CHAPTER 11: Perfect Competition

Question 1

Perfect Competition describes a market in which there are…

Answer 1

○ Many firms that sell identical products to many buyers
○ No restrictions on market entry
○ Established firms have no advantage over new ones
○ Sellers & buyers are well informed about prices

Question 2

When does perfect competition arise?

Answer 2

• Arises if the minimum efficient scale of a single producer is small relative to the market demand for the good or services
• Each firm produces a good that has no unique characteristics, so consumers don’t care which firm’s good they buy

Question 3

What is a price taker?

Answer 3

firm that cannot influence market price bc production is an insignificant part of the total market

Question 4

RECAP: total cost is …..

Answer 4

opportunity cost of production (includes normal profit)

Question 5

RECAP: total revenue is ….

Answer 5

Price of output multiplied by the quantity of output sold

Question 6

Marginal Revenue

Answer 6

Change in total revenue that results from a one-unit increase in the quantity sold
○ Divide change in total revenue by change in quantity sold
○ In perfect competition, marginal revenue = market price

Question 7

T/F: In perfect competition, a firm can sell any quantity it chooses at the market price

Answer 7

True

Question 8

What does it mean when the demand curve for product is a horizontal line at the market price?

Answer 8

Illustrates that the demand for the product is perfectly elastic
E.g. a sweater from Campus Sweaters is a perfect substitute for a sweater from any other factory

Question 9

The point at which a firm has zero economic profit is referred to as the the firm’s____________.

Answer 9

break-even point

Question 10

What is the purpose of marginal analysis?

Answer 10

Allows us to find profit-maximizing output
compares marginal revenue (MR) w/ marginal cost (MC)

Question 11

What supply decisions occur when marginal revenue exceeds marginal cost?

Answer 11

revenue from selling one more unit exceeds the cost of producing it & an increase in output increases economic profit

Question 12

What supply decisions occur when marginal revenue is less than marginal cost?

Answer 12

revenue from selling one more unit is less than the cost of producing that unit & a decrease in output increases economic profit

Question 13

What supply decisions occur when marginal revenue equals marginal cost?

Answer 13

then the revenue from selling one mores unit equals the cost incurred to produce that unit
○ Economic profit is maximized & either an increase or decrease in output decreases profit

Question 14

Explain the law of supply in relation to profit-maximizing output & market price.

Answer 14

Law of supply - higher the market price of a good, the greater the quantity supplied

○ If price was higher than quantity supplied at the market price (e.g. $25 for 9 sweaters), production increases

○ If price was lower than quantity supplied at the market price, production decreases

Question 15

Economic Loss Equation

Answer 15

TFC + (AVC - P) x Q

○ AVC - average variable cost
○ P - total revenue/price
○ Q - quantity

Question 16

If a firm shuts down, it produces ____ ______. Explain.

Answer 16

no output (Q = 0)
○ Has no variable costs & no revenue but it must pay its fixed costs, so its economic loss = TFC

Question 17

If a firm produces, in addition to fixed costs, it incurs _____ ______/ Explain.

Answer 17

variable costs (& revenue)
○ Economic loss = TFC (loss when shutdown) + TVC - Total Revenue (TR)
○ If TVC exceeds TR, loss exceeds TFC & firm shuts down
○If AVC exceeds P, loss exceeds TFC & firm shuts down

Question 18

The shutdown point describes _____.

Answer 18

price & quantity at which it is indifferent between producing & shutting down
Occurs at the price & quantity at which AVC is a minimum
Firm minimizes loss & its loss = TFC

Question 19

Describe the shut-down decision that occurs when price falls below the minimum AVC.

Answer 19

firm shuts down temporarily & continues to incur a loss equal to TFC

Question 20

Describe the shut-down decision that occurs when price is above the minimum AVC.

Answer 20

firm produces the loss-minimizing output & incurs a loss less than the TFC

Question 21

If the market is relatively small, and changes in output do not result in changes in the cost of factors of production, what is the market described as?

Answer 21

market is a constant-cost industry
The long run supply curve in such an industry is horizontal

Question 22

If the cost of factors of production increases due an increased demand from a particular market we say that the market is an…..

Answer 22

increasing cost industry
the long run supply curve is upward sloping.

*It is also possible that we have a decreasing cost industry and long run supply is downward sloping.

Question 23

In perfectly competitive markets equilibrium occurs where quantity supplied equals quantity demanded. What does this infer?

Answer 23

the willingness to pay of the individual who values the good least is exactly equal to the marginal cost of production of the firm that produces the last unit least efficiently

maximum willingness to pay of the consumer is greater than the marginal cost of production by the firm

total surplus is at its greatest level.

Question 24

What are monopolies?

Answer 24

consist of only one firm and the market demand curve is synonymous with the firm demand curve

Question 25

Describe price discrimination as a monopolist maximizing strategy.

Answer 25

Monopolist can charge either a single price to all consumers or charge different prices based on observable differences between consumers.

Question 26

Monopolistically competitive markets

Answer 26

consist of many firms producing similar, but not identical products, where barriers to entry or exit from the market do not exist.

downward sloping demand curves for their particular good but as there are many close substitutes the firm’s demand curve is relatively elastic compared to the monopolist’s demand curve.

Question 27

What does is mean when monopolistic competitive markets have demand curves with downward slopes?

Answer 27

marginal revenue is less than price and so monopolistically competitive markets are inefficient when compared to perfectly competitive markets