5a. Market Competition

Question 1

What is the goal of the “seller”?

Answer 1

PROFIT MAXIMISATION

Question 2

How much can a seller get for a product in the market, if the market is perfectly competitive?

Answer 2

If the market is perfectly competitive, the firm TAKES the market price, NO control over price!

Question 3

What does the profit equation for a firm look like?

Answer 3

π = R - C

Question 4

What does the DIG look like for a perfectly competitive market?

Answer 4

Question 5

Can firms in perfectly competitive markets create “scarcity”?

Answer 5

NO!!!

Whether he produces very little or a lot, it has no impact on the price (unlike monopolists who can create scarcity)

Question 6

What is important to remember about MR in a perfectly competitive market?

Answer 6

As price is ALWAYS the same (horizontal demand curve),

MR = P

Question 7

At which Q are profits maximized?

Answer 7

Profits are maximized at q* such as MR(q) = MC(q)

Question 8

How can you use marginal profit to find the profit maximization quantity?

Answer 8

Remember, profit = rev - costs

So, marginal profit = MR - MC

You can graph the profit curve and the SLOPE is the marginal profit. So where that is 0, (where MR - MC = 0), is the profit maximum qty

Question 9

What is the shutdown decision rule?

Answer 9

“the firm shuts down only if it can reduce its loss by doing so”

Question 10

In the SR firms have to pay what kind of costs?

Answer 10

BOTH VC as well as FC

Question 11

What do we consider FC in the short run?

Answer 11

fixed costs are considered sunk costs

Question 12

If a firm halts operations, what will it have to pay, and what will it avoid paying?

Answer 12

It will avoid paying VC, as no units of output are produced.

HOWEVER, considering its fixed costs are sunk, that money is still lost

Question 13

If a firm in the SR’s weekly revenue is 2000, variable cost is 1000, and fixed cost is 3000. Should it continue operating?

Answer 13

YES.

π = 2000 - 1000 - 3000 = -2000

So there is STILL a loss of 2000, but this is better than just accepting losing 3000 (which would happen if the firm halts operations).

Question 14

If a firm in the SR’s weekly revenue is 500, variable cost is 1000, and fixed cost is 3000. Should it continue operating?

Answer 14

NO.

π = 500 - 1000 - 3000 = -3500

a loss of $3500 is greater than losing the fixed cost of $3000, so its better to shut down

Question 15

Could a firm operate at a loss?

Answer 15

In the long run -> NO!

In the short run it may be acceptable if rev exceeds VC , which can help recoup some of the sunk fixed costs

Question 16

What is the equation of the supply function in a competitive market?

Answer 16

Because a competitive firm’s marginal revenue equals the market price…

p = MC(q*)

Question 17

What is the firms profit?

Answer 17

MC curve crosses the firm’s demand curve (MR) at point e

-> This is the profit maximizing quantity of output (284 units)

At 284 units, the lime firm’s average profit per unit is $1.50 = p - AC (284) = $8 - $6.50,
and the firm’s profit is π = $1.50 * 284,000 = $426,000.

Question 18

How are short-run and long-run supply different?

Answer 18

1. MC(q) in short run differs from marginal cost in the long run. (remember, K if fixed in SR!)
2. In Short Run firms cannot enter or exit the market whereas in Long Run, firms can enter or exit the market freely.

Question 19

What cost is considered “unavoidable” in the short-run?

Answer 19

fixed costs

Question 20

In the short-run, what does a firm look at to decide to shutdown?

Answer 20

Can I at least cover the variable costs?

Yes? -> Produce.

No? -> Shut Down.

Question 21

What should the firm do in this scenario?

Answer 21

What if the market price is between the minimum AC and the minimum AVC?
-> If the price is in this range, the firm makes a loss, but it reduces its loss by operating rather than shutting down.

Question 22

Why do we troncate the supply curve above AVC?

Answer 22

Firm would NOT produce at a qty where price is lower than AVC (just cleans up the graph to not show it!)

Question 23

What is the “market supply curve”?

Answer 23

The market supply curve is the horizontal sum of the firm supply curves.

Question 24

The more identical firms there are, the ______ the short-run market supply curve

Answer 24

“the more identical firms producing at a given price, the flatter (more elastic) the short-run market supply curve at that price”

Question 25

Is it possible for a market supply curve to look like this?

Answer 25

YES.

If firms in a competitive market have different minimum AVC costs, not all firms produce at every price,

–> resulting in this composite curve

Question 26

What is the long-run shutdown decision?

Answer 26

Shutdown if π < 0.

In the LR we consider fixed costs AVOIDABLE

Therefore, as all costs are variable in the LR, the firm shuts down if it would suffer an economic loss by continuing to operate.

Question 27

Does the firm produce more in the long run compared to the short run?

Answer 27

YES.

Because the AC is LOWER in the LR compared to the SR, it allows for a greater profit per unit
-> and consequently a greater supply curve and greater output

Question 28

What is important to remember about the number of firms in the LR compared to the SR?

Answer 28

In the LR, firms can enter or exit the market, so the number of firms is not fixed as it is in the SR.

Question 29

When does a firm enter a market?

Answer 29

a firm enters the market if it can make a long-run profit, π > 0.

Question 30

When does a firm exit a market?

Answer 30

a firm exits the market to avoid a long-run loss, π < 0.

Question 31

If a market makes zero LR profit, what do firms do?

Answer 31

We assume firms STAY in the market

Question 32

What are the 3 necessary conditions for the Long-run Market Supply to be flat?

Answer 32

The long-run market supply curve is flat at the minimum long-run average cost if…

1. firms can freely enter and exit the market
2. an unlimited number of firms have identical costs
3. input prices are constant

Question 33

Do competitive firms still make a profit in the long run?

Answer 33

Yes AND no…

They are said to make zero profit.

However, they technically still make a normal business profit that the firm could earn by investing elsewhere in the economy.

Question 34

Do competitive firms make a profit in the long run when entry is limited?

Answer 34

The reason why firms earn zero economic profits is that firms bidding for the scarce input drive its price up until the firms’ profits are zero.

In the Long Run the owner of the scarce input will make a RENT. And firms make zero profits.