econ 101 - Chp 11: Perfect Competition Flashcards
what are the characteristics of perfect competition?
a market in which:
1. many firms sell identical products to many buyers
2. there are no restrictions on entry into the market
3. established firms have no advantage over new ones
4. sellers + buyers are well informed about prices
- each firm produces a good that has no unique characteristics, so consumers don’t care which firm’s good they buy
how does perfect competition arise
arises if the minimum efficient scale of a single producer is small relative to the market demand for the good/service - there’s room in the market for many firms
define a price taker
a firm that cannot influence the market price because its production is an insignificant part of the total market
define total revenue
price of its output x quantity of output sold
define marginal revenue
the change in total revenue that resutls from a one-unit increase in the quantity sold
how to calculate marginal revenue
change in total revenue/change in quantity sold
in perfect competition, the firm’s marginal revenue is
the market price
what’s the demand elasticity for a firm’s product if they’re in a perfect competition?
perfectly elastic demand
what decisions must a firm decide to maximize profit
- how to produce at minimum cost
- what quantity to produce
- whether to enter or exit a market
how does a firm produce at a minimum cost
operating with the place that minimizes long-run average cost - by being on its LRAC curve
a firm’s cost curves describe the relationship between
its output and cost
a firm’s revenue curves describe the relations between
its output and revenue
how can we find the output that maximizes the firm’s economic profit
from the firm’s cost and revenue curves
using marginal analysis (compare MR to MC)
what’s the break-even point
a certain level of output that would lead a firm to make zero economic profit
in marginal analysis, what does it mean when:
MR > MC
MR = MC
MR < MC
if MR > MC, then revenue from selling 1 more unit exceeds the cost of producing it and an increase in output increases economic profit
if MR < MC, then revenue from selling 1 more unit is less than the cost of producing that unit and a decrease in output increases economic profit
if MR = MC, then revenue from selling 1 more unit equals the cost incurred to produce that unit –> economic profit is maximized and either an increase or decrease in output decreases economic profit
a firm’s profit maximizing output is its quantity supplied at the ____ price
market price
what’s the law of supply
ceteris paribus, the higher the market price of a good, the greater is the quantity supplied of that good
what happens if the firm’s profit maximizing output sells at a price that is less than the average total cost?
the firm incurs an economic loss, and that they are in their minium loss
what does the firm do if they expect the loss to be permanent?
they go out of business
what does the firm do if they expect the loss to be temporary? how do they make this decision?
firm must decide whether to shut down temporarily and produce no output or to keep producing
firm compares the loss from shutting down with the loss from producing and takes the action that minimizes its loss
what’s the firms economic loss formula?
TFC + TVC - TR –>TC - TR
TFC + Q*(AVC - P)
if the firm shuts down, its economic loss is
its total fixed cost
if the firm produces, then it incurs ___ and ___ costs
fixed and variable costs
if the firm produces, its economic loss is
TFC + TVC - TR
if the firm produces and if TVC > TR or AVC > P, then the firm
shuts down because it exceeds TFC
define a firm’s shutdown point
price and quantity at which it is indifferent between producing and shutting down
where does the shutdown point occur? why?
occurs at the price and the quantity at which AVC is at minimum
bc the firm’s loss = TFC, meaning that the firm is minimizing its loss
if the price falls below minimum AVC, the firm
shuts down temporarily and continues to incur a loss equal to total fixed costs
the firm also maximizes profit by temporarily shutting down and producing no output –> the firm produces 0 output at all prices below minimum AVC
at prices above the minimum AVC but below ATC, the firm
produces the loss minimizing output and incurs a loss, but a loss that is less than TFC
a perfectly competitive firm’s supply curve shows
how its profit-maximizing output varies as the market price varies, ceteris paribus
where is the supply curve derived from?
the firm’s marginal cost curve and the AVC curves
what happens when the price exceeds the minimum AVC cost? and if the price continues to rise
the form maximizes profit by producing the output at which marginal costs = price
if the price continues to rise, the firm increases its output (moves up along its marginal cost curve)
when the price = minimum AVC, the firm maximizes profit by?
by temporarily shutting down and producing no output or by producing the output at which AVC is at minimum (shutdown point)
fill in the blanks: the firm never produces a quantity between ___ and the quantity at the _____ point
between zero and the shutdown point
what’s the relationship between a firm’s supply curve and MC curve?
supply curve starts at point T (shutdown point) then follows the (shape of the) MC curve
how to determine the price and quantity in a perfectly competitive market
need to know how market demand and market supply interact
what’s the short-run market supply curve
shows the quantity supplied by all the firms in the market at each price when each firm’s plant and number of firms remain the same
fill in the blanks: the quantity supplied by the market at a given price is the
sum of the quantities supplied by all the firms in the market at that price
change in demand and change in short-run marginal equilibrium:
(1) if demand decreases + demand shifts leftward, what happens?
