Econ Chapter 15-Perfect Competition

A firm that is producing the quantity at which marginal cost exceeds both average total cost and the market price will increase its economic profit by ________. A. producing a larger quantity B. raising the price to equal marginal cost C. producing a smaller quantity D. producing the quantity that minimizes average total cost

B. CHECK ANSWER

Explain a perfectly competitive firm's profit-maximizing choices and derive its supply curve.

-A perfectly competitive firm is a price taker. -Marginal revenue equals price. -The firm produces the output at which price equals marginal cost. -If price is less than minimum average variable cost, the firm temporarily shuts down. -A firm's supply curve is the upward-sloping part of its marginal cost curve at all prices at or above minimum average variable cost (the shut- down point) and the vertical axis at all prices below minimum average variable cost.

Explain how output, price, and profit are determined in the long run and explain why perfect competition is efficient.

-Economic profit induces entry, which increases market supply and lowers price and profit. Economic loss induces exit, which decreases market sup- ply, raises price, and lowers the losses. -In the long run, economic profit is zero and there is no entry or exit. -An increase in demand increases the number of firms and increases the equilibrium quantity. -An advance in technology that lowers the cost of producing a good increases market supply, lowers the price, and increases the quantity. -Perfect competition is efficient because it makes marginal benefit equal marginal cost, and it is fair because trade is voluntary, consumers pay the lowest possible prices, and entrepreneurs earn normal profit.

Explain how output, price, and profit are determined in the short run.

-Market demand and market supply determine price. -Firms choose the quantity to produce that maximizes profit, which is the quantity at which marginal cost equals price. -In short-run equilibrium, a firm can make a positive economic profit, make zero economic profit, or incur an economic loss.

Trout farming is a perfectly competitive industry and all trout farms have the same cost curves. When the market price of a fish is $25, farms maximize profit by producing 200 fish a week. At this output, average total cost is $20 a fish, and average variable cost is $15 a fish. Minimum average variable cost is $12 a fish. 1.) If the price of a fish falls to $20, will a farm produce 200 fish a week? 2.) If the price of a fish falls to $12, what will the trout farmer do? 3.) What are two points on a trout farm's supply curve?

1.) The farm will produce fewer than 200 fish a week. The marginal cost curve slopes upward, so to lower marginal cost to $20, the farm cuts production. 2.) If the price of a fish falls to $12, farms cut output until marginal cost equals $12. Because $12 a fish is also minimum average variable cost, farms are at the shutdown point—some farms produce the profit-maximizing output and others produce nothing. 3.) One point on a farmer's supply curve is 200 fish at $25 a fish. Another point is the shutdown point or zero at a price below $12 a fish.

Tulip growing is perfectly competitive and all growers have the same costs. The market price is $25 a bunch, and each grower maximizes profit by producing 2,000 bunches a week. Average total cost is $20 a bunch, and average variable cost is $15 a bunch. Minimum average variable cost is $12 a bunch. 1.) What is the economic profit that each grower is making in the short run? 2.) What is the price at the grower's shutdown point? 3.) What is each grower's economic profit at the shutdown point?

1.) The market price ($25) exceeds the average total cost ($20), so growers make an economic profit of $5 a bunch. Each grower produces 2,000 bunches a week, so a grower's economic profit is $10,000 a week. 2.) The price at which a grower will shut down temporarily is equal to mini- mum average variable cost—$12 a bunch 3.) At the shutdown point, the grower incurs an economic loss equal to total fixed cost. Calculate TFC. When 2,000 bunches a week are grown, ATC is $20 a bunch and AVC is $15 a bunch. ATC = AFC + AVC, so AFC=ATC-AVC. AFC is $5 a bunch. Total fixed cost equals $10,000 a week— TFC = AFC * Q, $5 a bunch * 2,000 bunches a week. At the shutdown point, the grower incurs an economic loss of $10,000 a week.

Tulip growing is a perfectly competitive industry, and all tulip growers have the same cost curves. The market price of tulips is $15 a bunch, and each grower maximizes profit by producing 1,500 bunches a week. The average total cost of producing tulips is $21 a bunch. Minimum average variable cost is $12 a bunch, and the minimum average total cost is $18 a bunch. 1.) What is a tulip grower's economic profit in the short run and how does the number of tulip growers change in the long run? 2.) In the long run, what is the price and the tulip grower's economic profit?

1.) The price is less than average total cost, so the tulip grower is incurring an economic loss in the short run. Because the price exceeds minimum average variable cost, the tulip grower continues to produce. The economic loss equals the loss per bunch ($21 minus $15) multiplied by the number of bunches (1,500 per week), which equals $9,000 per week. Because tulip growers are incurring economic losses, some growers will exit in the long run. The number of tulip growers will decrease. 2.) In the long run, the price will be such that economic profit is zero. That is, as growers exit, the price will rise until it equals minimum average total cost. In the long run, the price will be $18 a bunch (Figure 2) and a tulip grower will make zero economic profit because average total cost equals price.

Airfares will drop to record lows this fall With a fall in the price of jet fuel, the price of an average round-trip airline ticket will slip to $244 next month, about 5% lower than the same time last year. Source: Fortune, July 27, 2015 Explain how a fall in the price of jet fuel changes the marginal cost of producing air trips and changes the equilibrium price and quantity of air trips in the short run.

