Micro economics Chapter 12
Assume the market for oranges is perfectly competitive. If the demand for oranges increases, will the market supply additional oranges? If the demand for oranges increases, then the market
will supply additional oranges because producers seek the highest return on their investments.
Does the market system result in allocative efficiency? In the long run, perfect competition
results in allocative efficiency because firms produce where price equals marginal cost.
If the firm is charging a price of $12 per unit
see #2 graph on = it is not selling any output.
Does the market system result in productive efficiency? In the long run, perfect competition
results in productive efficiency because firms enter and exit until they break even where price equals minimum average cost.
"According to the model of perfectly competitive markets , the demand for wheat should be a horizontal line. But this can't be true: When the price of wheat rises, the quantity of wheat demanded falls, and when the price of wheat falls, the quantity of wheat demanded rises. Therefore, the demand for wheat is not a horizontal line."
Incorrect. The commentator is confusing the market demand for wheat with the demand line facing the representative firm.
Refer to the diagram to the right which shows the cost and demand curves for a profitminusmaximizing firm in a perfectly competitive market. If the market price is $30, should the firm represented in the diagram continue to stay in business?
See graph #4 - Yes, because it is covering part of its fixed cost.
What conditions make a market perfectly competitive? A market is perfectly competitive if
it has many buyers and many sellers, all of whom are selling identical products, with no barriers to new firms entering the market.
The late Nobel Prize-winning economist George Stigler once wrote, "the most common and most important criticism of perfect competition... [is] that it is unrealistic." Source: George Stigler, "Perfect Competition, Historically Contemplated," Journal of Political Economy, Vol. 55, No. 1, (February 1957), pp. 1-17. Despite the fact that few firms sell identical products in markets where there are no barriers to entry, economists believe that the model of perfect competition is important because
it is a benchmark -a market with the maximum possible competition-that economists use to evaluate actual markets that are not perfectly competitive.
When are firms likely to be price takers? A firm is likely to be a price taker when
it sells a product that is exactly the same as every other firm it represents a small fraction of the total market
What determines entry and exit of firms in a perfectly competitive industry in the long run? In a perfectly competitive industry in the long run,
new firms will enter if existing firms are making a profit and existing firms will exit if they are experiencing losses.
Farmer Jones grows oranges in Florida. Suppose the market for oranges is perfectly competitive and that the market price for a crate of oranges is $17 per crate. Fill in total revenue, average revenue, and marginal revenue in the table below. (Enter your responses as integers.)
see notebook #1
If the market price for wheat were indeed $4 per bushel, should the wheat farmer exit the industry in the long run? In the long run, the wheat farmer
should continue to produce wheat because breaking even is as high a return as she could earn elsewhere.
What is a price taker? A price taker is
a firm that is unable to affect the market price.
Which of the following is an expression of profit for a perfectly competitive firm? Profit for a perfectly competitive firm can be expressed as
Profit= (P-ATC) x Q, where P is price, Q is output, and ATC is average total cost.
Characterize profits for the firms in this industry. Firms in this market are currently making a profit. The long-run equilibrium price will be $4.00 In long-run, firms will enter the market until the marginal firm is earning zero economic profit
Profits and losses: If P > ATC, then a firm will make a profit. If P = ATC, then a firm will break even. If P < ATC, then a firm will experience losses. The market price is initially $5.00, where market supply equals market demand. When farmers produce the profit-maximizing quantity of wheat, price is greater than average total cost, so firms are making a profit. The long-run equilibrium market price is at a level equal to the minimum point on the typical firm's average total cost curve.
Refer to the graph to the right of the demand curve facing a firm in the perfectly competitive market for wheat. The fact that the demand curve is horizontal implies which of the following?
The firm can sell any amount of output as long as it accepts the market price of $7.00.
The financial writer Andrew Tobias has described an incident when he was a student at Harvard Business School: Each student in the class was given large amounts of information about a particular firm and asked to determine a pricing strategy for the firm. Most of the students spent hours preparing their answers and came to class carrying many sheets of paper with their calculations. When his professor called on him in class for an answer, Tobias stated, "The case said the XYZ Company was in a very competitive industry . . . and the case said that the company had all the business it could handle." Source: Andrew Tobias, The Only Investment Guide You'll Ever Need, San Diego: Harcourt, 2005, pp. 6-8. Given this information, what price do you think Tobias argued the company should charge? (Tobias says the class greeted his answer with "thunderous applause.")
