Chapter 9 Flashcards
What does a competitive market structure refer to?
It refers to all the features of a market that affect the behaviour and performance of firms in that market, such as the number and size of sellers, the extent of knowledge about one another’s actions, the degree of freedom of entry, and the degree of production differentiation
When do firms have market power?
They have market power when they can influence the price of their product
When is a market said to be competitive?
When firms have little or not market power
The more market power the firms have, the less competitive is the market
When does the extreme form of competitive market structure occur? What is this extreme called?
When each firm has 0 market power
This extreme is called a perfectly competitive market
What does the term competitive behaviour refer to?
It refers to the degree to which individual firms actively vie with one another for business
What are the assumptions of perfect competition?
All firms sell a homogeneous product
Customers know the nature of the product being sold and the prices charged by each firm
The level of each firm’s output at which its long-run average cost reaches a minimum is small relative to the industry’s total output
The industry is characterized by freedom of entry and exit
What does the competitive firm’s demand curve look like?
It looks like a horizontal line meaning that it has perfectly elastic demand
What does a competitive industry’s demand curve look like?
It looks like a negatively sloped linear line meaning that it has an inelastic demand curve
What does the horizontal demand curve of a competitive firm’s demand indicate?
It indicates that any realistic variations in that firm’s production will leave the price unchanged because the effect on total industry output will be negligible
Why are small firms price takers?
Products have negatively sloped market demand
curves.
Hence, increase in industry’s output (caused by an
increase in supply) will cause some fall in the market
place.
However, any increase that one firm could make in its
output has such a negligible effect on the industry’s
price, that it can be ignored.
Thus, individual firms are price takers.
Therefore, individual firms face horizontal demand
curves.
What is total revenue?
It is the total amount received by the firm from the sale of a product
What is total revenue equal to?
TR = p x Q
What is the average revenue?
It is the amount of revenue per unit sold
What is average revenue equal to?
AR = (p x Q)/ Q = p
What is marginal revenue?
It is the change in a firm’s total revenue resulting from a change in its sales by one unit
What is marginal revenue equal to?
MR = ΔTR/ΔQ = p
What is the marginal and average revenue of a competitive price-taking firm?
The market price
What is the firm’s objective
To maximize profits
What is profits equal to?
Profits = TR - TC
If total revenues are not enough to cover total costs what will economic profits be?
They will be negative meaning that the firm is making economic losses
If the firm produces nothing what is the operating cost equal to?
It is equal to its fixed costs
If the firm decides to produce, what will the firm add to its costs?
The variable cost of production
Since the firm must pay its fixed costs in any event, it will be worthwhile for the firm to produce as long as it can find some level of output for which revenue exceeds what?
Variable cost
If revenue is less than its variable cost, the firm will lose more by doing what?
By producing than not producing at all
When should a firm not produce at all?
If, for all levels of output, total revenue is less than total variable cost
If, for all levels of output, the market price is less than average variable cost
What is the shut-down price?
It is the price that is equal to the minimum of a firm’s average variable costs
At prices below this, a profit-maximizing firm will produce no output
If a firm decides that production is worth undertaking, then it must decide what?
How much to produce
If any unit of production adds more to revenue than it does to cost, producing and selling that unit will do what?
Will increase profits
When does a unit of production raise production?
When the marginal revenue obtained from selling it exceeds the marginal cost of producing it
If it is worthwhile for the firm to produce at all, the profit-maximizing firm should produce what?
The output at which the marginal revenue equals marginal cost (p=MC)
In perfect competition, the industry supply curve is what?
The horizontal sum of the marginal cost curves (above the level of average variable cost) of all the firms in the industry
When an industry is in short-run equilibrium, quantity demanded equals what? And each firm is doing what?
Quantity supplied
Maximizing its profits given the market price
When the industry is in short-run equilibrium, a competitive firm may be doing what?
Making losses, breaking even, or making profits
When the firm produces at Q1, MC = MR = p, p1 < ATC. What happens to the firm?
The firm suffers losses (negative economic profit) equal to the shaded area. Since price exceeds AVC, the firm continues to produce
When the firm produces at Q2, MC = MR = p, p2 = ATC. What happens to the firm?
The firm is just covering its total costs. There is zero economic profit
When the firm produces at Q3, MC = MR = p, p3 > ATC. What happens to the firm?
The firm makes positive economic profit equal to the shaded area
When do new firms have incentive to enter the industry?
When existing firms are making positive economic profits
When are there no incentives for new firms to enter and no incentives for existing firms to exit
When existing firms are making zero profits
When is there an incentive for existing firms to exit the industry
When existing firms are making economic losses
What occurs when positive profits attract new firms?
Entry leads to an increase in supply so the market supply curve shifts rightward and the price falls
When does entry stop?
When all firms are just covering their total costs
What does exit lead to?
It leads to a reduction in supply and an increase in price
When does the long-run industry equilibrium of a competitive industry occur?
When firms are earning zero profits
What is the break-even price?
It is the price at which a firm is just able to cover all of its costs including the opportunity cost of capital
What are the conditions of long-run equilibrium?
Existing firms must be maximizing profits, given their
existing capital. Short-run marginal costs of production
must be equal to market price.
Existing firms must not be suffering losses.
Existing firms must not be earning profits.
Existing firms must not be able to increase their profits by changing the size of their production facilities. Each firm must be the minimum point of its LRAC curve.
In long-run competitive equilibrium, each firm is operating at which point?
At the minimum point on its LRAC curve
Consider a competitive industry in long-run equilibrium. Price is equal to average total cost of the existing plants.
Now suppose that some technological development lowers the costs of newly built plants.
What happens?
Plants with new technology earn economic profits. Other new plants enter the industry.
What does expanding industry output do?
It drive the price down to equal short-run average total cost of the new plants
Plants with old technology may continue, but they will earn losses and eventually exit
