Chapter 8 Perfect Competition

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Price taker

Individual firms in perfectly competitive markets get their prices from the market because they are so small they cannot influence market price. For this reason, perfectly competitive firms are price takers and can produce and sell all the output they produce at market-determined prices.

Monopoly

-One firm -No close substitutes -Substantial barriers to market entry -Potential for long-run economic profit -Shared market power and considerable control over price

When perfectly competitive firms are earning short-run economic profits, all of the following happens

-supply increases -market prices fall -firms are attracted to the industry by profits the number of firms in the industry will NOT fall

Market Structure Analysis

By observing a few industry characteristics such as number of firms in the industry or the level of barriers to entry, economists can use this information to predict pricing and output behavior of the firm in the industry.

Economists categorize industries using the following characteristics

Nature of the industry's product, barriers to entry, and extent to which firms can control prices.

Which sequence describes the long-run adjustment process in a competitive market when firms are earning short-run economic profits

New firms enter, industry supply increases, market price falls

In which market structure can mutual interdependent decision-making occur?

Oligopoly

Market structure analysis allows economists to

Predict the behavior of firms

The perfectly competitive model assumes that consumers will base their decisions purchases solely on:

Price

_____ is a market where there is no close substitute for the product, potential for long-run economic profit, and nearly impossible barriers to entry

Monopoly

If a perfectly competitive firm can sell a bushel of soybeans for $25 per bushel and it has an average variable cost of $20 per bushel, and the marginal cost is $22 per bushel, it should

expand output

A perfectly competitive firm in the short run will make a profit as long as price is

greater than average total cost

A perfectly competitive firm

has output that is so small, relative to market supply, that it cannot influence the market price.

When new firms enter a perfectly competitive market, it will cause an

increase in supply

When perfectly competitive firm X sells three units of product Z, its marginal revenue is $4.67. When it sells 100 units marginal revenue is $4.67. We can conclude that the price

is $4.67

If a firm produces where marginal revenue exceeds marginal costs, the firm

is not maximizing its profits

The cotton industry is experiencing less than normal profits. You can expect some firms to:

leave the industry in the long run

All market structures experience some type of control over price, EXCEPT

perfect competition. Unlike monopoly, oligopoly, and monopolistic competition

The perfectly competitive firm will

produce in the short run if the price is above the minimum of the AVC

If a competitive firm can sell a bushel of soybeans for $25 and it has an average variable cost of $24 per bushel and the marginal cost is $26 per bushel, the firm should

reduce output

In the short run, if a firm in a perfectly competitive market is producing where price exceeds marginal cost, the firm

should increase its output

The profit-maximizing rule states that a perfectly competitive firm:

should produce that level of output at which MR=MC

Normal Profits

Equal to zero economic profits where P=ATC

Oligopoly

-Fewer firms (such as auto industry) -Mutually interdependent decisions -Substantial barriers to market entry -Potential for long-run economic profit -Shared market power and considerable control over price

Monopolistic Competition

-Many buyers and sellers -Differentiated products -No barriers to market entry or exit -No long-run economic profit -Some control over price

Perfect Competition

A market structure with many relatively small buyers and sellers who take the price as given, a standardized product, full information to both buyers and sellers, and no barriers to entry or exit. -Many buyers and sellers -Homogeneous -No barriers to market entry or exit -No long-run economic profit -No control over price

Increasing Cost Industry

An industry that, in the long run, faces higher prices and costs as industry output expands. Industry expansion puts upward pressure on resources (inputs), causing higher costs in the long run.

Decreasing Cost Industry

An industry that, in the long run, faces lower prices and costs as industry output expands. Some industries enjoy economies of scale as they expand in the long run, typically the results of technological advances.

Constant cost industry

An industry that, in the long run, races roughly the same prices and costs as industry output expands. Some industries can virtually clone their operations in other areas without putting undue pressure on resource prices, resulting in constant operating costs as they expand in the long run.

Profit Maximizing Rule

Firms maximizing profit by producing output where where MR=MC. No other level of output produces higher profits.

Marginal Revenue

The change in total revenue from selling an additional unit of output. Because competitive firms are price takers, P=MR for competitive firms.

Consider the corn industry (a perfectly competitive industry). The price per bushel is $2 and there are constant returns to scale. If the long-run, minimum ATC is $1.50 per bushel, it should follow that (ceteris paribus):

The long run price will be $1.50 per bushel

Short-run Supply Curve

The marginal cost curve above the minimum point on the average variable cost curve.

Shutdown Point

When price in the short run falls below the minimum point on the AVC curve, the firm will minimize losses by closing its doors and stopping production. Because P<AVC, the firm's variable costs are not covered, therefore by shutting down the plant, losses are reduced to fixed costs only.

Normal profits are equal to

Zero economic profits

If a perfectly competitive market is in equilibrium, then the market is

both productively and allocatively efficient


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