MGEA02H3 Chapter Notes -Opportunity Cost, Sunk Costs, Average Variable Cost


Department
Economics for Management Studies
Course Code
MGEA02H3
Professor
Gordon Cleveland

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Chapter 9 Competitive Markets Notes
9.1 Market Structure and Firm Behaviour
x market structure : all features of market that affect behaviour and performance of firms in that market, such as number and size
of sellers, extent of knowledge about one another’s actions, degree of freedom of entry, and degree of product differentiation
Competitive Market Structure
x market power : the ability of a firm to influence the price of a product or the terms used which it is sold
x a market is said to have a competitive structure when its firms have little or no market power; the more market power the firms
have, the less competitive is the market structure
x in perfectly competitive market, there is no need for individual firms to compete actively with one another because none has any
power over the market; one firm’s ability to sell its product does not depend on the behaviour of any other firm
Competitive Behaviour
x the term competitive behaviour refers to the degree to which individual firms actively vie with one another for business
9.2 The Theory of Perfect Competition
x perfect competition : a market structure in which all firms in an industry are price takers and in which there is freedom of entry
into and exit from the industry
The Assumptions of Perfect Competition
1. All the firms in the industry sell an identical product. Economists say that the firms sell a homogenous product.
2. Consumers know the nature of the product being sold and the prices charged by each firm.
3. The level of a firm’s output at which its long-run average cost reaches a minimum is small relative to the industry’s total output.
(This is a precise way of saying the firm is small relative to the size of the industry.)
4. The industry is characterized by freedom of entry and exit; that is, any new firm is free to enter the industry and start producing if
it so wishes, and any existing firm is free to cease production and leave the industry. Existing firms cannot block the entry of
new firms, and there are no legal prohibitions or other barriers to entering or exiting the industry.
x homogenous product : in the eyes of purchasers, every unit of the product is identical to every other unit
x price taker : a firm that can alter its rate of production and sales without affecting the market price of its product
The Demand Curve for a Perfectly Competitive Firm
x even though the demand curve for the entire industry may be negatively sloped, each firm in a perfectly competitive market faces
a horizontal demand curve because variations in the firm’s output have no effect on price
Total, Average, and Marginal Revenue
x total revenue (TR) : total receipts from the sale of product; price times quantity
x TR = p × Q, where TR represents total revenue, Q represents units sold, and p represents price
x average revenue (AR) : total revenue divided by quantity sold; that is the market price when all units are sold at the same price
x AR = TR / Q = (p × Q) / Q = p where AR = p
x marginal revenue (MR) : the change in a firm’s total revenue resulting from a change in its sales by one unit
x MR = d TR / d Q = p (d Q / d Q) = p where MR represents marginal revenue and MR = p
x if the market price is unaffected by variations in the firm’s output, the firm’s demand curve, its average revenue curve, and its
marginal revenue curve all coincide in the same horizontal line
x for a firm in perfect competition, price equals marginal revenue
9.3 Short – Run Decisions
Rules for All Profit – Maximizing Firms
x two rules apply to all profit-maximizing firms, whether or not they operate in perfectly competitive markets
x the first rule determines whether the firm should produce at all, and the second determines how much it should produce
x Rule 1: A firm should not produce at all if, for all levels of output, the total variable cost of producing of producing that output
exceeds the total revenue derived from selling it. Equivalently, the firm should not produce at all if, for all levels of output, the
average variable cost of producing the output exceeds the price at which it can be sold.
x Rule 2: If it is worthwhile for the firm to produce at all, the firm should produce the output at which marginal revenue equals
marginal cost.
x a firm that is operating in a perfectly competitive market will produce the output that equates its marginal cost of production with
the market price of its product (as long as price exceeds average variable cost)
x the perfectly competitive firm adjusts its level of output in response to changes in the market-determined price
ShortRun Supply Curves
x a competitive firm’s supply curve is given by the portion of its marginal cost curve that is above its average variable cost curve
x in perfect competition, the industry supply curve is the horizontal sum of the marginal cost curves (above the level of average
variable cost) of all firms in the industry
Short Run Equilibrium in a Competitive Market
x short-run equilibrium : for a competitive industry, the price and output at which industry demand equals short-run industry
supply, and all firms are maximizing their profits; either profits or losses for individual firms are possible
x when an industry is in short-run equilibrium, quantity demanded equals quantity supplied, and each firm is maximizing its profits
given the market price
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