COMM 171 - Lecture 6 competitive market

Question 1

Perfect competition vs competitive marekts

Answer 1

Perfect competition occurs when all companies sell identical products, market share does not influence price, companies are able to enter or exit without barriers, buyers have perfect or full information, and companies cannot determine prices.

PC model equilibrium has the nice property of efficiency
 Efficient = Pareto Optimal: no one can be made better off
without making someone worse off

Question 2

PC model equilibrium has the nice property of efficiency

Answer 2

Efficient = Pareto Optimal:
Pareto Optimal: no one can be made better off without making someone worse off

All mutually beneficial trades occur

Question 3

Perfect competition: Key CHARACTERISTICS

Answer 3

1) There are many buyers and sellers, each with a small market share

This means both sellers and buyers are price-takers; their actions have no effect on price.

2) The product is standardized
across sellers

Standardized product (aka
commodity): consumers regard
different sellers’ products as
equivalent

3) Free entry and exit

New producers can easily enter into an industry and
existing producers can easily leave that industry.

Question 4

Market share, price takers

Answer 4

Market share: the fraction of the total industry output
accounted for by that producer’s output

This means both sellers and buyers are price-takers; their
actions have no effect on price

Question 5

Marginal revenue, formula in general (not for competitive firms)

Answer 5

Marginal revenue: change in total revenue generated by
an additional unit of output

MR = change in total revenue / change in total quantity

Question 6

Optimal output rule

Answer 6

Optimal output rule: profit is maximized by producing
the quantity of output at which the marginal revenue of
the last unit produced is equal to its marginal cost

Question 7

Why is profit maximized where MR = MC?

Answer 7

• Each time the firm produces another unit, there are
  extra costs and extra revenues.
• If producing another unit adds more to revenue than it costs, profit will increase.

– If MR > MC, producing more will add to profit;
– If MR < MC, producing less will add to profit.

• Since MR = P for competitive firms, the profit-maximizing
  rule is: Choose the quantity of output where P = MC.

Question 8

In a perfectly competitive market, MR is equal

Answer 8

In a perfectly competitive market, MR is equal to the market price P for all levels of output.

Question 9

How to know when to shut down

Answer 9

Shortcut: Is the price at or below the shut-down price?

– Shut-down price: minimum average variable cost

Question 10

What is the industry supply curve

Answer 10

The industry supply curve shows the relationship between the price of a good and the total output of the
industry as a whole.

• The short-run industry supply curve shows how the quantity supplied by an industry depends on the market
  price given a fixed number of producers.
• There is a short-run market equilibrium when the
  quantity supplied equals the quantity demanded, taking
  the number of producers as given.

Question 11

The short run indsutry supply curve

Answer 11

The short-run industry supply curve: how the Q supplied by an industry depends on the market price (given a fixed number of producers).

Question 12

Compare THE SHORT-RUN AND LONG-
RUN INDUSTRY SUPPLY CURVES

Answer 12

The long-run supply curve is
flatter than the short-run
supply curve :
– A higher price attracts
new entrants in the long
run, raising industry
output and lowering
price.
– A fall in price induces
existing producers to exit
in the long run, reducing
industry output and
raising price.