Chapter 9: Firms in a competitive market

Question 1

When do Competitive Markets exist?

Answer 1

When there are so many buyers and sellers that each one has only a small impact on the market price and output

Question 2

What are the characteristics of a highly competitive market?

Answer 2

• Similar goods
• Many sellers
• Firms small
• Price taking
• Low barriers of entry

Question 3

Who is a price taker?

Answer 3

• Someone who has no control over the price set by the market
• Takes the price determined by the overall supply and demand conditions that regulate the market

Question 4

Why is a market structure of perfect competition most beneficial to society?

Answer 4

Creates the maximum combined consumer and producer surplus

Question 5

What is the Profit Maximising Rule?

Answer 5

• Profit maximisation occurs when a firm chooses the quantity of output that equates marginal revenue and marginal cost (MR = MC)

Question 6

What is Marginal Revenue?

Answer 6

Change in total revenue a firm receives when it produces one additional unit of output

Question 7

What is the two-step process in determining the most profitable output?

Answer 7

1. Locate the point at which the firm will maximise its profits: MR=MC
2. Follow the point to the x-axis
   PUT IN THE IMAGE
3. The ATC of producing Q units can be found at the intersection between the lines
4. Profit = (price - ATC [along the dashed line at quantity Q]) x Q
5. Profit is made whenever the price is higher than ATC

Question 8

When should a firm shut down?

Answer 8

• Firms should continue operating if the variable costs can be covered (as some money may also cover the fixed costs)
• However, if it cannot cover its variable costs then it should shut down

Question 9

Profit and Loss in the Short Run

Answer 9

INSERT THE TABLE IMAGE

Question 10

What is the Firm’s Short-Run Supply Curve

Answer 10

• The marginal cost curve is the firm’s short run supply curve as long as the firm is operating.
• Below the minimum point on the AVC curve (where the business would shut down), the short run supply curve is vertical at a quantity of zero.
  INSERT THE IMAGE!

Question 11

The Firm’s Long-Run Supply Curve

Answer 11

• All costs are variable in the long run

- The firm’s long-run supply curve does not exist when the firm cannot cover its total costs of production (ATC)

Question 12

What is the Short-Run Market Supply Curve?

Answer 12

It is the sum of the market supply curves

Question 13

Where does the Long-Run Market Supply Curve exist?

Answer 13

Existing firms decide whether to enter and exit a market based on incentives (profits)

• When profits exist, firms would enter the market, increasing the supply, adjusting price to decrease to P = min. ATC
• When losses exist, firms would leave the market, decreasing supply, adjusting prices up to P = min. ATC
• At zero economic profit, no firms are incentivised to enter or exit the market

Question 14

Why are firms happy with zero economic profit?

Answer 14

• Both explicit costs and the implicit costs have been covered
  
  • Includes the value of the next-best alternative (opportunity cost)
• You could not have made any more money elsewhere

Question 15

How do markets adjust in the long run?

Answer 15

Market influences firms’ price

Question 16

How are Long-Run Equilibrium represented?

Answer 16

The short-run supply curve and the short-run demand curve intersect along the long-run supply curve. P = min. ATC → economic profit for the firm is zero

Question 17

How are Short-Run Profits represented?

Answer 17

• The short-run supply curve and the short-run demand curve intersect above the long-run supply curve, the price would be higher than the min. ATC

Question 18

How are Short-Run Losses represented?

Answer 18

• The short-run supply curve and the short-run demand curve intersect below the long-run supply curve, the price would be lower than the min. ATC

Question 19

What is the Short-Run adjustment to a decrease in demand?

Answer 19

• A decrease in demand causes price to fall in the market
• Because the firm is a price-taker in a competitive market, the price falls to P2
• The intersection between MR2 and MC occurs at Q2, which is lower than minimum ATC
• The firm incurs a short-run loss

Question 20

What is the Long-Run adjustment to a decrease in demand?

Answer 20

• Due to the decrease in price, firms exit the market, decreasing the supply curve until the price returns to long-run equilibrium (C), but at a lower level of output
• Price is restored in the individual firm and the firm starts earning zero economic profit again

Question 21

When is the Long-Run supply curve not horizontal?

Answer 21

• It can slope upwards (increase in cost) because of:
  
  • Resources needed to produce the product may only be available in limited supplies (bidding)
  • Opportunity cost of the labor used in producing the good

Question 22

What are sunk costs?

Answer 22

Unrecoverable costs that have been incurred because of past decisions

Question 23

When is production optimised

Answer 23

• Production should stop at the point at which profit opportunity no longer exists and losses have not yet occurred