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ECO100Y1 (110)

# 2 - Short-Run Competitive Equilibrium

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School
University of Toronto St. George
Department
Economics
Course
ECO100Y1
Professor
Gustavo Indart
Semester
Summer

Description
SHORT-RUN COMPETITIVE EQUILIBRIUM Total, Average, and Marginal Revenue Total revenue (TR): TR = p*Q Average revenue (AR): AR = TR/Q = (p*Q)/Q = p Marginal revenue (MR): MR = dTR/dQ Short-Run Decisions Any profit-maximizing firm will produce at a level output at which: P ≥ AVC and MC = MR Note: When MR > MC, revenue from last unit produced > cost of last unit produced Produce this unit and increase production When MR < MC, revenue from last unit produced < cost of last unit produced Do not produce this unit and decrease production Short-Run Competitive Equilibrium Assumptions of Perfect Competition: 1) All firms sell an identical (homogeneous) product 2) Consumers know the nature of the product being sold and the prices charged by firms 3) Each firm is small relative to the size of the industry 4) The industry is characterized by freedom of entry and exit Even though the demand curve for the entire industry is negatively sloped, each firm in a perfectly competitive market faces a horizontal demand curve because variations in the firm’s output have no significant effect on price. (Firms are price takers.) The Competitive Firm Equilibrium occurs at P = MC Short-Run Profit Maximization for a Competitive Firm: Given price (P), the firm chooses the quantity supplied to maximize profit when P = MC (since P = MR and MR = MC) Economic Profit = P*q - Total Cost = P*q - (Average Cost)q = (P - AC)q 1) P > AC (Economic Profit) 2) P = AC (Break-even output, 0 Economic Profit) 3) AVC < P < AC (Economic Loss, but will continue producing since P > AVC) 4) P < AVC (Economic Loss, firm shuts down) Shutdown Pr
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