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Department
Economics
Course
Economics 1021A/B
Professor
Michael Parkin
Semester
Fall

Description
Economics – Textbook Notes What is Perfect Competition? Perfect competition is 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 Examples:  Farming, fishing, wood pulping and paper milling, plumbing, painting, and laundry services are all examples of highly competitive industries How Perfect Competition Arises Perfect competition arises if the minimum efficient scale of a single producer is small relative to the market demand for the good or service. Each firm produces a good that has no unique characteristics, so consumers don’t care which firms good they buy. Price Takers A price taker is a firm that cannot influence the market price because its production is an insignificant part of the total market. Economic Profit and Revenue  Total Revenue o A firm’s total revenue equals the price of its output multiplied by the number of units of output sold (price X quantity) o Each additional unit of a good brings in a constant amount, the total revenue curve is an upward-sloping straight line  Marginal Revenue o Marginal revenue is the change in total revenue that results from a one- unit increase in the quantity sold o The marginal revenue = Demand (MR=D=AR=P) 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.  Demand for the Firm’s Product o The firm can sell any quantity it chooses at the market price, so the demand curve for the firm’s product is a horizontal line at the market price  Perfectly elastic demand The Firm’s Decisions The goal of the competitive firm is to maximize economic profit. To achieve this goal, it must decide: 1. How to produce at minimum cost 2. What quantity to produce 3. Whether to enter or exit a marketThe Firm’s Output Decision From the firm’s cost curves and revenue curves, we can find the output that maximizes the firm’s economic profit. Economic profit equals total revenue minus total cost. Marginal Analysis an the Supply Decision  Marginal analysis compares marginal revenue, MR, with marginal cost, MC. As output increases, marginal revenue is constant but marginal cost eventually increases.  If marginal revenue exceeds the firm’s marginal cost (MR > MC), then the revenue from selling one more unit exceeds the cost of producing that unit and an increase in output will increase economic profit.  A firm’s profit-maximizing output is its quantity supplied at the market price Temporary Shutdown Decision At this quantity, price is less than average total cost. In this case, the firm incurs an economic loss. Maximum profit is a loss (a minimum loss).  If the firm expects the loss to be permanent, it goes out of business  If it expects the loss the be temporary, the firm must decide whether to shut down temporarily and produce no output, or to keep producing  Loss Comparisons o A firm’s economic loss equals total fixed cost, TFC, plus total variable cost minus total revenue  Economic Loss = TFC + (AVC – P) X Q o If the firm shuts down, it produced no output (Q = 0). The firm has no variable cost and no revenue but it must pay its fixed cost, so its economic loss equals total fixed cost  Its economic loss equals total fixed cost – the loss when shut down – plus total variable cost minus total revenue  The Shutdown Point o A firm’s shutdown point is the price and quantity at which it is indifferent between producing and shutting down  The shutdown point occurs at the price and the quantity at which average variable cost is a minimum  At the shutdown point, the firm is minimizing its loss and its loss equals total fixed cost  If the price falls below minimum average variable cost, the firm shuts down temporarily  At prices above minimum average variable cost but below average total cost, the firm produces the minimizing output and incurs a loss The Firm’s Supply Curve A perfectly competitive firm’s supply curve shows how its profit-maximizing output varies as the market price varies as the market price varies, other things remaining the same.  When price exceeds minimum average variable cost, the firm maximizes profit by producing the output at which marginal cost equals price  When the price is less than minimum average variable cost, the firm maximizes profit by temporarily shutting down and producing no output  When the price equals minimum average variable cost, the firm maximizes profit either by temporarily shutting down and producing no output or by producing the output at which average variable cost is minimum – the shutdown point The firm’s supply curve runs along the y-axis from a price of zero to a price equal to minimum average variable cost, and then, as the price rises above minimum average variable cost, follows the marginal cost curve. Output, Price, and Profit in the Short Run Market Supply in the Short Run The short run market supply curve show the quantity supplied by all firms in the market at each price when each firm’s plant and the number of firms remains the same.  The market supply curve is derived from the individual supply curves. 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  To construct the market supply curve, we sum the quantities supplied be all the firms at each price o The market supply curve is horizontal – supply is perfectly elastic at the shutdown point Short-Run Equilibrium Market demand and short-run market supply determine the market price and market output. Each firms takes this price as given and produced its profit maximizing output. Change in Demand Changes in demand bring changes to short run market equilibrium.  If demand increases and the demand curve shifts rightward, the market price rises  If demand decreases and the demand curve shits leftward, the market price falls  If demand curve shifts further left than the shutdown point, the price remains at the shutdown price o Some firms continue to produce, and others temporarily shut down o Firms are indifferent between these two activities, and whichever they choose, they incur an economic loss equal to total fixed cost Three Possible Short-Run Outcomes  Economic profit (or loss) per unit of a good is price, P, minus average total cost, ATC. If price equals average total cost, a firm breaks even o The entrepreneur makes normal profit  If price exceeds average total cost, the firm makes an economic profit  If price is less than average total cost, the firm incurs an economic lossOutput, Price, and Profit in the Long Run In the long run, firms can enter and exit the market. Entry and Exit Entry occurs in a market when new firms come into the market and the number of firms increases. Exit occurs when existing firms leave a market and the number of firms decreases.  Firms respond to economic profit and economic loss by either entering or exiting a market o New firms enter a market in which existing firms are making an economic profit. o Firms exit a market in which they are incurring an economic loss Entry and exit changes the market supply, which influences the market price, the quantity produced by each firm, and the firm’s economic profit (or loss)  If firms enter a market, supply increases and the market supply curve shifts
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