7) Competitive Markets

For price taking firms (only): MR =

P (profit)

When referring to the graph of the costs for an individual perfectly-competitive firm, what (graphically) represents the total profit for a quantity?

The area [MC(Q) - ATC(Q)] * Q See graph:

When referring to the graph of the costs for a perfectly competitive firm, what represents the per-unit profit?

The distance between the Price and the Break-Even price at the same quantity MC(Q) - ATC(Q) On graph: the distance between A and B

When (graphically) will a perfectly competitive firm have negative economic profit for a given quantity?

When the ATC curve lies above the MC curve

What determines entry and exit of firms in a perfectly competitive industry in the long run?

new firms will enter if existing firms are making a profit (P > 0) and existing firms will exit if they are experiencing losses (note: long-run only. if we are talking about short-run, they may stay if losses < min AVC)

The number of firms initially in an industry can be determined by:

note: market price is where S = D

In perfect competition, long-run equilibrium occurs when the economic profit is

zero

When a firm is producing at a price which P = MC = ATC what kind of profit is the firm earning?

zero economic profit

marginal revenue is calculated by

∆TR/∆Q

Loss is represented by the area (on the graph for a short-run *individual* supply curve)

(distance between ATC and MR) * Q On graph: C

Total revenue is represented by the area (on the graph for a short-run *individual* supply curve)

(price where MR = MC) * Q On graph: A + B

A perfectly competitive market is categorized by

1. Many buyers and sellers 2. Standardized product among sellers 3. Free entry and exit

*break-even point*: A firm is breaking even when its _____________ equals ________________.

A firm is breaking even when its *total cost* equals its *total revenue*. Since perfectly competitive firms produce where P (price) = MC, this occurs when P equals the lowest point on the ATC curve (Where MC curve and ATC curve intersect).

Total *cost* is represented by the area (on the graph for a short-run *individual* supply curve)

ATC(Q) * Q On graph: A + B + C

Variable cost is represented by the area (on the graph for a short-run *individual* supply curve)

AVC(Q) * Q On graph: A

*Production decision in the short run*: If a firm produces, then it will produce an ideal output level where *price ____________ marginal cost* If Price > ATC , then Profit _____ 0 If Price < ATC, the Profit _______ 0 If Price = ATC, Profit _______ 0

If a firm produces, then it will produce an output level where *price equals marginal cost* > 0 ; TR > TC <==> Price > ATC < 0 ; TR < TC <==> Price < ATC = 0 ; TR = TC <==> Price = ATC

The number of firms in the long-run equilibrium

In long run, profits = 0 so the price is where MC = ATC and the number of firms is

In the *long run*: If market price is ________ than average total cost (P __ ATC), then new firms will enter the market If market price is ________ than average total cost ( P ___ ATC), then existing firms will exit.

In the *long run*: If price is *greater* than average total cost (P > ATC), then new firms will enter the market If price is *less* than average total cost ( P <ATC), then existing firms will exit.

Entry and exit decisions: In the long run: If P ____ ATC, then new firms will enter the market. If new firms enter, then the market supply curve will ________ and _____________ the market price If P ____ ATC, then rxisting firms will exit the market. If existing firms exit then the market supply curve will ________ and _____________ the market price

In the long run: If P*>*ATC, then new firms will enter the market. If new firms enter, then the market supply curve will *shift to the right* and *decrease* the market price If P *<* ATC, then existing firms will exit the market. If existing firms exit then the market supply curve will *shift to the left* and *increase* the market price

What is the difference between a firm's *shutdown point* in the *short run* and its *exit point* in the *long run*

In the short run a firm's *shutdown point* is the *minimum point on the variable cost curve*, while a firm's *exit point* is the minimum point on the *average total cost curve* *This is because in the short run, firm's will choose to produce (even at a loss) if they can cover their variable AND SOME of their fixed costs* *In the long run, each firm will exit when/if the equilibrium price is below its break even price because nothing is fixed in the long run, so they don't need to stay*

What is the difference between the short run and the long run?

In the short run, at least one of a firm's outputs is fixed, while in the long run, a firm is able to vary all its inputs and adopt new technology.

*shut-down point in the short run*: In the short run, if __________ is greater than ______________, then the firm should continue to produce (because the firm would lose an amount less than the fixed costs by shutting down). However, if ___________ is less than ____________, then the firm should stop production by shutting down.

In the short run, if *price* is greater than *average variable cost*_, then the firm should continue to produce (because the firm would lose an amount less than the fixed costs by shutting down). However, if *price* is less than *average variable cost*, then the firm should stop production by shutting down. *A firm should stay open in the short run if it can cover its variable costs*

Profit maximizing rule is

Increase quantity if Profit is above MC curve (MC < ATC) Decrease Quantity if Profit is below MC curve (MC > ATC) Choose the quantity where Profit = MC Ex. In the graph, the profit P is *above* the MC curve, so it is therefore *negative*. Thus Q should be *increased*

*Given the market price in $*, how do you calculate the profit from producing the profit maximizing quantity?

Profit = P(Q) - ATC(Q) Profit-maximizing output (for price-taking firms) = Q where P (given) = MC

Why are firms willing to accept losses in the short run but not in the long run?

There are sunk costs (the fixed costs) in the short run, but in the long run nothing is fixed

*Economic profit*: A firm's revenues minus ___________________________

all its costs, implicit and explicit Since accounting profit generally only includes explicit costs, breaking even corresponds to positive accounting profit. When breaking even, one should continue to produce in the long run because this as high a return as one could earn elsewhere Because economic profit takes into account all of one's cost, one should continue to produce because one can cover all of one's implicit opportunity costs

When MC is below ATC for a perfectly competitive firm, is profit positive or negative?

negative

In the long run, if the market price is above ATC, new firms will (enter/exit)

enter

If the market price is below the ATC curve, then firms will (enter/exit) the market in the long run

exit

What is the relationship between a perfectly competitive firm's MC curve and its supply curve?

supply curve = MC curve above the shutdown price (min AVC) A firm's marginal cost curve is the short-run individual supply curve [supply curve for prices above average variable cost (shutdown price)]

firms earn positive economic profits at any market price above

the price at the equilibrium point (intersection of MC and ATC) This is because it as after this point that the marginal costs are greater than the average total costs with increasing quantity