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Chapter 14

Chapter 14 EC120.docx

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Peter Sinclair

EC120 Chapter 14-Firms in Competitive Markets Week 7 The Meaning of Competition -A competitive market has two characteristics: There are many buyers and many sellers in the market The goods offered by the various sellers are largely the same -An example is the market for milk, no single buyer of milk can influence the price of milk, and no single seller of milk can change the price because all milk is essentially identical. -Because each seller can sell all he wants to at the going price, he has little reason to charge less, and if he charges more, buyers will go elsewhere -There is a third condition to markets: Firms can freely enter or exit the market in the long run The Revenue of a Competitive Firm -A firm in a competitive market, tries to maximize its profits -Any small company must take the price of its market conditions -P x Q = Total Revenue How much revenue does the farm receive for the typical jug of milk? How much additional revenue does the farm receive if it increases production of milk by 1 jug? -Average Revenue – total revenue divided by the quantity sold -Marginal Revenue – the change in total revenue from an additional unit sold Profit Maximization and The Competitive Firm’s Supply Curve A Simple Example of Profit Maximization EC120 Chapter 14-Firms in Competitive Markets Week 7 The Marginal-Cost Curve and the Firm’s Supply Decision -The price is horizontal because the firm is a price taker -The price of the firm’s output is the same regardless of the quantity that the firm decides to produce -Three general rules for profit maximization: If marginal revenue is greater than marginal cost, the firm should increase its output If marginal cost is greater than marginal revenue, the firm should decrease its output At the profit-maximizing level of output, marginal revenue and marginal cost are exactly equal -These rules are key to rational decision making by a profit-maximizing firm -Because the firm’s marginal-cost curve determines the quantity of the good the firm is willing to supply at any price, it is the competitive firm’s supply curve The Firm’s Short-Run Decision to Shut Down -In some circumstances, a firm will shut down and not produce anything at all A shutdown refers to a short-run decision not to produce anything during a specific period of time because of current market conditions -Exit refers to a long run decision to leave the market -Shutdown is TR
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