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Chapter Seven Textbook Notes

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ECN 104
Ibrahim Hayani

Week Ten CECN 104 Chapter Seven Four Market Structures  Perfect Competition: a market structure in which a very large number of firms produce a standardized product.  Monopoly: A market structure in which one firm is the sole seller of a product or service.  Monopolistic Competition: A market structure in which a relatively large number of sellers produce differentiated products.  Oligopoly: A market structure in which a few large firms produce homogenous or differentiated products.  Imperfect Competition: The market models of monopoly, monopolistic competition, and oligopoly considered as a group. Characteristics of Perfect Competition and the Firm’s Demand Curve  Very Large Numbers- A basic feature of a perfectly competitive market is the presence of a large number of independently acting sellers offering their products in large national or international markets.  Standardized Product- firms in a perfectly competitive industry sell standardized products, they make no attempt to differentiate their products and do not engage in other forms of nonprice competition.  Price-Takers-the competitive firm is a price-taker: it cannot change market price, it can only adjust to it.  Price-Takers: A firm in a purely competitive market that cannot change market price, only adjust it.  Easy Entry and Exit- new firms can easily enter, and existing firms can easily leave perfectly competitive industries in the long run. Demand for a Firm in Perfect Competition  each firm in a perfectly competitive industry offers only a negligible fraction of total market supply, so it must accept the price determined by the market; it is a price-taker, not a price-maker. Average, Total, and Marginal Revenue  Average Revenue: total revenue from the sale of a product divided by the quantity of the product sold.  Total Revenue: total number of dollars received by a firm from the sale of a product.  Marginal Revenue: the change in total revenue that results from selling one more unit of a firm’s product.  In perfect competition, marginal revenue and price are equal.  The marginal revenue curve coincides with the demand curve because the product price is constant. The average revenue equals price and therefore also coincides with the demand curve. Profit Maximization in the Short Run  Since the firm in a perfectly competitive industry is a price-taker, it can maximize the economic profit (or minimize its loss) only by adjusting its output.  Two methods exist to determine the level of output at which a competitive firm will obtain maximum profit or minimum loss. One method is to compare total revenue and total cost; the other is to compare marginal revenue and marginal cost. Total-Revenue- Total-Cost Approach  Competitive producer will ask: (1) should we produce this product? (2) if so, in what amount? (3) What economic profit (or loss) will we realize?  The total revenue for each output level is found by multiplying output (total cost) by price  Profit or loss at each output level by subtracting total cost, TC from total revenue, TR  Total cost increases with output because more production requires more factors of production, but the rate of increase in total cost varies with the relative efficiency of the firm.  Total revenue covers all costs (including a normal profit, which is included I the cost curve) but there is no economic profit  Break-eve point: an output at which a firm makes a normal profit but not an economic profit. Marginal-Revenue-Marginal-Cost Approach  The firm compares the marginal revenue (MR) and the marginal cost (MC) of each successive unit of output.  The firm will produce any unit of output whose marginal revenue exceeds its marginal cost because the firm would gain more in revenue from selling that unit than it would add to its cost by producing it.  If the marginal cost of a unit of output exceeds its marginal revenue, the firm will not produce that unit. Producing it would add more to costs than to revenue, and profit would decline or loss would increase.  In the initial stages of production, where output is relatively low, marginal revenue will usually (not always) exceed marginal cost. But at later stages of production, where output is relatively high, rising marginal costs will exceed marginal revenue.  In the short run, the firm will maximize profit or minimize loss by producing the output at which marginal revenue equals marginal cost (as long as is preferable to shutting down); known as the MR=MC RULE o For most sets of MR=MC data, MR and MC will be precisely equal at a fractional level of output o The rule applies only if producing is preferable to shutting down; if marginal revenue does not equal or exceed average variable cost, the firm will shut down rather than produce the MR=MC output. o The rule is an accurate guide to profit maximization for all firms o The rule can be restated as P=MC when applied to a firm in a perfectly competitive industry; the demand schedule faced by a competitive seller is perfectly elastic at the going market price, product price and marginal revenue are equal, under perfect competition we may substitute P for MR in the rule; when producing is preferable to shutting down, the competitive firm should produce at that point where price equals marginal cost (P=MC) Profit-Maximization Case  The economic profit can be calculated by subtracting total cost from total revenue; total revenue is calculated by multiplying price by output  To calculate the economic profit: Profit= (P-A) x Q  A is average total cost  By subtracting the average total cost from the product price we obtain a per-unit profit  There the per-unit economic profit is P-A, where P is the market price and A is the average total cost for an output. Shutdown Case  The shutdown case reminds us of the qualifier to our MR (=P) =MC rule. A competitive firm will maximize profit or minimize loss in the short run by producing that output at which MR (=P) =MC, provided that market price exceeds minimum average variable cost. Generalized Depiction  We can conclude that the portion of the firm‘s marginal-cost curve lying above its average-variable- cost curve is its short-run supply curve.  Short-run supply curve: a curve that shows the quantities of the product a firm in a purely competitive industry will offer to sell at various prices in the short run. Diminishing Returns, Production Costs, and Product Supply  Because of the law of diminishing returns, marginal cost eve
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