitive markets guarantee resource allocative efficiency.
Perfect Competition in the Long Run
The number of firms in a perfectly competitive market may not be the same in the short-run as in the long-run
The Perfectly Competitive Firm's Short-Run Supply Curve
The short-run supply curve is that por- tlon of the firm's marginal cost curve that lies above the average varlable cost curve.
Theory and Real-World Markets
• The assumptions underlying the theory of perfect competition are closely met in some real-world markets, such as some agricultural markets and a small subset of retail trade; the stock market also
Which of the following is the best example of a homogeneous product?
wheat
The Process of Moving from One Long-run Competitive Equilibrium Position to Another
(2) For some reason, the market demand curve rises and price rises.
The Process of Moving from One Long-run Competitive Equilibrium Position to Another
(3) This raises the demand and marginal revenue curves for the firm, and it produces more output
The Process of Moving from One Long-run Competitive Equilibrium Position to Another
(6) As new firms join the industry,. the market supply curve shifts to the right and price declines.
The Process of Moving from One Long-run Competitive Equilibrium Position to Another
(8) Eventually, all firms earn zero economic profit and are in long-run competitive equilibrium.
Common Misconceptions about Demand Curves
- A single perfectly competitive firm's supply is so small, compared with the total market supply, that the inverse relationship between price and quantity demanded cannot be observed on the firm's level, only on the market level
The theory of perfect competition is based on the following four assumptions:
1. There are many sellers and many buyers, none of which is large in relation to total sales or purchases. Each firm produces and sells a homogeneous product. 3. Buyers and sellers have all relevant information about prices, product quality, sources of supply, and so forth. Firms have easy entry into and exit out of the market.
What four assumptions Is the theory of perfect compettlon built on?
1.There are many buyers and many sellers. 2. Each firm produces and sells a homogeneous good. 3. Buyers and sellers have all relevant Informaton about prices, product quality, SOUICES of supply, and so forth. 4. Firms have easy entry Into the market and easy exit out of the market.
In the shart run, a perfectly competitive firm will maximize profits (minimize losses) by producing the level of quantity at which MR = MC . The firm will only operate at the lowest per-unit cost if the firm is breaking even and P=MR=MC= Minimum ATC
MR = MC—breaking even - Minimum ATC
Many plumbers charge the same price if they come to your house to fix a kitchen sink. Is this enough to prove that plumbers are colluding to keep prices high?
No. It is possible that plumbing is close to a perfectly competitive industry, and the current price is the equilibrium price resulting from competition.
Consider the following data: equilibrium price $8, quantity of output where MR equals MC = 500 units, average total cost = $10, average varlable cost = $9. What will the perfectly competitive firm do in the short run and why? Shut down, because price is less than average variable cost.
Shut down, because price is less than average variable cost.
Market Structure
The environment whose char- acteristics influence a firm's pricing and output decisions.
Market Structure:
The environment whose characteristics influence a firm's pricing and output decisions
What Should a Perfectly Competi- tive Firm Do in the Short Run?
The firm should produce in the short run as long as price (P is above average variable cost (AVC). It should shut down In the short run if price Is below average variable cost.
Suppose society is producing a perfectly competitive good or service at the lowest possible cost in the long run. Which of the following must be true? Check all that apply.
The market is productively efficient. and. Price (P) - marginal cost (MC) - minimum average total cost (ATC).
Resource Allocative Efficiency:
The situation in which firms produce the quantity of output at which price equals marginal cost: P = MC
The market demand curve in a perfectly competitive market is —————while the Individual firm's demand curve (that it faces) is———-
downward-sloping, horizontal
The theory of perfect competition assumes that
each buyer and each seller may act independently of other buyers and sellers, respectively.
perfectly competitive firm
is a price taker, which is a seller that does not have the ability to control the price of its product: in other words, such a firm "takes" the price determined in the market.
That portion of the perfect competitive firm's——————- that is above Its———————- Is its———————-
marginal cost curve, AVC curve, supply curve
perfectly competitive firm's short run supply curve is that portion of the firm's———————- curve that lies——————-
marginal cost, above its average variable cost curve
If total revenue is increasing at a constant rate, what does this condition imply about marginal revenue?
marginal revenue is positive and is constant
The perfectly competitive firm does not increase its quantity of output without limit even though it can sell all it wants at the going price. Regardless of the limitless demand, the perfectly competitive firm will take its own cost curves into account. Therefore, it will only sell up to the quantity where P= MC because to go beyond that point would cause the firm's profits to decrease
will ———P=MC ——-decrease