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Econ 102 > Chapter 15 > Flashcards

Chapter 15 Flashcards

1
Q

Competitive market

A

A market with many buyers and sellers trading identical products so that each buyer and seller is a price taker

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2
Q

Characteristics of a competitive market

A

-Market has many buyers and many sellers
-Goods offered by the various sellers are identical
—Because of the first two: each buyer and seller is a price taker (takes the price as given)
-Firms can freely enter or exit the market

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3
Q

Examples of perfectly competitive market

A

Farming, fishing, wood pulping and paper milling, the manufacture of paper cups and shopping bags, grocery and fresh flower retailing, photo finishing, lawn services, plumbing, painting, dry cleaning are examples.

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4
Q

Revenue of a competitive firm

A

A firm in a competitive market, like most other firms in the economy, tries to maximize profit (total revenue minus total cost).

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5
Q

Total revenue

A

TR = P ˣ Q

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6
Q

Average revenue

A

AR = TR / Q

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7
Q

Marginal revenue

A

MR = ∆TR / ∆Q

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8
Q

For all types of firms, average revenue…

A

equals the price of the good

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9
Q

MR=P

A

for only competitive firms.

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10
Q

A competitive firm…

A

Can keep increasing its output without affecting the market price.

So, each one-unit increase in Q causes revenue to rise by P, i.e., MR = P

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11
Q

What Q maximizes a firm’s profit?
If Q increases by one unit …

A

Revenue rises by MR, cost rises by MC

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12
Q

If MR > MC…

A

increase Q to raise profit

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13
Q

If MR < MC…

A

decrease Q to raise profit

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14
Q

Maximize profit for Q where…

A

MR = MC

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15
Q

The MC curve is the firm’s …

A

Supply curve

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16
Q

Shutdown…

A

A short-run decision not to produce anything because of market conditions.

17
Q

Exit…

A

A long-run decision to leave the market.

18
Q

Difference between shutdown and exit…

A

If shut down in SR, must still pay FC.
If exit in LR, zero costs.

19
Q

Should a firm shut-down in the short run?

A

Shut down if TR < VC, TR/Q< VC/Q ,or P < AVC

Cost of shutting down = revenue loss
= TR
Benefit of shutting down = cost savings
= VC
(because the firm must still pay FC)

20
Q

Should a firm shut-down in the short run?(2)

A

firm will shut down if
P < AVC
If the price doesn’t cover the average variable cost, the firm is better off stopping production altogether.

21
Q

Sunk cost

A
  • A cost that has already been committed and cannot be recovered
  • Should be ignored when making decisions
  • You must pay them regardless of your choice
  • In the short run, FC are sunk costs
  • So, FC should not matter in the decision to shut down
22
Q

Should a firm exit or enter in the long run?

A

Cost of exiting market = revenue loss = TR
Benefit of exiting market = cost savings = TC (remember, FC = 0 in long run)

23
Q

Firm’s long-run decision…
Exit market if…
Enter market if…

A

Exit the market if: TR < TC (same as: P < ATC)
Enter the market if: TR > TC (same as: P > ATC)

24
Q

Profit-Maximizing Rules for a Competitive Firm..

A
  1. Find Q at which P = MC
  2. If P < AVC, shut down immediately and remain out of business
  3. If AVC < P < ATC, operate in the short run but exit in the long run
  4. If ATC < P, stay in business and enjoy your profits!
25
Q

The Short Run: Market Supply with a Fixed Number of Firms
Assumptions…

A
  • Assumptions
  • All existing firms and potential entrants have identical cost curves
  • Each firm’s costs do not change as other firms enter or exit the market
  • Number of firms
  • Fixed in the short run (due to fixed costs)
  • Variable in the long run (due to free entry and exit)
26
Q

As long as P > AVC

A

Each firm will produce its profit-maximizing quantity, where MR = MC

27
Q

For P > AVC: (curve)

A

Supply curve is MC curve

28
Q

Entry & Exit in the Long Run:

If existing firms earn positive economic profit (P > ATC ) :

A

In the long run, the number of firms can change due to entry and exit:
If existing firms earn positive economic profit (P > ATC ) :
- New firms enter, SR market supply shifts right
- P falls, reducing profits and slowing entry

29
Q

Entry & Exit in the Long Run:

If existing firms incur losses (P < ATC) :

A

If existing firms incur losses (P < ATC) :
- Some firms exit, SR market supply shifts left
- P rises, reducing remaining firms’ losses

30
Q

The Zero-Profit Condition:
Long-run equilibrium:

A
  • The process of entry or exit is complete
  • Remaining firms earn zero economic profit
31
Q

The Zero-Profit Condition:
Zero economic profit: when P = ATC

A
  • Since firms produce where P = MR = MC
  • The zero-profit condition is P = MC = ATC
  • Recall that MC intersects ATC at min ATC
  • Hence, in the long run, P = min ATC
32
Q

Why Do Competitive Firms Stay in Business If They Make Zero Profit?

A
  • Profit = Total revenue − Total cost
  • Total cost includes all opportunity costs
  • Zero-profit equilibrium
  • Economic profit is zero
  • Accounting profit is positive
33
Q

Long-Run Supply Curve:
Long-run supply curve is horizontal if:

A
  • All firms have identical costs, and
  • And costs do not change as other firms enter or exit the market
34
Q

Long-Run Supply Curve:

Long-run supply curve might slope upward if:

A
  • Firms have different costs
  • Or costs rise as firms enter the market
35
Q

Long-Run Supply Curve:
Firms have different costs

A
  • As P rises, firms with lower costs enter the market before those with higher costs.
  • Further increases in P make it worthwhile 
for higher-cost firms to enter the market, 
which increases market quantity supplied.
  • Hence, LR market supply curve slopes upward
36
Q

Costs rise as firms enter the market

A

The entry of new firms increases demand for this input, causing its price to rise
- This increases all firms’ costs
— Hence, an increase in P is required to increase the market quantity supplied, so the supply curve is upward-sloping

37
Q

Profit-maximization: Q where MC = MR

The competitive equilibrium is efficient

A
  • Profit-maximization: Q where MC = MR
    Perfect competition: P = MR
    So, in the competitive equilibrium: P = MC
  • The competitive equilibrium is efficient
    Maximizes total surplus because P = MC
    MC is the cost of producing the marginal unit
    P is value to buyers of the marginal unit

Econ 102 (6 decks)

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