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Chapter 12

Chapter 12

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Department
Economics
Course
Economics 1021A/B
Professor
Jeannie Gillmore
Semester
Fall

Description
Chapter 12 Notes Perfect Competition Markets  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  perfect competition arises if the minimum efficient scale of a single producer is small relative to the market demand for the good or service o a firm’s minimum efficient scale is the smallest output at which long-run average cost reaches its lowest level o in this situation, there is room in the market for many firms  each firm produces a good that has no unique characteristics, so consumers don’t care which firm’s good they buy Price Takers  firms in perfect competition are price takers o a price taker is a firm that cannot influence the market price because its production is an insignificant part of the total market  firms must sell at market price o goods priced over market price  no one buys o goods price below market price  everyone buys, sold out immediately losing money Economic Profit and Revenue  a firm’s goal is to maximize economic profit o economic profit = total revenue – total cost  a firm’s total revenue equals the price of its output multiplied by the number of units of output sold (P • Q)  marginal revenue is the change in total revenue that results from a one-unit increase in the quantity sold o calculated by ∆TR ÷ ∆Q Marginal Revenue and Demand  because firms in perfect competition are price takers, the change in total revenue that results from a one-unit increase in the quantity sold equals the market price o in perfect competition, the firm’s marginal revenue equals the market price  firms can sell any quantity of products at the market price o the demand curve is thus a horizontal line at the market price (same as marginal revenue curve)  demand for the firm’s products is perfectly elastic  e/x a sweater from Campus Sweaters is a perfect substitute for a sweater from any other factory  the market demand for a product is not perfectly elastic o its elasticity depends on the substitutability of products for other goods and service  e/x a sweater from Campus Sweaters could be substituted for t-shirts, sweatpants, etc. Decisions of a Firm  to achieve its goal of maximizing profit, a firm must decide three things o how to produce at minimum cost o what quantity to produce o whether to enter or exit a market  firms produce at minimum cost by operating with the plant that minimizes long-run average cost o does this by being on its long-run average cost curve Firm’s Output Decision  a firm’s revenue curves describe the relationship between its output and revenue o economic profit occurs whenever total revenue is greater than total cost  firms with to produce at points where is maximized o when firms make 0 economic profit, they produce at the break even point Marginal Analysis and Supply Decision  another way to find the profit-maximizing output is to use marginal analysis o compares marginal revenue (MR) with marginal cost (MC) o as output increases, the firm’s marginal revenue is constant, but its marginal cost eventually increases  if marginal revenue exceeds marginal cost, the revenue from selling one more unit exceeds the cost of producing it o increase in output increases 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 it o decrease in output increases economic profit  if marginal revenue equals marginal cost, then the revenue from selling one more unit equals the cost incurred to produce that unit o economic profit is maximized o an increase or decrease in output decreases profit  a firm’s profit-maximizing output is its quantity supplied at the market price o other things remaining the same, the higher the market price of a good, the greater the quantity supplied of that good Temporary Shutdown Decision  a firm’s economic loss equals total fixed cost, TFC, plus total variable cost, TVC, minus total revenue o EL = TFC + TVC o EL = TFC + (AVC – P) • Q  if a firm shuts down, it produces no output (Q=0) o the firm has no variable costs and no revenue, but it must pay its fixed costs o EL = TFC  if the firm produces, then it incurs variable costs, but also receives revenue o economic loss equals TFC, plus total variable cost minus revenue o if TVC exceeds total revenue, this loss exceeds TFC and the firm shuts down o if average variable cost exceeds price, this loss exceeds total fixed cost and the firm shuts down  a firm’s shutdown point is the price and quantity at which it is indifferent between producing and shutting down o occurs at the price and the quantity at which AVC is a minimum  the firm is minimizing its loss and its loss equals total fixed cost o if the price falls below minimum average variable cost, the firm shuts down temporarily and continues to incur a loss equal to total fixed cost o at prices above minimum average variable cost, but below average total cost, the firm produces the loss- minimizing output and incurs a loss (but the loss is less than total fixed cost) The Firm’s Supply Curve  when the price exceeds minimum average variable cost, the firm maximizes profit by producing the output at which marginal cost equals price o the price rises, the firm increases its output (moves along marginal cost curve)  when the price is less than minimum average variable cost, the firm maximizes profit by temporarily shutting down and producing no output o the firm produces zero output at all prices below minimum AVC  when the price equals minimum average variable cost, the firm maximizes profit by either shutting down and producing no output or by producing the output at which average variable cost is a minimum (shut down point) o firms never produce a quantity between zero and the quantity at the shutdown point o supply curves thus run along the y-axis from 0 to the price of AVC, and then follows the marginal cost curve Market Supply in the Short Run  the short-run market supply curve shows the quantity supplied by all the firms in the market at each price  market demand and short-run market supply determine the market price and market outpu
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