01:220:102 Lecture Notes - Lecture 10: Perfect Competition, Marginal Cost, Fixed Cost

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17 May 2018
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1. Overview
1. Basic Concepts
1. Demand Curve of Market/Industry
1. Downward sloping to the right
2. Demand Curve of the Individual Firm
1. Is horizontal
1. implies a perfectly elastic demand function
2. therefore: P = MR for the firm
3. Firms are price-takers
1. the price remains constant
2. the only decision: the optimal quantity to produce given a price
4. P = MR
1. implies that there is no pricing strategy
5.
6. P = MC
1. implies that the price of the product is equal to the extra cost
incurred by the seller in producing the marginal or extra unit of
production
7. P = Minimum Average Cost
1. implies that firms are operating at zero economic profits
2. efficiency has been attained
1. each increase in the cost of an extra unit of production equals
the price that the consumer is willing to pay
8. Short run
1. price as reflected by the demand function remains horizontal but
can increase or decrease in the short run
2. there can be profits or losses
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3. the firm want to maximize profits by producing the optimal output
(the level at which MR = MC)
1. in perfect competition, MR = P
9. At long-run equilibrium:
1. P = MR
2. P = MC
3. P = Minimum average cost
4. firms realize zero economic profit or normal profits
5. firms have no incentive to price their goods and services below
the market price
6. the demand function for each firm is horizontal
7. products are homogenous
8. therefore: no need for advertising
10. Profits and competition
1. normal profits
1. zero economic profits
2. economic losses
1. profits less than normal
3. economic profits
1. greater than normal profits
11. For each price (P = MR) in the short run:
1. If P < AVC, firm should shut down
1. total losses = total fixed cost (FTC)
2. If P > AVC, firm continues to produce as long as MR > MC up to
the level of output at which profits are maximized (at which MR =
MC)
12. Price elasticity of supply
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01:220:102 Full Course Notes
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