(2) if demand decreases + demand shifts leftwards past the shutdown point, and onto the horizontal line of the short-run market supply, what happens?
(3) if demand increases + demand shifts rightward, what happens?
- market price falls, + each firm maximizes profit by decreases its output
- market price remains at $17 because the market supply curve is horizontal. firms are indifferent between temporarily shutting down or continue to produce
- market price rises, and each firm maximizes profit by increase its output
what’s the economic profit/loss formula?
(Price - ATC)*Q
in the economic profit/loss formula, if:
- P> ATC
- P< ATC
- P = ATC
- firm makes economic profit
- firm incurs an economic loss
- firm breaks even, the entrepreneur makes normal profit
when does entry in a market occur
when new firms come into the market and the number of firms increase
when does exit in a market occur
when existing firms leave a market and the number of firms decreases
how do firms respond to economic profit and loss?
by either entering or exiting a market
new firms enter a market where existing firms are making an (persistent) economic profit
firms exit a market where they are incurring an (persistent) economic loss
what does not trigger entry and exit in the market
temporary economic profit and temporary economic loss
what happens when economic profit reaches 0?
entry into the market stops
what happens when firms enters a market
supply increases, and the market supply curve shifts rightward,
lowers the market price and eventually eliminates economic profit
what happens when firms exits a market
supply decrease and the market supply curve shifts leftward
the market price rises and economic loss decreases
as entry of a new firm leads to an increase in market output but each firm’s output ________
decreases
exit results in decrease in market output, but each firm’s output _______
increases
when is the competitive market in long-run equilibrium
when economic profit and economic loss have been eliminated and entry and exit have stopped
why is a competitive market rarely in a state of long-run equilibrium
the market is constantly bombarded with events that change the constraints that firms face
markets are constantly adjusting to keep up with changes in tastes
changes in demand + supply with technology on the market + firm
(1) decrease in demand
(2) increase in demand
- equilibrium price falls, firms incur economic losses, as losses seem permanent, stores start to close, supply decreases and prices stop falling and then being to rise –> eventually enough firms have exited for the supply and decreased demand to be in balance at a price that enables the firms in the market to return to zero economic profit - long-run equilibrium - economic loss brings exit and short-run supply decreases. the decrease in supply (eventually?) raises the market price and firms increase output
- brings a higher price, economic profits, and entry –> entry increases supply, which lowers the price to its original level and economic profit returns to zero in the new long-run equilibrium
what’s the difference between the initial long-run equilibrium and the new long-run equilibrium
the number of firms in the market
what’s the effect of technology on the supply curve?
lowers production costs –> brings temporary gains to producers but brings permanent gains for consumers
how does technology affect the supply curve?
from the long-run equilibrium, when new technology becomes available that lower production costs, the first firms use it to make economic profit
as more firms begin to use new technology, market supply increases and price falls –> at first, new-technology firms continue to make positive economic profit, so more enter. But firms that continue to use the old technology incur economic losses –> old-technology firms exit
‘
eventually all the old-technology firms have exited and enough new-technology firms have entered to increase the market supply to a level that lowers the price to equal the minimum AVC using the new technology –> all the firms (new-technology) are making zero-economic profit
when new technology becomes available, ATC and MC of production gall, and firm sthat use the new technology produce with ATC(new) and MC(new)
when 1 firm adopts the new technology, it is too small to influence supply so price remains the same and firm makes an economic profit. but economic profit brings entry of new-technology firms –> market supply increases and the price falls. when a new long-run equilibrium is achieved, the old-technology firms have gone, the new-technology firms that have entered shifts the supply curve (rightward)
what are the permanent gains consumers get from technological advances
lower prices + better products
how can we test whether resources are allocated efficiently
compare MSB and MSC
how is the market demand curve the marginal social benefit curve
market demand curve measure the benefit to the entire society as consumers allocate their budgets to get the most value possible out of them.
how is the market supply curve the marginal social cost curve
market supply curve measures the marginal cost to the entire society as competitive firms produce the quantity that maximizes profit –> firms get the most value out of their resources at all points along their supply curves and if the firms that produce a good or service bear all the costs of producing it?
resources are used efficeintly when
MSB = MSC
how does competitive equilibrium achieve this effiecient outcome?
with no externalities, price = MSB for consumers (pay lowest possible price) and price = MSC for producers
and gains from trade are maximizes (total surplus)
is it only in the long-run equilibrium that economic profit is driven to zero and consumers pay the lowest feasible price
yes
when firms in perfect competition are away from long-run equilibrium either ____ or ___ moves the market toward long-run equilibrium
entry or exit
