Chapter 8.1, 8.2: Perfect Competition

Question 1

Conditions of Perfect Competition

Answer 1

1. Many small firms and customers.
2. Identical products.
3. Price takers.
4. No barriers to entry.
5. Efficient (no DWL).

Question 2

Price taker

Answer 2

A firm in perfect competition that must take the prevailing market price as is (the firm cannot charge consumers more or less than market price).

Question 3

Profit formula

Answer 3

=total revenue-total cost=(price)(quantity produced)-(average total cost)(quantity produced)

Question 4

Calculating the Highest Profit: Compare Total Revenue and Total Cost

Answer 4

The maximum profit at the quantity where the difference between total revenue and total cost is largest. (where profit is highest).

See fig. 8.1

Question 5

Calculating the Highest Profit: Compare marginal revenue and marginal costs

Answer 5

The profit-maximising choice will occur at output level where MC=MR or MC<MR (where gap is smallest). Firms will not produce beyond this point.

See fig. 8.2

Question 6

Marginal revenue

Answer 6

the additional revenue gained from selling one more unit AKA the market price.

Question 7

Marginal cost

Answer 7

The cost per additional unit sold = change in TC divided by change in quantity.

Question 8

*

Does MR = MC guarantee actual economic profit?

Answer 8

Whether a firm is profitable depends on the relationship between ATC and price, the profit margin.
* Price > ATC; Firm earns an economic profit
* Price = ATC; Firm earns zero economic profit
* Price < ATC; Firm earns a loss

See fig. 8.4, learn to calculate TR, TC, and profit.

Question 9

Perfectly competitive market vs individual firm’s supply and demand

Answer 9

• For one firm’s demand graph is horizontal, also equal to price line.
• Supply curve for a perfectly competitive firm is the portion of its MC curve that lies above the AVC curve
• But market demand is downward sloping curve.

see fig. 8.3 and 8.7

Question 10

Identify the areas of MC curve

Answer 10

See fig. 8.6

Question 11

Break-Even Point

see MC = MR

Answer 11

Where MC crosses AC. If:
* If firm is operating where price > break-even point, then price > AC and the firm is earning economic profits.
if price = break even point, firm is earning zero economic profits.

Question 12

Shut down rules

Answer 12

Compare Price and AVC.
If:
* Price (revenue) < minimum AVC, then firm shuts down.
* Price (revenue) > minimum AVC, then firm can cover variable coss and stays in business in the short run.

Compare loss and FC. Which one is preferable?
If:
* Loss > fixed costs, firm shuts down.
* Loss < fixed costs, firm stays open in short run.