Econ 102: Perfect Competition

How do you find the area of maximum profit?

The area on the graph of maximum profit depends on price versus average total cost at the profit maximizing level or output.

What happens if a firm keeps producing?

-A firm can reduce its loss below the amount of its total fixed cost by continuing to produce, provided that the total revenue it receives is greater than its variable cost. -A firm can use the revenue over and above the amount of its variable cost to cover part of its fixed cost. In this case, a firm will have a smaller loss by continuing to produce than if it shuts down.

In the short run, what choices does a firm have it is experiencing a loss?

-Continue to produce. -Stop production by shutting down temporarily. -In many cases, a firm experiencing a loss will consider stopping production temporarily. -Even during a temporary shutdown, however, a firm must still pay its fixed costs.

What is the key to making a decision when a firm is experiencing a loss?

-For any firm, whether total revenue is greater or less than variable cost is the key to deciding whether to shut down or to continue producing in the short run. -As long as a firm's total revenue is greater than its variable cost, it should continue to produce no matter how large or small its fixed cost.

What happens if a firm shuts down?

-If a firm does not produce, it will suffer a loss equal to its fixed cost. -This loss is the maximum the firm will accept as a result of producing. -The firm will shut down if producing would cause it to lose an amount greater than its fixed cost.

How can we tell if a company is making a profit, breaking even, or experiencing a loss?

-P>ATC, which means the firm makes a profit. -P=ATC, which means the firm breaks even (its total cost equals its total revenue). -P<ATC, which means the firm experiences a loss.

Why do firms supply goods that provide consumers with a marginal benefit at least as great as the marginal cost of producing them?

-The price of a good represents the marginal benefit consumers receive from consuming the last unit of the good sold. -Perfectly competitive firms produce up to the point where the price of the good equals the marginal cost of producing the last unit. -Firms therefore produce up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.

What is a price taker?

A buyer or seller that is unable to affect the market price.

What are sunk costs?

A cost that has already been paid and cannot be recovered. -In analyzing a firm's decision to shut down, we are assuming that its fixed costs are sunk costs.

What is the long-run supply curve?

A curve that shows the relationship in the long run between market price and the quantity supplied. -In the long run, a perfectly competitive market will supply whatever amount of a good consumers demand at a price determined by the minimum point on the typical firm's average total cost curve. -Because the position of the long-run supply curve is determined by the minimum point on the typical firm's average total cost curve, anything that raises or lowers the costs of the typical firm in the long run will cause the long-run supply curve to shift.

What are perfectly competitive markets?

A market that meets the conditions of (1) many buyers and sellers, (2) all firms selling identical products, and (3) no barriers to new firms entering the market. -This prevents firms from controlling the prices and earning economic profit in the long run.

What is allocative efficiency?

A state of the economy in which production is in accordance with consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to society equal to the marginal cost of producing it.

What are constant-cost industries?

Any industry in which the typical firm's average costs do not change as the industry expands production will have a horizontal long-run supply curve. -It's possible, however, for the typical firm's average costs to change as an industry expands. -if an input used in producing a good is available in only limited quantities, the cost of the input will rise as the industry expands.

What is marginal revenue?

Change in total revenue over change in quanity. -For a firm in a perfectly competitive market, price is equal to both average revenue and marginal revenue. -Therefore, the marginal revenue curve for a perfectly competitive firm is the same as its demand curve.

The situation in which a firm's total revenue is less than its total cost, including all implicit costs.

Economic Loss

A firm's revenues minus all of its implicit and explicit costs.

Economic Profit

How do you find fixed costs in a table or graph?

Fixed costs are total costs when the output is zero.

How can you read this on a graph?

If the price drops below average variable cost, the firm will have a smaller loss if it shuts down and produces no output. So, the firm's marginal cost curve is its supply curve only for prices at or above average variable cost.

What is are decreasing-cost industries?

Industries with downward-sloping long-run supply curves. -In the long run, competition will force the price of the smartphone to fall to the level of the typical firm's new lower average cost.

What are increasing-cost industries?

Industries with upward-sloping long-run supply curves. -More of the wine will be produced in the long run only if the price rises to cover the typical firm's higher average cost.

What is the lhe long-run average cost curve?

The long-run average cost curve shows the lowest cost at which a firm is able to produce a given quantity of output in the long run. -We would expect that in the long run, competition drives the market price to the minimum point on the typical firm's long-run average cost curve.

What is product efficiency?

The situation in which a good or service is produced at the lowest possible cost. -Perfect competition results in productive efficiency. -The managers of every firm strive to earn an economic profit by reducing costs. But in a perfectly competitive market, other firms quickly copy ways of reducing costs. Therefore, in the long run, only the consumer benefits from cost reductions.

What is a long-run competitive equilibrium?

The situation in which the entry and exit of firms has resulted in the typical firm breaking even.

Why are optimal decisions produced at the margin?

To understand why profit is maximized at the level of output where marginal revenue equals marginal cost. -Firms use this principle to decide the quantity of a good to produce.

What is average revenue?

Total revenue divided by the quantity of the product sold. -Total revenue is price times quanitity. -In a funny way, average revenue equals price.

Profit is...

Total revenue minus total cost