Chapter 9: Competitive Markets Flashcards
What does a “market structure” refer to?
All the features of a market that affect the behavior and performance of firms in that market
What does it mean for a firm to have market power?
That firm can influence the price of their product
When is a market competitive?
When firms have little or no market power
Market power is ______ proportional to how competitive the market is
inversely
What is a perfectly competitive market?
When each firm has zero market power
What is competitive behavior?
The degree to which individual firms actively vie with one another for business
What are the 4 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 Each firm reaches its minimum LRAC at a level of output that is small relative to the industry’s total output (1, 2, and 3 imply that the firm is “price taker”) The industry is characterised by freedom of entry and exit
What does the demand curve of a perfectly competitive firm look like? What about a competitive industry?
Each firm has a horizontal demand curve, even though the industry demand curve is downward sloping
True/False? For a perfectly competitive market: Because the firm faces a perfectly elastic demand, the firm can sell an infinite amount of product at the going price
False. The horizontal demand curve indicated that any realistic variations in that firm’s production will leave the price unchanged because the effect on total industry output will be negligible (the firm has little market power)
What is total revenue and how is it calculated?
The total amount received by the firm from the sale of a product TR = p x Q
What is average revenue and how is it calculated?
The amount of revenue per unit sold AR = (p x Q) / Q = p
What is marginal revenue and how is it calculated?
The change in a firm’s total revenue resulting from a change in its sales by one unit MR = delta(TR)/delta(Q) = p
How are average product, marginal product, and price all related in a perfectly competitive market?
AR = MR = p
How are a firm’s profits calculated?
Profits = TR - TC Recall TC = TVC + TFC
When is a firm in economic loss?
When TR < TC Profits < 0
What happens when a firm produces nothing? What happens when it starts producing?
It will have an operating loss equal to its fixed costs If the firm decides to produce it will add the variable cost of production to its costs
If the revenue is ___ than its variable cost, the firm will lose more money by producing than not producing anything at alll
less Since the firm has to pay for its fixed cost in any event, it will be worthwhile for the firm to pay its fixed cost *as long as it can find some level of output for which revenue exceeds variable cost*
A firm will not produce if the TVC of producing that output is ____ than the total revenue of selling the outcome
Greater Recall AVC = TVC / Q Recall AR = TR / Q Therefore AR = P * Q / Q Therefore AR = P So if AVC > AR = P, firm does not produce
What is the shut down price and how is it calculated?
The price that is equal to the minimum of a firms average variable costs P = AR < AVC
After a firm decides that production is worth undertaking, what is its next decision?
How much to produce p > AVC or TR > TVC
What happens if marginal revenue is less than, equal to, or greater than Marginal cost?
MR > MC - Produce more q MR = MC - No incentive to change q MR < MC - Produce less q
For 0 <= Q < Q1
What is the relation between Total Revenue and Total Cost?
What is the relation between Marginal Revenue and Marginal Cost?
TC > TR profit is negative
MR > MC, possibility of profit for higher output quantities
For Q1 <= Q < Q*,
What is the relation of Total Revenue and Total Cost?
What is the relationship of MR and MC?
What are profits doing?
TR > TC, profits are positive
MR > MC, higher profit for higher output qs
Profits increasing
For Q* < Q <= Q2
What is the relationship between TR and TC?
What is the relationship between MC and MR?
TR > TC, profit is positive
MC > MR, lower profit for higher output quantities
Profits decreasing
For Q > Q2,
Profit is _____
Loss is _____ as Q increases
Negative
Greater and Greater
What happens when MR = MC?
Profit is maximized
Competitive firms choose outputs such that MR is equal to what?
Shutdown price (since MR = p)
How do you derive the supply curve for a competitive firm?
The supply curve is given by the portion of its marginal cost curve that is above average variable cost curve (prices above AVC)
How do you derive a competitive industry’s supply curve?
(in a perfect competition) the industry supply curve is the horizontal sum of the marginal cost curves
What are the 2 properties of Short Run Equilibrium?
Quantity demanded equals quantity supplied
Each firm is maximizing its profits given the market price
How are profits calculated in short run equilibrium?
Profits = TR - TC
= (p x Q) - (ATC x Q)
= (p - ATC) x Q
What happens when p(Q) = ATC?
Zero profit
Profit = TR - TC = (p - ATC) x Q
p = ATC therefore profit = 0
What happens when MC > ATC?
Profit > 0
Profit = TR - TC = Q(p-ATC)
p > ATC
What happens when MC < ATC?
Losses
Profit = TR - TC = Q (p - ATC)
p < ATC
If existing firms in an industry are making positive economic profits, new firms have incentive to ______ the industry
If existing firms in an industry are making no economic profits, firms have incentive to ______ the industry,
If existing firms in an industry are making negative economic profits, existing firms have incentive to ______ the industry
Enter
nothing
Exit
What is the effect of new entrants attracted by positive profits?
- Positive profits attract new firms
- Entry leads to an increase in supply
- The market supply curve shifts rightwards, price falls
- Entry stops when all firms are just covering their total costs
What happens to the market and the firm when loss induces exits?
Market: Exit leads to a reduction in supply and an increase in price
FIrm: Losses due to lower price eventually lead to exit
What are 3 conditions for long-run equilibrium?
All firms must be maximizing their profits
All firms are earning zero economic profits
Existing firms are at the minimum point of its LRAC (not able to increase profits by changing size of production facilities)
What happens when a competitive industry in LR equilibrium experiences a continual decrease in demand?
The efficient response is to continue operating with existing equipment as long as variable costs of production can be covered
Governments are often tempted to support declining industries because they are worried about resulting job losses
Antiquated equipment is often the effect rather than the cause of an industry’s decline