A fall in the price of jet fuel decreases an airline's marginal cost of producing air trips. The airline's marginal cost curve shifts downward. With lower marginal cost of an air trip, the market supply of air trips increases and the market supply curve shifts rightward. The increase in supply lowers the equilibrium price of an air trip and increases the equilibrium quantity of air trips in the short run.

Price taker

A firm that cannot influence the price of the good or service that it produces. A firm in Perfect Competition is a price taker.

Monopolistic competition

A market in which a large number of firms compete by making similar but slightly different products.

Oligopoly

A market in which a small number of interdependent firms compete.

Monopoly

A market in which one firm sells a good or service that has no close substitutes and a barrier blocks the entry of new firms.

A firm's short-run supply curve is the same as ________ if it produces the good. A. its marginal revenue curve B. the upward-sloping part of its marginal cost curve C. its marginal cost curve above minimum average variable cost D. its marginal cost curve above minimum average total cost

B CHECK

A permanent increase in demand ________ economic profit in the short run and some firms will ________ in the long run. A. does not change; exit the market B. increases; enter the market C. increases; raise their price D. does not change; advertise their good

B CHECK

In perfect competition, all the following situations arise except ________. A. firms produce an identical good or service B. each firm chooses the price at which to sell the good it produces C. firms can sell any quantity they choose to produce at the market price D. buyers know each seller's price

B CHECK

A firm will shut down in the short run if at the profit-maximizing quantity, ________. A. total revenue is less than total cost B. marginal revenue is less than average fixed cost C. average total cost exceeds the market price D. marginal revenue is less than average variable cost

B CHECK ANSWER

Perfect competition is efficient because all the following conditions hold except ________. A. total product is maximized B. firms maximize profit and produce on their supply curves C. consumers get a real bargain and pay a price below the value of the good D. firms minimize their average total cost of producing the good

C CHECK or A

At the shutdown point, the firm ________. A. incurs an economic loss equal to total variable cost B. makes zero economic profit C. incurs a loss equal to total fixed cost D. stops production to decrease its economic loss

C CHECK ANSWER

In the short run, the profit-maximizing firm will ________. A. break even if marginal revenue equals marginal cost B. make an economic profit if marginal cost is less than average total cost C. incur an economic loss if average fixed cost exceeds marginal revenue D. incur an economic loss if average total cost exceeds marginal revenue

D CHECK

Sarah's Salmon Farm produced 1,000 fish last week. The marginal cost was $30 a fish, average variable cost was $20 a fish, and the market price was $25 a fish. Did Sarah maximize profit? If Sarah did not maximize profit and if nothing has changed will she increase or decrease the number of fish she produces to maximize her profit this week?

Profit is maximized when marginal cost equals marginal revenue. In perfect competition, marginal revenue equals the market price, which was $25 a fish last week. Because marginal cost exceeded marginal revenue, Sarah did not maximize profit. To maximize profit, Sarah will decrease her output until marginal cost falls to $25 a fish

Marginal revenue

The change in total revenue that results from a one-unit increase in the quantity sold. In perfect competition, marginal revenue = price. Because, the firm can sell any quantity it chooses at the going market price. So if the firm sells one more unit, it sells it for the market price and total revenue increases by that amount. This increase in total revenue is marginal revenue.

U.s. steel lays off 756 With a drop in the demand for steel pipe and tube, U.S. Steel Corporation will idle plants in Ohio and Texas and lay off 756 workers. Source: The Wall Street Journal, January 6, 2015 As U.S. Steel responded to the fall in demand, how did its marginal cost change? What can you say about minimum AVC in the plants that closed?

The fall in demand for steel pipe and tube lowered the price of steel pipe and tube. U.S. Steel cut production. Marginal cost decreased to equal the lower price. At the plants that closed temporarily, the firm's minimum AVC exceeded price.

Shutdown point

The point at which Price = Min. AVC and the Quantity produced is that at which AVC is at its minimum. If TR < TVC, a firm shuts down temporarily and limits its loss to an amount equal to total fixed cost. If TR just equals TVC, a firm is indifferent between producing and shutting down. This situation arises when price equals minimum average variable cost and the firm produces the quantity at which average variable cost is a minimum—called the shutdown point.

California's commercial drone industry is taking off Customers are finding ever more creative ways to use drones, and 3D Robotics Inc., America's largest producer of consumer drones, expects sales to soar. Source: Los Angeles Times, June 13, 2015 Explain what is happening in the market for commercial drones. How would you expect the price of a drone to change in the short run and the long run? How would you expect the economic profit of a drone producer such as 3D Robotics to change in the short run and in the long run?

With customers finding ever more creative ways to use drones, the demand for drones is increasing. In the short run, an increase in demand brings a rise in the price of a drone and an increase in the quantity of drones supplied. The higher price increases the economic profit of drone producers in the short run. Economic profit is an incentive for new firms to enter the market. In the long run, entry increases supply, which lowers the price and increases the quantity of drones demanded. As the price of a drone falls, economic profit decreases. In the new long-run equilibrium, the price of a drone is lower and drone producers make zero economic profit.

Perfect competition exists when

• Many firms sell an identical product to many buyers. • There are no barriers to entry into (or exit from) the market. • Established firms have no advantage over new firms. • Sellers and buyers are well informed about prices.