The market price
Suppose a farmer in Georgia begins to grow peaches. He uses $1,000,000 in savings to purchase land, he rents equipment for $60,000 a year, and he pays workers $110,000 in wages. In return, he produces 150,000 baskets of peaches per year, which sell for $3.00 each. Suppose the interest rate on savings is 5 percent and that the farmer could otherwise have earned $35,000 as a shoe salesman. What is the farmer's economic profit? The peach farmer earns economic profit of $ 195,000
The peach farmer earns economic profit of $195,000 The peach farmer earns accounting profit of $280,000
Suppose a farmer in Georgia begins to grow peaches. He uses $1,000,000 in savings to purchase land, he rents equipment for $100,000 a year, and he pays workers $120,000 in wages. In return, he produces 150,000 baskets of peaches per year, which sell for $3.00 each. Suppose the interest rate on savings is 3 percent and that the farmer could otherwise have earned $40,000 as a shoe salesman. What is the farmer's economic profit?
Total revenue (TR): TR equals P x Q. The farmer's total revenue is $450,000: ($3.00 per basket of peaches multiplied by 150,000 baskets of peaches). The farmer's explicit costs are $100,000 in rent and $120,000 in wages. The farmer's implicit costs are $40,000 in foregone salary and $30,000 in foregone interest (from $1,000,000 multiplied by the 3 percent interest rate). Economic profit: A firm's revenues ($450,000) minus all its costs, implicit ($40,000 + $30,000) and explicit ($100,000 + $120,000). The peach farmer earns economic profit of $ 160,000. Therefore, accounting profit is $ 230,000, from $450,000 in revenue minus $220,000 in explicit costs.
A buyer or seller that is unable to affect the market price is called
a price taker.
The figure to the right represents the cost structure for a perfectly competitive firm with its average total cost (ATC) curve, average variable (AVC) curve, and marginal cost (MC) curve. Fixed costs are $50.00. Suppose the market price is $13.00 per unit. Characterize the firm's profit Should the firm instead shut down in the short run? In the short run, the firm should
a. See graph #5 - If the firm produces output, then it will experience losses b. shut down because price is less than average variable cost.
Suppose the market for cotton is perfectly competitive and that input prices decrease as the industry expands. Characterize the industry's long-run supply curve. The cotton industry's long-run supply curve will be
downward sloping because the long-run average cost of production will be decreasing.
Refer to the diagram to the right which shows cost and demand curves facing a profit - maximizing perfectly competitive firm. At price P1, the firm would
graph 6 -lose an amount equal to its fixed costs.
What are the three conditions for a market to be perfectly competitive? For a market to be perfectly competitive, there must be
many buyers and sellers, with all firms selling identical products, and no barriers to new firms entering the market.
What effect will firms exiting have on the market price? When firms exit,
market supply will decrease, increasing price
In 2015, some beer drinkers filed a lawsuit against Anheuser-Bucsh, the brewer of Beck's beer. The beer drinkers claimed that Beck's was marketed as an authentic German beer, but was actually brewed in St. Louis. Other breweries have established facilities in Canada so they can truthfully claim that their beers are "imported." Source: Jacob Greshman and Tripp Mickle, "Trouble Brews for 'Imported' Beers Brewed in America," Wall Street Journal, June 24, 2015. If the market for beer were perfectly competitive, the location of breweries would
not matter to consumers since the product would be homogeneous.
What is the supply curve for a perfectly competitive firm in the short run? The supply curve for a firm in a perfectly competitive market in the short run is
that firm's marginal cost curve for prices at or above average variable cost.
How should firms in perfectly competitive markets decide how much to produce? Perfectly competitive firms should produce the quantity where
the difference between total revenue and total cost is as large as possible.
In perfect competition
the market demand curve is downward sloping while demand for an individual seller's product is perfectly elastic.
