Chapter 23 Perfect competition Flashcards
what is market structure?
features of a market that affect the behavior and performance of the firms within the market
what are features of the market?
number of sellers, amount of info available, barriers to entry, product differentiation
why are market structures important?
- understanding market structure helps us understand firm behavior
- it helps us analyze industry output and efficiency
- it helps us understand how price is determined within a market
what is market power?
firm is considered to have market power when the firm can influence the price of the product it is selling or the terms in which the product is sold
what are in competitive markets?
firms that have little or no market power
what are in markets that are not competitive?
firms have a high degree of market power
what are perfectly competitive markets?
firms have no market power
what are perfectly competitive firms?
each firm is such a small part of the total industry that is can’t affect the price of the product it sells
why are firms price takers?
no individual firm can influence the price in the market, so firms must take the price that the market gives them
they take the market price and determine what quantity they want to produce at that price
each firm acts independently in a perfectly competitive market
what are assumptions about perfectly competitive markets?
- firms in the market produce identical products, so there are numerous perfect substitutes for a product
- consumers and producers have equal access to price info
- there are a larger number of firms in the market, and each firm supplies only a small portion of the market
- there are no barriers to entry or exit, so firms are free to enter and exit the market whenever they like
very rare to happen
lemonade stands, copy centers
what is no market power?
firms in perfect competition have a lack of leverage in their market, which means they have no market power or the ability to set price
what is no market power good for consumers?
guarantees they will receive competitive prices
what is an entire market (industry) graph?
demand curve is downward sloping
supply curve is upward sloping
what is an individual firm graph?
perfectly elastic demand curve bc if they try to charge a price above the market price no one will buy from them
what are price takers?
firms that have no market power in perfectly competitive markets bc they have to take the price that the market gives them
what is profit maximizing rule?
price takers will continue to produce output until MR=MC
when MR=MC is the profit maximizing point
this is the point where the difference between TR and TC is the greatest
what is average revenue(AR)?
total revenue divided by the number of units sold
AR=TR/q
will always be equal to price in perfect competition bc price is constant
what is marginal revenue(MR)?
the incremental change in revenue when we sell one more unit
MR=change in TR/change in q
what is total cost?
TC=ATC x q
what is MR in perfect competition?
in perfect competition the market price is the MR
in perfect comp. price is constant
firms produce at the point where MR=MC
MR=price
what output do firms choose for a perfectly competitive market?
P=MR=MC
what happens if MR>MC?
the firm should increase output until it reaches level q
what happens if MR<MC?
the firm should decrease output until it reaches level q
what happens when P>ATC?
the firm will earn a profit
what happens when P=ATC?
the firm will make zero economic profit in the short run, and the price is actually the long run equilibrium price
what happens when AVC< or equal to P<ATC?
the firm will have a loss but should continue to operate in the short run
you still make enough money on each unit you are selling, but you don’t make enough money to cover your fixed costs
your losses are less than your fixed costs
what happens when P<AVC?
the firm will have a loss and should shut down
its losses will be equal to its fixed costs
what happens in a perfectly competitive firm’s supply curve?
firms won’t produce at below short run shutdown point
what happens with supply?
supply = MC above the intersection with AVC
what is an industry supply curve?
summation of all the individual supply curves
total the industry will supply is simply the sum of all the units supplied by the individual firms
why is the short run supply curve upward sloping?
because of diminishing marginal product
also means the industry supply also must be upward sloping
what factors influence industry supply?
- changes in firm productivity
- changes in resource(input) prices
- changes in per-unit taxes
- anything else that affects the firm’s MC curve
what are signals?
convey info and incentivize firms to act appropriately
profits and losses signal to firms whether they want to enter a new market or exit a current market
what are economic profits?
firms enter the market that will cause output to increase, prices to fall, and profit to eventually disappear
what are economic losses?
firms exit the market that will cause output to decrease, prices to increase, and losses to eventually disappear
what is breakeven?
when a market is at the breakeven point, no firms will enter or exit bc the market is giving a normal rate of return
what are low barriers to entry?
the ease of entry and exit in pure competition markets is bc of the low barriers to entry
what is long run industry supply curve?
the relationship between price and quantity supplied by the entire industry once firms have been allowed to enter or exit
why is the long run supply curve more elastic than the short run supply curve?
supply becomes more elastic as time passes
what is a constant cost industry?
the long run supply curve is perfectly elastic
horizontal
what happens with a perfectly elastic supply curve?
it is possible to increase total output without increasing the long run per unit costs
why is long run price constant?
any shift in demand is eventually met by just enough entry or exit of suppliers so that the long run price is constant
how does supply react to an increase in demand for a constant cost industry?
quantity increases and price goes back it its previous level
how would you describe a long run industry supply curve in a constant cost industry?
horizontal
perfectly elastic
if there is a big increase in demand their is an equally large increase in supply
how would you describe the long run industry supply curve in an increasing cost industry?
upward sloping
what happens in the long run if demand increases in an increasing cost industry?
price will increase
if their is a big increase in demand their will be a small increase in supply
how would you describe the long run industry supply curve in a decreasing cost industry?
downward sloping
what happens in the long run if demand decrease in a decreasing cost industry?
price increases
why is there no long run economic profit?
a perfectly competitive industry, firms earn zero economic profit
what happens if firms are earning a profit in the short run?
more firms will enter the market, which will cause the supply curve to shift to the right, which will cause prices to fall until economic profits are zero
what happens if firms have negative profits?
firms will exit the market which will cause the supply curve to shift to the left, which will cause prices to rise until economic profits are zero.
are you in the long run when firms are entering and exiting the market?
NO, once the market stabilizes you are in the long run
what happens in perfect competition?
the market moves toward zero economic profit over time
what is marginal cost pricing(P=MC)?
ideal pricing bc the price consumers pay reflects the opportunity cost to society
what happens is P>MC?
not enough is being produced
what happens if P<MC?
too much is being produced
what happens in long run equilibrium in perfectly competitive markets?
prices are driven down to the minimum per unit cost
only war to make more short run profits is to innovate and lower costs
profits will attract entrants and market price will fall
consumers benefit the most bc they get to buy at lowest possible price
production will use the least costly combo resources
what are conditions for long run equilibrium in a perfectly competitive industry?
- each maximizing is profits by producing q
- the economic profit that each firm is making is equal to zero
- all firms are content to stay in (or out of) the industry
- the final result is AR=P=d=MR=MC= short run ATC= long run ATC
