Textbook Notes (362,735)
Canada (158,032)
Economics (697)
Chapter 12

Chapter 12 Textbook Notes

12 Pages
Unlock Document

Western University
Economics 1021A/B
Michael Parkin

Economics Chapter 12 Notes Nov. 13 What is Perfect Competition? • Perfect competition: a market in which: ○ Many firms sell identical products to many buyers ○ There are no restrictions on entry into the market ○ Established firms have no advantage over new ones ○ Sellers and buyers are well informed about prices How Perfect Competition Arises • Arises if the minimum efficient scale of a single producer is small relative to the market demand for the good or service • A firms minimum efficient scale is 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 firms 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 ○ E.g. all wheat is the same as any farmer. Market price is $300/tonne (highest price you can get for your wheat). That is the price you will sell it at. Economic Profit and Revenue • Economic profit: total revenue minus total cost ○ Total cost is the opportunity cost of production which includes normal profit • Total revenue: equals the price of a firms output multiplied by the number of units of output sold (price X quantity) • Marginal revenue: the change in total revenue that results from a one-unit increase in the quantity sold ○ Calculated by dividing the change in total revenue by the change in the quantity sold • Total Revenue ○ Equal to the price multiplied by the quantity sold ○ If the picture above, is they sell 9 sweaters, total revenue is $225 • Marginal Revenue ○ The change in total revenue that results from a one-unit increase in quantity sold ○ In the picture above, when it increases from 8 to 9 sweaters, marginal revenue is $25/sweater ○ Because the firm in perfect competition is a price taker, the change in total revenue that results from a one-unit increase in the quantity sold equals the market price ○ In perfect competition, the firm’s marginal revenue equals the market price • Demand for the Firm’s Product ○ The firm can sell any quantity it chooses at the market price sot he demand curve for the firm’s product is a horizontal line at the market price, the same as the firm’s marginal revenue curve ○ Horizontal demand curve = perfectly elastic demand The Firm’s Decision • The goal of the competitive firm is to maximize economic profit • To achieve its goal, a firm must decide 1. How to produce at minimum cost 2. What quantity to produce 3. Whether to enter or exit a market The Firm’s Output Decision • Firms cost curves (total, average, marginal) describe the relationship between its outputs and costs • Firms revenue curves (total, marginal) describe the relationship between its output and revenue • From these two curves, we can find the output that maximizes total profit • Economic profit equals total revenue minues total cost • Economic profit is maximized at an output of 9 sweaters Marginal Analysis and the Supply Decision • Another way to find the profit-maximizing output is to use marginal analysis ○ Compares marginal revenue with marginal cost • As output increases, marginal revenue is constant but marginal cost eventually increases • If marginal revenue exceeds the firms marginal cost, then the revenue from selling one more unit exceeds the cost of producing that unit and an increase in output will increase economic profit • If marginal revenue is less than marginal cost then the revenue from selling one more unit is less than the cost of producing that unit and a decrease in output will increase economic profit • If marginal revenue equals marginal cost, then the revenue from selling one more unit equals the cost incurred to produce that unit ○ Economic profit is maximized and either an increase or a decrease in output decreases economic profit • All things remaining the same, the higher the market price of a good, the greater is the quantity supplied of that good Temporary Shutdown Decision • Firms maximize profit by producing the quantity at which marginal revenue (price) equals marginal cost • Suppose that at this quantity, price is less than average total cost • In this case, the firm incurs an economic loss • If the firm expects the loss to be permanent, they go out of business • If they expect the loss to be temporary, the firm must decide whether to shut down temporarily and produce no output or to keep producing • To make this decision, the firm compares the loss from shutting down with the loss from producing • Loss Comparisons ○ Economic loss = TFC + (AVC – P) X Q ○ If the firm shuts down, they produce no output (Q = 0) ○ If the firm produces then in addition to its fixed costs, it incurs variable costs  Also receives revenue ○ If total variable cost exceeds total revenue, this loss exceeds total fixed cost and the firm shuts down • The Shutdown Point ○ Shutdown point: the price and quantity at which it is indifferent between producing and shutting down ○ Occurs at the price and quantity at which average variable cost is a minimum ○ Firm is minimizing its loss and its loss equals total fixed cost ○ At prices above minimum average variable cost buw below average total cost, the firm produces the loss minimizing output and incurs a loss, but a loss that is less than total fixed cost ○ Marginal revenue equals marginal cost at 7 sweaters/day, so this quantity maximizes economic profit The Firm’s Supply Curve • A perfectly competitive firms supply curve shows how its profit maximizing output caries as the market price varies, other things remaining the same • Supply curve is derived from the firms marginal cost curve and average variable cost curves • When the price exceeds minimum average variable cost (more then $17), the firm maximizes profit by producing the output at which marginal cost equals price ○ Price rises – firm increaes its output (move up along marginal cost curve) • When the price is less than minimum average variable cost (less than $17), the firm maximizes profit by temporarily shutting down and producing no output ○ The firm produces zero output at al prices below minimum average variable cost • When the price equals minimum average variable cost, the firm maximizes profit either by temporaily shutting down or producing the output at which average variable cost is a minimum (shutdown point) • A firm never produces a quantity between xero and the shutdown point 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 the firms in the market at each price when each firms plant and the number of firms remains the same • The quantity supplied by the market at a given price is the sum of the quantities supplied by all the firms in the market at that price • The market supply curve is a graph of the market supply schedule, and the points on the supply curve A-D represent the rows of the table • To construct the market supply curve, we sum the quantities supplied by all the firms at each price Short-Run Equilibrium • Market demand and short-run market supply determines the market price and market output A Change in Demand • Changes in demand bring changes to short-run market equilibrium • If demand increase and the demand curve shifts rightward to D2, the
More Less

Related notes for Economics 1021A/B

Log In


Don't have an account?

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.