Chapter 9 : Competitive Markets Flashcards
What are characteristics of a market that affect the behaviour of the firms in it? (4)
- Number of sellers in the market (firms)
- Their market shares
- Barriers to entry
- Degree of product differentiation
What does it mean for a firm to have market power?
It can influence the price of its product
What is market power related to?
The number of firms and their market shares.
The more market power the firms have, the ______ competitive is the market.
Less
Monopoly definition
When a market is occupied by a single firm
Perfectly competitive market definition
When each firm has zero market power.
4 types of market, from least to most competitive
Monopoly, oligopoly, monopolistic competition, perfect competition
4 assumption of perfectly competitive market
- All firms sell a homogeneous product
- Costumers know the nature of the product being sold and the prices sold by each firm
- 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
- Industry is characterized by freedom of entry and exit
When are profits maximized (equation)
When MR (Q) > MC (Q)
True or False? Perfectly competitive firms adjust their level of output in response to changes in the market-determined price.
True. They have 0 control over the market price.
Average revenue / units sold in a competitive market
AR = (p x Q)/Q = p
When should a firm not produce at all?
When, for all output levels, TR <TVC
Also, when market price <AVC
If the firm produces nothing, it will have an operating loss that is equal to ________.
Its fixed costs.
What is the shut-down price?
price = AVC
When is profit maximized in this graph?
When the vertical distance between TR (green) and TC (red) is the largest, and the slopes of the curves are =
Why is profit maximized at the point encircled in red?
Because, in a competitive market, p = MR = AR. Therefore, at the red circle, the MR = MC
How to obtain a firm’s supply curve?
The MC curve that is above the AVC curve.
How to obtain an industry’s supply curve?
By adding, horizontally, all the individual supply curves.
True or False? When the industry is in a short-run equilibrium, each firm is maximizing its profits given the market price.
True.
Can a firm that is maximizing profit, given the market price, still be making losses?
Yes. At profit maximization, a firm can either be making profit, cutting it even, or making losses.
How does economic profit affect entry and exit of firms in the market?
If existing firms are making positive profits : new firms enter
If existing firms are making 0 profit : staying put.
If firms are making negative profit : existing firms exit the industry.
Explain how entry-inducing price ends up in equilibrium
Positive profits attract new firms
Supply curve increases, shifts to the right and new equilibrium = price falls.
Entry stops when all firms are just covering their total costs.
Explain how exit-inducing price ends up in equilibrium
Negative profits lead to a reduction in supply and an increase in price.
What is the break-even price?
The market price at which a firm is just able to cover all of its costs, including the opportunity cost of capital.
What are the conditions for long-run equilibrium?
- Existing firms must be maximizing profits (MC = 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.
