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Chapter 9

Economics 101: Chapter 9

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ECON 101
Robert Gateman

Economics 101: Principles of Microeconomics Chapter 9 9.1 Market Structure and Firm Behaviour  Market structure: the features that may affect the behaviour and performance of the firms in a market o Number of firms, types of products sold etc. Competitive Market Structure:  Market power: when firms have the ability to influence the price of their products o Turns in which they are purchased (buyer power, whole sale cost etc.) o Competitiveness of the market is the degree to which firms lack such market power  More competition, less market power  Competitive structure: when its firms have little or no market power o More market power a firm has, the less competitive the market structure  When the market is so competitive, the firm has zero market power o Firms must accept the market prices set by the forces of demand and supply markets  Perfectly competitive: no need to compete with other firms because no firm has market power o One firm's ability to sell a product does not depend on the actions of another firm Competitive Behaviour:  The degree to which individual firms actively compete with another firm for business o Some firms actively compete and are still able to change market prices/rates o Some firms can only change profits in a competitive market by production level  Firms that do compete with each other do not operate in perfectly competitive markets Significance of Market Structure:  A firm's output to maximize profits depends on demand for the product and production costs o This where the demand curve for an industry meets the demand curve for a firm  Market structure plays a central role in determining the behaviour of a firm o Affects overall efficiency of the market outcome 9.2 The Theory of Perfect Competition  Perfect competition: perfectly competitive market structure o Applies to several markets (agriculture, raw materials etc.) o Provides a benchmark comparison with other market structures The Assumption of Perfect Competition:  Theory is built on a number of assumptions relation to each firm and the industry as a whole: 1. All firms in the industry sell a homogenous product (identical good/product/service) 2. Consumer know about the products and the prices charged by each firm 3. A firm's output when long-run average cost reaches a minimum is part of the industry output 4. Firms are able to enter and exit the market at any time (no blocking or legal prohibitions) Economics 101: Principles of Microeconomics  Price taker: the firm can alter its production and sales without affecting the market price Demand Curve for Perfectly Competitive Firm:  Demand curve for the entire industry is negatively sloped o Each firm in a perfectly competitive market faces a horizontal demand curve o Variations of a firm's output have no significant effect on price  Some firm's demand curves are very elastic even though the industry in inelastic Total, Average, and Marginal Revenue:  Total revenue (TR): total amount received by a firm from the sale of a product o  Average revenue (AR): amount of revenue per unit sold o Total revenue divided by the number of units sold (otherwise known as selling price) o  Marginal revenue (MR): change in a firm's total revenue from a change in its sales by one unit o  o Drawn as a horizontal level at the price level (market price) o Total revenue is an increasing curve (supply curve) 9.3 Short-Run Decisions Should the Firm Produce?  If a firm produces nothing, its loss is equal to the fixed costs o When production starts, variable costs are added to the fixed costs  Beneficial for a firm to produce a level of output in which revenue is greater than variable costs o If revenue is less than variable costs, the firm is losing more money producing than if it was not  Firm should not produce at all if for all levels of output, the total variable cost of producing that outputs exceeds the total revenue from selling it  Firm should not produce at all if for all levels of output, the average variable cost of producing the output exceeds the market price  Shut-down price: price at which the firm can just cover its variable cost How Much Should the Firm Produce?  The product that adds more revenue than variable cost is the minimal output level o Marginal revenue exceeds marginal cost of producing a product  If the last unit produced increases revenue by less than it increases cost, the profit maximizing firm should reduce its output  Economics 101: Principles of Microeconomics  Profit maximizing firm operating in a perfectly competitive market will produce the output that equates its marginal cost of production with the market price of its product o As long as price exceeds variable cost  A perfectly competitive firm adjusts its level of output in response to changes in the market-determined price o A profit maximizing firm will not change output if profits are maximized Short-Run Supply Curve - One Firm:  Derive a supply curve that shows the quantity of output that the firm will supply at each price o Prices below average variable cost, the firm will supply zero units o Price above average VC the firm will choose output to equate price and marginal cost  Competitive firm's supply curve is given by the portion of its marginal cost curve that is above its average variable cost curve Short-Run Supply Curve - Industry:  Derivative on an industry supply curve for an industry containing two firms  Perfect competition industry supply curve is the horizontal sum of marginal cost curve of all firms in the industry o Marginal cost curve above the level of average variable cost  Firm's marginal cost curve shows the supply at each given market price o Industry supply is the sum of what each firm will supply Short-Run Equilibrium in a Competitive Market:  Collective actions of all firms in an industry and actions of households can together determine the equilibrium price o Point at which the supply and demand curve intersect  Short-run equilibrium: each firm is producing/selling a quantity so marginal cost = market price o No firm is motivated to change its output in the short-run  Industries in short-run equilibrium have Qd = Qs, and each firm is maximizing profits  Economic profit: area where market price exceeds average total cost at q*  In the short-run firms maximize profits o Do not know if profits are zero, negative or positive o In all cases the firm is maximizing profits where price = marginal cost   Some firms will continue to produce even after incurring losses o Firm should continue to produce as long as revenues are more or equal to variable cost 9.4 Long-Run Decisions  In the long-run both the number of firms and the size of the firm's plant are variable  Assume all firms in the industry have the same technology, same curves o Short-run equilibrium in the industry will have all firms being equally profitable Economics 101: Principles of Microeconomics Entry and Exit:  Key difference between short-run and long run, is the entry or exit of firms  If firms in an industry are breaking even there is no incentive for
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