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ECON 208 Chapter 9.docx

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Economics (Arts)
ECON 208
Sebastien Forte

 The competitiveness of the market- the influence that individual firms have on market prices  The less power an individual firm has to influence the market price, the more competitive is that market structure  Competitive behaviour refers to the degree to which individual firms actively bie with one another for business  Examples: 1. GM and Toyota engage in competitive behaviour but their market is not competitive (products are differentiated) 2. Two wheat farmers do not engage in competitive behaviour but they both exist in a very competitive market- no product differentiation  Assumptions of perfect competition: 1. All firms sell a homogenous product 2. Customers know the product and each firm’s price 3. Each firm reached its minimum LRAC at a level of output that is small relative to the industry’s total output 4. Firms are free to exit and enter the industry (able to fail) 5. Very large number of firms (each company is small relative to the market)  Firms in a perfectly competitive market will see a completely flat demand curve (horizontal), even though the industry demand curve is downward sloping- because they are price taking and have no effect  This does not mean the firm could actually sell an infinite amount at the market price  Normal variations in the firms level of output have a negligible effect on total industry output  Total Revenue (TR) TR = p x q  Average Reveunue AR = (p x q)/q = p  Marginal Revenue (MR) MR = ΔTR/Δq = p  For a perfectly competitive firm, AR = MR  9.3: Short Run Decisions  Should the firm produce at all?  A firm should produce only if at some level of output, price exceeds AVC (fixed costs have nothing to do with the decision because you have them no matter what. Fixed costs matter in the long run though because you can change them in the long run)  At the shut down price the firm can just cover its average variable cost, and so is indifferent between producing and not producing (you have just enough to pay your workers). You are indifferent because you can’t do better by closing your doors  How much should a firm produce?  As long as price is above average variable cost, they will produce and will not shut down  The maximize profits, the firm chooses the output where MR=MC. But for a competitive firm, MR = p  The rule: choose output where p = MC  The market determines the equilibrium price. The firm the picks the quantity of the output that maximizes its own profits  When the firm has reached Q* (maximum profit) it has no incentive to change its output (you made money off the last unit so don’t want to produce less, and you lose money off the next one so won’t produce more)  A competitive firms supply curve is given by its marginal cost curve (at prices above AVC)  A competitive industry’s supply curve is the horizontal summation of the individual MC curves (above minimum AVC curves)  Short run equilibrium in a competitive market  When an industry is in short-run equilibrium, two things are true: 1. Market price is such that the market clears 2. Each firm is maximizing its profits at this price  There are three possibilities for how large each firm’s profits in the short run equilibrium 1. Zero economic profits (the price that the producer will get per unit will be exactly equal to its average total cost). The typical firm is just covering its costs, p=ATC 2. Positive Economic Profits (the firm makes more money off of its activity than the best alternative usage of all the resources involved). If the business were to stop working and use the resources for something else (building, employees) then everyone would be worse off. Since price is greater than ATC the firm makes positive economic profits. 3. Negative Profits (Losses). If price is below the minimum of the ATC curve, the fir
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