Chapter 8 (Week 5) Flashcards
Competitive firms
Firms that are rivals for the same customers
Perfectly competitive markets characteristics
The market consists of many small buyers and sellers→ no single firm can raise or lower the market price
All firms produce identical products→ sell identical or homogeneous products
All market participants have full information about price and product
characteristics→ no firm can unilaterally raise its price above this price
Transaction costs are negligible→ very low transaction costs
Firms can freely enter and exit the market→ freely leads to many firms in a market and promotes price taking - can’t earn supernormal profits
Elasticity of demand if market has n identical firms
ne - (n-1)no
- e is the market elasticity of demand
- no is the elasticity of supply of the other firms
- n-1 is the number of other firms
Residual demand curve
Market demand not met by other sellers at any given price
Dr = D - S of others
Profit
Revenue - Cost
MC = MR, because MR = p
Profit is negative: firm makes a loss
Opportunity or economic cost
The value of the best alternative use of any input the firm employs
Economic profit
Revenue minus opportunity (economic) cost
Shut down decision rules
Rule 1: the firm shuts down only if it can reduce its loss by doing so
Rule 2: the firm shuts down only if its revenue is less than its avoidable cost
Short run shutdown decision
AR = AVC –> remain in market
Revenue < VC –> shut down
P < AVC –> shut down
3 cases for shutdown in the short run
- Market price > minimum AC
- the firm makes a profit so it operates - Minimum AVC < Market Price < Minimum AC - the firm makes a loss, so it reduces its loss by operating rather than shutting down
- Market price < Minimum AVC
- shut down in the short run
Short run market supply curve
The market supply curve is the horizontal sum of all the individual firms’ supply curves
Market supply at any price is n times the supply of an individual firm.
Long run shutdown decision
p < AC –> shutdown
Long run competitive profit max
Operates where long-run marginal profit is zero and where marginal revenue equals long-run marginal cost.
Long run firm supply curve
A firm’s long-run supply curve is its long-run marginal cost curve above the minimum of its long-run average cost curve because all costs are variable in the long run.
Long run market supply curve
The competitive market supply curve is the horizontal sum of the individual firms’ supply curves in both the short and long run.
Entry and exit in the long run
A firm enters the market if it can make a long-run profit, π > 0.
A firm exits the market to avoid a long-run loss, π < 0.
If the firms in a market are making zero long-run profit, they are indifferent between staying in the market and exiting.
Why the long run market supply curve is flat
–> Free entry and exit
–> Identical costs for all firms
–> Constant input prices
Long run market supply when firms’ cost functions differ
Firms with relatively low minimum long-run average costs enter the market at lower prices than others, resulting in an upward-sloping long-run market supply curve
If lower-cost firms can produce as much output as the market wants, only low-cost firms produce. Thus, the long-run market supply curve is horizontal at the minimum of the low-cost firm’s average cost curve.
The long-run supply curve is upward sloping if lower-cost firms cannot produce as much output as the market demands.
Long run competitive equilibrium
Equilibrium price equals the long-run average cost.
A shift in the demand curve affects only the equilibrium quantity, which remains constant at minimum long-run average cost.
