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# ch 12 perfect competition.docx

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School
Department
Economics
Course
ECON 102
Professor
Eva Lau
Semester
Summer

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12 – perfect competition Chapter 12: Perfect Competition What is Perfect Competition  perfect competition: a market where  many firms sell the exact same products to many buyers  free entry into the market  established firms have no advantage over newer ones  sellers and buyers are informed about prices  examples: fishing, paper milling, lawn services, photo finishing, etc HowPerfect Competition Arises  when the minimum efficient scale of a single producer is small relative to the market demand for the good/service  minimum efficient scale: the smallest output at which long-run average cost reaches its lowest level  in perfect competition, each firm produces a good that has no unique characteristics so consumers don’t care which firm’s good they buy Price Takers  price taker: a firm that cannot influence the market price because its production is an insignificant part of the total market  if you sell it at higher than the market price, no one will buy from you  If you sell it at a lower price, then you will be sold out really quickly and lose the difference Economic Profit and Revenue  a firm’s goal is to maximize economic profit (total revenue – total cost)  total cost = opportunity cost, which includes normal profit  total revenue: price × quantity  marginal revenue: the change in total revenue that results from a one-unit increase in the quantity sold  change in total revenue ÷ change in quantity sold  the firm can sell any quantity it chooses at the market price so the demand curve for the product is horizontal  the demand curve is the same as the firm’s marginal revenue curve The Firm’sDecisions  how to produce at minimum cost  recall: operating with the plant that minimizes long-run average cost  what quantity to produce  whether to enter or exit a market The Firm’s OutputDecision  we can find the output that maximizes the firm’s economic profit from the firm’s cost and revenue curves  economic profit = TR – TC  break-even: economic profit = 0, i.e. TR = TC Marginal Analysisand the Supply Decision  marginal analysis compares marginal revenue with marginal cost  MR > MC: revenue from selling one more unit exceeds the cost of producing that unit  an increase in output will increase economic profit  MR < MC: revenue from selling one more unit is less than the cost of producing that unit  an increase in output will decrease economic profit page 1 of 5 12 – perfect competition  MR = MC: the revenue from selling one more unit equals the cost of producing that unit  economic profit is maximized  either an increase or a decrease in output decreases economic profit TemporaryShutdown Decision  profit maximization occurs when a firm produces at the quantity where MR = MC  what if the price at this quantity is less than the average cost?  firm incurs an economic loss at maximum profit economic loss=TFC+TVC-TR  =TFC+(AVC ×Q)-(P×Q) = TFC+(AVC-P)×Q  if the firm shuts down, then the economic loss = TFC  if the firm produces, then the firm has variable cost as well as revenue  if TVC is more than TR, than the firm should shut down  or ... if AVC is more than price  shutdown point: the price and quantity at which it is indifferent between producing and shutting down  occurs at the price and quantity where average variable cost is a minimum  if the price falls below the min. AVC, the firm shuts down temporarily and continues to incur a loss of TFC The Firm’sSupply Curve  shows how its profit-maximizing output varies as the market price varies  when price is more than the minimum AVC, the firm maximizes profit by  producing the output at which MC = price  when price is less than the minimum AVC, the firm maximizes profit by  temporarily shutting down and stopping production  when the price is the same as the minimum AVC, the firm maximizes profit by either  temporarily shutting down  producing no output  producing the output at which AVC is a minimum  the firm’s supply curve runs along the y-axis from \$0 to the price of the minimum of AVC, then jumps to the shutdown point and follows the MC curve Output, Price and Profit in the Short Run Market Supply in the Short Run  short-run market supply curve: shows the quantity supplied by all firms in the market at each price  the market supply curve is derived from the individual supply curves  the quantity is the sum of the quantities by all the firms in the market at that price Short-Run Equilibrium  the short run supply curve is the same as the market supply curve  the equilibrium occurs when then short run supply curve intersects with the demand curve A Change in Demand  if demand increases then the demand curve shifts to the right,  causing an increase in market price  firm’s increases output  if demand decreases then the demand curve shifts to the left,  causing a decrease in market price  each firm produces less output to maximize profit Profitsand Losses in the Short Run page 2 of 5 12 – perfect competition  a firm producing at profit-maximizing output doesn’t mean it’s making an economic profit  it might break even or incur an economic loss instead  if price equals average total cost, a firm breaks even  if price is more than average total cost, the firm makes an economic profit  if price is less than average total cost, the firm incurs an economic loss Three Possible Short-Run Outcomes  breakeven  produces at the quantity where MC = ATC  price = minimum ATC  economic profit  produces at the quantity where MC > ATC  price > ATC  profit = (P – ATC) × Q  economic loss  produces at the quantity where MC = AVC  price < ATC  loss
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