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Chapter 14

Chapter 14 Economics.docx

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Economics 10a
Gregory Mankiw

Chapter 14 Economics: Firms in Competitive Markets • Afirm that can influence the market price of the good it sells has market power • Competitive market (perfectly competitive market): a market with many buyers and sellers trading identical products so that each buyer and seller is a price taker o The actions of any individual buyers or sellers has a negligible impact on the market price o Firms can freely enter or exit the market • Afirm tries to maximize profit • Total revenue: P × Q o Total revenue is proportional to output • Average revenue: total revenue divided by the quantity sold o For all firms in a perfectly competitive, average revenue equals the price of the good • Marginal revenue: the change in total revenue from an additional unit sold o For competitive firms, marginal revenue equals the price of the good • Profit= total revenue – total cost • MR=MC in order to maximize profits • Review of Ch. 13: Marginal cost curve slops upward;ATC is u-shaped; MC=ATC at the minimum ofATC; P is perfectly elastic (horizontal line), making the firm a price-taker o Price-taker: (P=MR=Average Revenue (AR)) the price of a firm’s output is the same regardless of quantity produced • Rules apply to all firms: o As long as marginal revenue exceeds marginal cost, increasing the quantity produced/output raises profit; profit can be increased o When marginal cost exceeds marginal revenue, losses are incurred and the quantity should not rise to that point; profit can be increased by reducing production/output o The firm will self-regulate to reach the profit-maximizing level of output (where MR=MC) • In a competitive firm, because P=MR (it’s a price-taker), the intersection of Price, Marginal Revenue, and Marginal Cost is the profit-maximizing level of output • Because the marginal cost curve determines the quantity of the good the firm is willing to supply at any price, MC=supply curve • In a competitive market:An increase in price corresponds to an increase in quantity of output • 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 • Profit from an extra unit sold is zero • The short-run and long-run decisions are different because most firms cannot avoid their fixed costs in the short run but can do so in the long run o Afirm that shuts down temporarily still has to pay its fixed coststhese are called sunk costs  It loses all revenue from the sale of its product and saves the variable cost  Afirm shuts down if the revenue that it would earn form producing is less than its variable costs of production (TRATC, meaning that it is profitable • Long-Run Profit Maximization: o If the firm is in the market, it produces the quantity at which MC=P=MR o If P
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