HL - Theory Of The Firm: Perfect Competition Flashcards
What are the assumptions of perfect competition?
1) . Large/infinite number of firms, thus the actions of one will not affect market price.
2) . Homogenous product.
3) . Freedom of entry and exit.
4) . Perfect information.
5) . Perfect recourse mobility (they can be switched to other uses at no cost).
Why is the Demand curve for perfect competition perfectly elastic?
There’s a set market equilibrium price. It won’t be set higher as perfect information means no one would buy it. It won’t be set lower because the firm can sell am infinite amount at the market price.
So average revenue and marginal revenue are perfectly elastic.
Why can’t firms make economic profit in the long run in perfect competition?
If a firm is making economic profit, it’s an incentive for other firms to join the market, (also taking into account the assumptions of perfect competition). This will shit the supply curve to the right and price will drop and will continue to do so until it normal profit. Then the equilibrium will be stable because there’s no more incentive for firms to join the market.
How does a firm move to short run loss to normal profit?
If there’s a loss, firms will start to leave to market making supply shift to the left and creating a new equilibrium price of normal profit.
What is the shut down price in the short run?
Firms will continue to produce as long as it’s count AVC, because it has to pay fixed costs anyway, so if they continue to produce some money can go towards it.
Below this level is shut down price.
AVC > P (AR)
What’s the shut down price in the long run?
Firms need to cover all costs, so they would shut down when price (AR) is lower than AC.
What is the break-even price?
Total revenue = total costs
AR = AC
It’s the same in the short and long run: only normal profit can be made.
In the long run, the shut down and break even price are the same.
What is the condition for allocative efficiency and why?
P = MC ( with externalities MSB = MSC)
If P>MC consumers would be better off if more of the good were produced. There’s an under allocation of resources.
What is productive efficiency?
Production takes place at the lowest possible cost. Where ATC is at the minimum. It’s only achieved in the long run not in the short run.
What does it mean if P is less than MC
It costs more to produce another unit of the good than it is worth to consumers and the resources would be better used somewhere else.
