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Chapter 14

ECN 104 Chapter Notes - Chapter 14: Sunk Costs, Marginal Revenue, Perfect Competition

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ECN 104
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ECN104 – Chapter 14 Notes
Chapter 14 Notes
oWhat is a perfectly competitive market?
oWhat is marginal revenue? How is it related to total and average
oHow does a competitive firm determine the quantity that maximizes
oWhen might a competitive firm shut down in the short run? Exit the
market in the long run?
oWhat does the market supply curve look like in the short run? In the
long run?
Introduction: A Scenario
oThree years after graduation, you run your own business
oYou must decide how much to produce, what price to charge, how
many workers to hire, etc.
oWhat factors should affect these decisions?
Your costs (studied in preceding chapter)
How much competition you face
oWe begin by studying the behaviour of firms in perfectly competitive
Characteristics of Perfect Competition
o1. Many buyers and many sellers
o2. The goods offered for sale are largely the same.
o3. Firms can freely enter or exit the market.
oBecause of 1 and 2, each buyer and seller is a price taker – takes the
price as given
The Revenue of a Competitive Firm
oTotal Revenue (TR) = Profit x Output (P x Q)
oAverage Revenue (AR) = Total Revenue (TR) / Output (Quantity) = P
oMarginal Revenue (MR) (Change in TR from selling one more unit) =
(Change in Total Revenue) / (Change in Output)
MR = P for a Competitive Firm
oA competitive firm can keep increasing its output without affecting the
market price
oSo, each one-unit increase in Output causes revenue to rise by P
(Profit), E.g., MR = P
oMR = P is only true for firms in competitive markets.
Profit Maximization
oWhat Output maximizes the firm’s profit?
oTo find the answer, “think at the margin.”
If you increase Output by one unit, revenue rises by MR, cost
rises by MC
oIf MR > MC, then increase Output to raise profit
oIf MR < MC, then reduce Output to raise profit
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