Chapter 9: Competitive Markets

Question 1

What does a “market structure” refer to?

Answer 1

All the features of a market that affect the behavior and performance of firms in that market

Question 2

What does it mean for a firm to have market power?

Answer 2

That firm can influence the price of their product

Question 3

When is a market competitive?

Answer 3

When firms have little or no market power

Question 4

Market power is ______ proportional to how competitive the market is

Answer 4

inversely

Question 5

What is a perfectly competitive market?

Answer 5

When each firm has zero market power

Question 6

What is competitive behavior?

Answer 6

The degree to which individual firms actively vie with one another for business

Question 7

What are the 4 assumptions of Perfect competition?

Answer 7

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

Question 8

What does the demand curve of a perfectly competitive firm look like? What about a competitive industry?

Answer 8

Each firm has a horizontal demand curve, even though the industry demand curve is downward sloping

Question 9

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

Answer 9

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)

Question 10

What is total revenue and how is it calculated?

Answer 10

The total amount received by the firm from the sale of a product TR = p x Q

Question 11

What is average revenue and how is it calculated?

Answer 11

The amount of revenue per unit sold AR = (p x Q) / Q = p

Question 12

What is marginal revenue and how is it calculated?

Answer 12

The change in a firm’s total revenue resulting from a change in its sales by one unit MR = delta(TR)/delta(Q) = p

Question 13

How are average product, marginal product, and price all related in a perfectly competitive market?

Answer 13

AR = MR = p

Question 14

How are a firm’s profits calculated?

Answer 14

Profits = TR - TC Recall TC = TVC + TFC

Question 15

When is a firm in economic loss?

Answer 15

When TR < TC Profits < 0

Question 16

What happens when a firm produces nothing? What happens when it starts producing?

Answer 16

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

Question 17

If the revenue is ___ than its variable cost, the firm will lose more money by producing than not producing anything at alll

Answer 17

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*

Question 18

A firm will not produce if the TVC of producing that output is ____ than the total revenue of selling the outcome

Answer 18

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

Question 19

What is the shut down price and how is it calculated?

Answer 19

The price that is equal to the minimum of a firms average variable costs P = AR < AVC

Question 20

After a firm decides that production is worth undertaking, what is its next decision?

Answer 20

How much to produce p > AVC or TR > TVC

Question 21

What happens if marginal revenue is less than, equal to, or greater than Marginal cost?

Answer 21

MR > MC - Produce more q MR = MC - No incentive to change q MR < MC - Produce less q

Question 22

For 0 <= Q < Q1

What is the relation between Total Revenue and Total Cost?

What is the relation between Marginal Revenue and Marginal Cost?

Answer 22

TC > TR profit is negative

MR > MC, possibility of profit for higher output quantities

Question 23

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?

Answer 23

TR > TC, profits are positive
MR > MC, higher profit for higher output qs
Profits increasing

Question 24

For Q* < Q <= Q2

What is the relationship between TR and TC?

What is the relationship between MC and MR?

Answer 24

TR > TC, profit is positive

MC > MR, lower profit for higher output quantities

Profits decreasing

Question 25

For Q > Q2,

Profit is _____

Loss is _____ as Q increases

Answer 25

Negative

Greater and Greater

Question 26

What happens when MR = MC?

Answer 26

Profit is maximized

Question 27

Competitive firms choose outputs such that MR is equal to what?

Answer 27

Shutdown price (since MR = p)

Question 28

How do you derive the supply curve for a competitive firm?

Answer 28

The supply curve is given by the portion of its marginal cost curve that is above average variable cost curve (prices above AVC)

Question 29

How do you derive a competitive industry’s supply curve?

Answer 29

(in a perfect competition) the industry supply curve is the horizontal sum of the marginal cost curves

Question 30

What are the 2 properties of Short Run Equilibrium?

Answer 30

Quantity demanded equals quantity supplied

Each firm is maximizing its profits given the market price

Question 31

How are profits calculated in short run equilibrium?

Answer 31

Profits = TR - TC

= (p x Q) - (ATC x Q)

= (p - ATC) x Q

Question 32

What happens when p(Q) = ATC?

Answer 32

Zero profit

Profit = TR - TC = (p - ATC) x Q

p = ATC therefore profit = 0

Question 33

What happens when MC > ATC?

Answer 33

Profit > 0

Profit = TR - TC = Q(p-ATC)

p > ATC

Question 34

What happens when MC < ATC?

Answer 34

Losses

Profit = TR - TC = Q (p - ATC)

p < ATC

Question 35

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

Answer 35

Enter

nothing

Exit

Question 36

What is the effect of new entrants attracted by positive profits?

Answer 36

1. Positive profits attract new firms
2. Entry leads to an increase in supply
3. 5. The market supply curve shifts rightwards, price falls
4. Entry stops when all firms are just covering their total costs

Question 37

What happens to the market and the firm when loss induces exits?

Answer 37

Market: Exit leads to a reduction in supply and an increase in price

FIrm: Losses due to lower price eventually lead to exit

Question 38

What are 3 conditions for long-run equilibrium?

Answer 38

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)

Question 39

What happens when a competitive industry in LR equilibrium experiences a continual decrease in demand?

Answer 39

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