Perfect Competition
Total Costs
(TC) Sum of all production costs at a certain level of output
Graph of decreasing cost industry
-Long run supply curve is downward-sloping -Market grows -Individual firm expenses decrease
Graph of constant cost industry
-Long run supply curve is horizontal -Market grows -Individual firm expenses stay the same
Graph of increasing cost industry
-Long run supply curve is upward-sloping -Market grows -Individual firm expenses increase
Characteristics of a competitive market
-Many buyers and sellers -Similar (if not identical) goods -Free entry and exit -Firms are price takers
What is a price taker?
A firm that can't influence market price so it has to take the highest price it can get
Why would a firm shut down?
A firm will shut down if it cannot cover variable costs
An individual seller in perfect competition will not sell at a price lower than market price because A. The seller can sell any quantity he or she wants at the prevailing market price B. Demand for the product will exceed supply C. The seller would start a price war D. Demand is perfectly inelastic
A.
Suppose Alice's Candy Company operates in a perfectly competitive market and is producing at its profit maximizing level of output. Suppose further that at this level of production its average total cost of producing candy is $0.40, average variable cost is $0.30, and marginal cost is $0.20. Alice should A. Shut down immediately B. Continue to produce in the short run since she is covering some of her fixed costs C. Maintain her current level of production since she is earning a positive economic profit D. Decrease production since it will increase her economic profit
A.
What is the difference between ATC and AVC?
ATC is fixed and AVC varies.
A perfectly competitive firm's supply curve is its A. Marginal cost curve above the minimum of its average fixed cost B. Marginal cost curve above its minimum average variable cost C. Marginal cost curve D. Marginal cost curve above its minimum average total cost
B.
If the price a firm charges in a perfectly competitive market is greater than its average total cost, the the firm is earning a economic profit __________ zero. A. Equal to B. Greater than C. Less than
B.
In perfect competition: A. The market demand curve is perfectly inelastic while demand for an individual seller's product is perfectly elastic. B. The market demand curve is downward sloping while demand for an individual seller's product is perfectly elastic C. The market demand curve is perfectly elastic while demand for an individual seller's product is perfectly inelastic D. The market demand curve and the individual's demand are identical
B.
Jason, a high school student, mows lawns for families in his neighborhood. The going rate is $12 for each lawn-mowing service. Jason would like to charge $20 because he believes he has more experience mowing lawns than the many other teenagers who also offer the same service. If the market for lawn mowing services is perfectly competitive, what would happen if Jason raised his price? A. If Jason raises his price, then all others supplying the same service will also raise their prices B. If Jason raises his price he would lose all of his customers C. Initially, his customers might complain, but over time they will come to accept the new rate D. He would lose some but not all of his customers
B.
If a competitive industry is making positive economic profits, what will eventually happen in the industry? A. The market supply will shift to the left B. The market supply will shift to the right C. The market demand will shift to the left D. The market demand will shift to the right
B. This is because we expect the market supply to increase
Long run, short run, or both? Eric is a farmer. Given the price of corn, he chooses how much to produce.
Both A profit maximizing firm will always choose the optimal quantity output in both the short run and long run.
Both individual buyers and sellers in perfect competition A. Have market price dictated to them by the government B. Can influence the market price by their own individual actions C. Have to take the market price as a given D. Can influence the market price by joining with a few of their competitors
C.
What do you suppose is one of the main reasons that competitive firms all earn zero economic profits in the long run? A. Each firm is setting MR = MC B. All firms want to earn zero economic profits C. Free entry and exit into the industry D. The cost curves are U-shaped
C.
Which of the following is NOT true for a firm in perfect competition? A. Profit equals total revenue minus total cost B. Marginal revenue equals the change in total revenue from selling one more unit C. Average revenue is greater than marginal revenue D. Price equals average revenue
C.
Change in Profit
Change in Profit = Marginal Revenue - Marginal Cost
Sunk Costs
Costs that have been incurred as a result of past decisions, they are unrecoverable
Suppose Wendy's Coffee Factory produces and sells in a perfectly competitive market. At Wendy's current level of production, she is producing the profit-maximizing level of coffee. At this quantity the average total cost of a pound of coffee is $5 and marginal revenue is $7. Given this information, what will be the long-run equilibrium price of a pound of Wendy's coffee? A. $7 B. $5 C. Greater than $7 D. Less than $5 E. Between $5 and $7
D.
Steve runs a competitive sandwich shop. Right now he is producing at a level where MR > MC. To increase his profits, Steve should A. Try to use more capital in his production B. Try to use more labor in his production C. Produce less output D. Produce more output
D. This is because he is making more units than he is spending.
Suppose that for a competitive firm, Market Price < minimum ATC. What should it do? A. Raise the market price B. Go out of business, because it is making a loss C. Produce at the output level where Price = Marginal Revenue D. More information is needed to give a clear answer
D. This is because we need to know if the firm is in the long run or the short run. If it's in the long run, the answer would be B. If it's in the short run, the firm may not shut down.
What happens when market price is below ATC and AVC?
For every unit produced, money is lost and the firm should exit the market.
Market Structure
How a market is made up
Why would a firm go out of business?
If, in the long run, price is less than average total cost.
Economic profits
Include opportunity costs
What happens to the level of market power as it moves from monopoly to perfect competition?
It decreases
What happens to the level of competition as it moves from monopoly to perfect competition?
It increases
Long run, short run, or both? Pizza barn builds a new restaurant.
Long run Changing levels of capital
Long run, short run, or both? A new competitor enters the industry.
Long run Entering or exiting involves changing levels of capital which only happens in the long run.
Marginal Cost
Marginal Cost = Change in Total Cost / Change in Quantity MC = Change in TC / Change in Q
Marginal Revenue
Marginal Revenue = Change in Total Revenue / Change in Quantity MR = Change in TR / Change in Q
How to maximize profit in a perfectly competitive firm
Marginal Revenue = Marginal Cost MR = MC
Profit
Profit = Total Revenue - Total Costs
Long run, short run, or both? Jamie owns a firm in a perfectly competitive industry. She is making positive economic profits.
Short run In perfect competition industries, profits can be positive in the short run, but will be zero in the long run.
What is the firm's supply curve?
The MC curve
If MR > MC
The firm can increase profits by producing more
If MR < MC
The firm has produced too much and profits are not maximized
P > ATC
The firm makes a profit
What happens when market price is above AVC?
The firm should continue.
ATC > P > AVC
The firm will operate to minimize loss
AVC > P
The firm will shut down temporarily
What happens when market price is between ATC and AVC?
The price will cover the AVC but will not fully cover the ATC
What is the goal of a firm?
To maximize profit
Profit Maximizing Rule
To maximize profits, the firm should use marginal analysis
Total Revenue
Total Revenue = Price x Quantity TR = P x Q
Should a firm continue to produce when price is between ATC and AVC?
Yes, because even though it is undesirable, some of the cost can still be covered.
In perfect competition, what is long run profit?
Zero
In a perfect competition price is equal to
marginal revenue
As long as firms are entering and exiting the market,
we are NOT in long run equilibrium.
