Chapter 10 Flashcards
Pure Competition in the Short Run
Four Market Models
Pure competition
Pure monopoly
Monopolistic competition
Oligopoly
Pure Competition: Characteristics
Very large numbers of sellers
Standardized product
“Price takers”
Easy entry and exit
standardized product (Pure Competition: Characteristics)
is a product for which all other products in the market are identical and thus are perfect substitutes. The consequence of this is that buyers are indifferent as to whom they buy from.
Price takers (Pure Competition: Characteristics)
are sellers that have no pricing power; in other words, they do not have the ability to price their product.
Easy entry and exit (Pure Competition: Characteristics)
means that there are no obstacles to entry or to exit the industry.
Perfectly elastic demand
means that firm has no power to influence price so the firm merely chooses to produce a certain level of output at the price that is given.
The demand curve is not perfectly elastic for the industry; it only appears that way to the individual firm, since they must take the market price no matter what quantity they produce. The firm faces a perfectly elastic demand because each individual firm makes up such a small part of the total market and the goods are perfect substitutes. Note that this perfectly elastic demand curve is a horizontal line at the price.
Average revenue
Revenue per unit
AR = TR/Q = P
When a firm charges the same price for each unit of output, the ____ ____ is just the price of the good
Total revenue
TR = P X Q
refers to the total amount of money that the firm collects for the sale of all of the units of their good.
Marginal revenue
Extra revenue from 1 more unit
MR = ΔTR/ΔQ
reflects the additional revenue that the firm will receive by producing one more unit of output. When the firm is deciding how much to produce, the firm considers the _____ _____ in their decision.
Profit Maximization: TR – TC Approach
The competitive producer will ask three questions?
Should the firm produce?
If so, in what amount?
What economic profit (loss) will be realized?
When looking at profit maximization there are essentially 3 questions that the firm must answer. The first question is whether or not the firm should produce at all in the short run. In the short run, the firm should shut-down under certain circumstances. If it has been determined that the firm should produce in the short run, then the firm must determine how much to produce. Lastly, based on the answers to the first two questions, it is necessary to calculate the profit or loss for the firm. Part of the profit-maximization rule is producing an output that minimizes losses in the short run when that is the best option.
Loss-Minimizing Case
Loss minimization
Still produce because MR > minimum AVC
Losses at a minimum where MR = MC
Producing adds more to revenue than to costs
In the short run the firm only has two choices: produce or shut-down. There is not enough time in the short run for the firm to get out of business. Given these options, sometimes the firm will produce, but still make a loss. In these situations, the loss from producing is smaller than the loss if the firm shut-down so this is the firm’s best choice.
Production Question
Should this firm produce?
Yes, if price is equal to, or greater than, minimum average variable cost. This means that the firm is profitable or that its losses are less than its fixed cost.
Production Question
What quantity should this firm produce?
Produce where MR (=P) = MC; there, profit is maximized (TR exceeds TC by a maximum amount) or loss is minimized.
Production Question
Will production result in economic profit?
Yes, if price exceeds average total cost (TR will exceed TC). No, if average total cost exceeds price (TC will exceed TR).
Production questions to ask following Output Determination in Pure Competition in the Short Run
Should this firm produce?
What quantity should this firm produce?
Will production result in economic profit?
The market equilibrium condition
where quantity demanded equals quantity supplied
Firm versus Industry: Equilibrium Graph
Short-run competitive equilibrium for (a) a firm and (b) the industry. The horizontal sum of the 1000 firms’ individual supply curves (s) determines the industry supply curve (S). Given industry demand (D), the short-run equilibrium price and output for the industry are $111 and 8000 units. Taking the equilibrium price as given, the individual firm establishes its profit-maximizing output at 8 units and, in this case, realizes the economic profit represented by the green area.
Individual firms must take price as given, but the supply plans of all competitive producers as a group are a major determinant of product price.
