Chapter 9: Firms in a competitive market Flashcards
When do Competitive Markets exist?
When there are so many buyers and sellers that each one has only a small impact on the market price and output
What are the characteristics of a highly competitive market?
- Similar goods
- Many sellers
- Firms small
- Price taking
- Low barriers of entry
Who is a price taker?
- 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
Why is a market structure of perfect competition most beneficial to society?
Creates the maximum combined consumer and producer surplus
What is the Profit Maximising Rule?
- Profit maximisation occurs when a firm chooses the quantity of output that equates marginal revenue and marginal cost (MR = MC)
What is Marginal Revenue?
Change in total revenue a firm receives when it produces one additional unit of output
What is the two-step process in determining the most profitable output?
- Locate the point at which the firm will maximise its profits: MR=MC
- Follow the point to the x-axis
PUT IN THE IMAGE - The ATC of producing Q units can be found at the intersection between the lines
- Profit = (price - ATC [along the dashed line at quantity Q]) x Q
- Profit is made whenever the price is higher than ATC
When should a firm shut down?
- 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
Profit and Loss in the Short Run
INSERT THE TABLE IMAGE
What is the Firm’s Short-Run Supply Curve
- 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!
The Firm’s Long-Run Supply Curve
- 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)
What is the Short-Run Market Supply Curve?
It is the sum of the market supply curves
Where does the Long-Run Market Supply Curve exist?
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
Why are firms happy with zero economic profit?
- 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
How do markets adjust in the long run?
Market influences firms’ price
How are Long-Run Equilibrium represented?
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
How are Short-Run Profits represented?
- 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
How are Short-Run Losses represented?
- 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
What is the Short-Run adjustment to a decrease in demand?
- 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
What is the Long-Run adjustment to a decrease in demand?
- 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
When is the Long-Run supply curve not horizontal?
- 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
What are sunk costs?
Unrecoverable costs that have been incurred because of past decisions
When is production optimised
- Production should stop at the point at which profit opportunity no longer exists and losses have not yet occurred
