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Chapter 12

Economics 1021A/B Chapter Notes - Chapter 12: Average Variable Cost, Marginal Revenue, Market Power


Department
Economics
Course Code
ECON 1021A/B
Professor
Michael Parkin
Chapter
12

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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

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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

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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
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