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Lecture 8

ECON101 Lecture Notes - Lecture 8: Marginal Revenue, Market Power, Perfect Competition


Department
Economics
Course Code
ECON101
Professor
Mesbah Sharaf
Lecture
8

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CH 8 Perfect Competition
Conditions of Perfect Competition
Large number of sellers and buyers!1.
No seller can control the price!2.
Market supply and demand determine price!A.
Each firm is a price taker !B.
Free entry and exit (no barriers to entry) !3.
Sellers sell identical/homogenous goods !4.
!
Total Revenue: TR = P * Q
Marginal Revenue: MR = /\TR / /\Q (extra revenue
from selling an extra unit) !
Average Revenue: AR = TR / Q = P*Q / Q = P!
Under perfect competition, P = MR = constant !
!
Producer Objective
Maximize profit!
Profit = total revenue - total cost (P = TR - TC) !
Total Revenue > Total Cost - profits!
Total Revenue < Total Cost- loss !
Total Revenue = Total Cost - break even "no profit, no
loss" !
Profit is maximized if the following two conditions are satisfied:!
##1. MR = MC!
##2. Marginal cost is increasing!
Producers will keep producing as long as MR > MC !
Producers will produce less if MR < MC !
!
Profit
TR > TC!
P > ATC
!
Break Even
TR = TC!
P = ATC !
!
Loss
TR < TC!
P < ATC!
!
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Three Cases in a Loss!
1. Loss & Continue!
P > AVC!
TR > TVC!
2. Loss & Indierent!
P = AVC!
TR = TVC!
3. Loss & Shutdown !
P < AVC!
TR < TVC!
!
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Profit Break Even Loss

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EXAMPLE:
1. Suppose TR = 100, TVC = 80, and TFC = 40
TC = TFC + TVC!
120 = 40 + 80!
Loss = 20 !
!
If the firm continues, the loss will be 20!
If the firm shuts down, the loss will be 40!
Therefore, by continuing the firm has covered all variable costs and was able to cover part of the fixed cost which
is better than shutting down and paying all the fixed !
!
2. Suppose TR = 100, TVC = 100, and TFC = 20
!
TC = TFC + TVC!
120 = 20 + 100!
!
If the firm continues, the loss will be 20!
If the firm shuts down, the loss will be 70!
Whether the firm continues or shuts down, she will be losing $20 (loss and indierent)!
!
3. Suppose TR = 100, TVC = 110, and TFC = 20!
!
TC = TFC + TVC!
130 = 20 + 110!
!
If the firm continues, the loss will be 30!
If the firm shuts down, the loss is 20!
By shutting down, the firm's loss will be less than if she continued !
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Loss and Continue
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