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Chapter 14

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Boston University
CAS EC 101

Chapter 15: firms in competitive markets - What is a competitive market o the meaning of competition  Sometimes called a perfectly competitive market, has 2 characteristics • Many buyers and sellers • Goods offered are largely the same • Firms can freely enter/exit market  Buyers and sellers are price takers, they must accept the market price o The revenue of a competitive firm  Firm tries to maximize profit  Average revenue: total revenue divided by quantity sold  Average revenue = price of the good  Marginal revenue: change in total revenue from additional unit sold, marginal revenue = price of good for competitive firms - Profit maximization and the competitive firm’s supply curve o The marginal cost curve and the firm’s supply decision  Firm maximizes profit by producing the quantity at which marginal cost = marginal revenue  If marginal revenue is greater than marginal cost, the firm should increase output  If marginal cost is greater than marginal revenue, firm should decrease output  Because firm’s marginal cost curve determines the quantity of the good the firm is willing to supply at any price, the marginal cost curve is also the competitive firm’s supply curve • Some caveats to this o The firm’s short run decision to shutdown  Shutdown refers to a short-run decision not to produce anything during a specific period of time b/c of current market conditions  Exit is a long run decision to leave the market  Long run and short run differ b/c most firms cannot avoid fixed costs in short- term  If firm shuts down, it loses all revenue, saves variable costs, but must pay fixed costs  The fir shut down if the revenue that it would get from producing is less than its variable costs of production • Shutdown = TC
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