Chapter 8: Analysis of Perfectly Competitive Markets

Question 1

How do firms respond to the price signals that the market sends to them?

Answer 1

Three key propositions:

• Supply decisions of a firm depend upon its marginal cost of production
• In the long-run firms will enter or exit an industry until the profits in that industry are driven to zero.
• A perfectly competitive industry will be efficient.

Question 2

Shutdown rule:

Answer 2

The shutdown point comes where revenues just cover variable costs or where losses are equal to fixed costs. When the price falls below the level where revenues are equal to variable costs, the firm will minimize its losses by shutting down.

Question 3

The Concept of Efficiency:

Answer 3

EFFICIENCY is one of the central concepts in economics. In general sense, an economy is efficient when it provides its consumers with the most desired set of goods and services, given the resources and technology of the economy.

Question 4

Pareto Efficiency:

Answer 4

Occurs when no possible reorganization of production or distribution can make anyone better off without making someone else worse off. Under conditions of allocative efficiency, one person’s satisfaction or utility can be increased only by lowering someone else’s utility.

Question 5

Market Failures:

Answer 5

• Imperfect Competition (e.g. monopolies)
• Externalities (arise when some of the side effects of production or consumption are not included in market prices)
• Imperfect Information (buyers and sellers don’t have complete information about goods and services they buy and sell)