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Chapter 12

Economics 1021 Chapter 12 Notes

3 Pages

Course Code
Economics 1021A/B
Jeannie Gillmore

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Chapter 12 What is perfect competition?  Perfect competition is a market in which: o Many firms sell identical products to many buyers. o There are no restrictions on entry into the industry. o Established firms have no advantage over new ones. o Sellers and buyers are well informed about the prices.  Ex. Farming, fishing, wood pulping, paper milling  Arises if the minimum efficient scale (smallest output at which long-run average cost reaches its lowest level) of a single producer is small relative to the market demand for the good or service.  Each firm is a price taker (a firm that cannot influence the price of a good or service because its production is an insignificant part of the total market) because products are so identical.  Firm’s goal is to maximize economic profit (total revenue minus total cost) o Total revenue: Price of its output multiplied by the number of outputs sold o Total cost: opportunity cost of production o Marginal revenue: Change in total revenue that results from a one-unit increase in the quantity sold.  In perfect competition, the firm’s marginal revenue equals the market price. o Demand: Firms can sell any quantity it chooses at the market place, so the demand curve for the firm’s product is a horizontal line at market price.  Demand for the firm’s product is perfectly elastic.  Market demand for the product depends on the substitutability of the good to other goods.  A product from one from is a perfect substitute for a sweater from any other firm.  Firms’ Decisions: Goal of competitive firms is to maximize economic profit. To achieve its goals, firms must decide o How to produce at minimum cost  Operate with the plant that minimizes long-run average cost  Operating on the long-run average cost curve o What quantity to produce, or to enter or exit the market The firm’s output decision  Profit-maximization point: Economic profit is maximized when: o Total revenue exceeds total cost by the largest amount o Marginal revenue equals marginal cost  When MR exceeds MC, the revenue from selling one more unit exceeds the cost of producing it, and an increase in output increases economic profit.  When MC exceeds MR, the revenue from selling one more unit is less than the cost of producing that unit, and a decrease in output increases economic profit. o This is following the law of supply, which states that other things remaining the same, the higher the market price of a good, the greater is the quantity supplied of that good.  Break-even point: A point at which a firm makes zero economic profit (total revenue – total cost = 0)  Temporarily shut down decision: o If the maximum profit to be a loss, compare the loss from shutting down with the loss from producing.  Economic loss = Total fixed cost + (Average variable cost – price) x quantity  If the firm shuts down, economic loss equals total fixed cost since AVC and quantity equals 0.  If the firm produces, economic loss equals total fixed cost in addition to (TVC – total revenue)  Therefore, the firm shuts down if total variable cost exceeds total revenue
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