Intro - Chptr 11/Perfect Competition

Question 1

What is a perfectly competitive market?

Answer 1

A market in which economic forces operate unimpeded.

Question 2

What are the conditions for a perfectly competitive market (6)?

Answer 2

(1) Both buyers and sellers are price takers (take the price determined by market supply & demand as a given); (2) Number of firms is large- output of an individual firm is imperceptible; there is no collusion and what one firm does has no influence on what other firms do; (3) no [social, political, economical] barriers to entry; (4) firms are identical; (5) complete information (no firm or consumer has competitive edge over another); (6) selling firms are profit-maximizing entrepreneurial firms- they seek only maximum total profit.

Question 3

Define “supply” and describe a supply curve in the contex of perfect competition.

Answer 3

Supply is a schedule of quantities of goods that will be offered to the market at various prices. Supplier is a price taker with no ability to collude and seeking only to maximize profit. A firm’s supply curve will be that portion of the firms’s short-run MC curve above the AVC curve.

Question 4

Differentiate between the demand curve for the market/industry and the demand curve for a firm in perfect competition.

Answer 4

The market (or industry) demand curve is downward sloping. The firm demand curve is perfectly elastic (horizontal) at the market demand price. The difference is because of a difference in perception- each firm is so small that it perceives that its actions will not affect the price it can get; the price it can get is determined by the MARKET supply & demand curves. IMAGE: 11-1.

Question 5

What is marginal revenue (MR)?

Answer 5

Change in total revenue associated with a change in quantity. For a perfect competitor, MR curve and demand curve are the same: MR = P = demand (firm). This is because a perfect competitor accept market price as a given.

Question 6

To maximize profit, where should a firm produce?

Answer 6

Where MC = MR.
Since profit is TR - TC, then what happens to profit in response to a change in output is determined by MR (ΔTR/ΔQ) and MC (ΔTC/ΔQ).

Question 7

What is the profit-maximizing condition for a competitive firm?

Answer 7

MC = MR = P

**IMAGE: 11-2

Question 8

A firm’s supply curve is equal to which cost curve?

Answer 8

The MC curve above its AVC curve. This is because the MC curve tells us how much of a produced good a firm will supply at a given price.

Question 9

Firms maximize what type of profit?

Answer 9

TOTAL profit- not profit per unit.

Question 10

An alternative method of determining profit-maximizing level of output is to look at TR and TC curves directly. How?

Answer 10

TC is cumulative sum of marginal costs plus fixed cost. Total profit = TR - TC. TC curve is mostly bowed upwards because of increasing MC at different levels of output. Profit is maximized where vertical distance between TR & TC is greatest which is where slopes of TR & TC are equal: MR (slope of TR = ΔTR/ΔQ) = MC (slope of TC = ΔTC/ΔQ). IMAGE 11-4.

Question 11

Describe how to determine profit from a graph.

Answer 11

(1) Determine what output the firm will choose to produce by seeing where MC = MR; (2) determine the ATC at that quantity by dropping a line down/up to ATC curve. *IMAGE: 11-5.

Question 12

MC = MR = P is both a profit-maximizing condition and a …..?

Answer 12

Loss-minimizing condition. This is because a firm may continue production even if it is incurring a loss- in the short run, fixed costs are sunk costs and up to the shut down point a firm will remain open.

Question 13

What is the shutdown point for a firm?

Answer 13

The point at which a firm will be better off it it temporarily shuts down. The firm considers only costs it can save by stopping production; fixed costs are sunk and so the only costs that can be saved are variable costs.
The firm should continue to produce in the short-run if:
P > minimum of AVC -or- if loss < FC.
The firm should shutdown if:
P </= minimum of AVC -or- if loss >/= FC.
IMAGE: 11-6.

Question 14

How is the short-run market supply curve determined and why is it important?

Answer 14

In the short-run, number of firms is fixed so the market supply curve is the horizontal sum of all the firms’ MC curves, taking into account of any changes in input prices that might occur. This is important because in the long-run the number of firms can change and as more firms enter the market, the market curve shifts right. As the number of firms decline, the market curve shifts left.

Question 15

What is “normal” profit and how does it differ from economic profit?

Answer 15

Normal profit is the OC of an entrepreneur; it is the amount the owners of business would have received in the next-based alternative. In order to stay in business the owners must receive normal profit and it is built into the cost of the business. Economic profit is profit above normal profits.

Question 16

Are economic profits possible in the long-run?

Answer 16

No. In the long-run firms enter and exit the market driving supply up and down (& therefore price up and down) until neither economic profits nor economic losses are possible. Only zero profit equilibrium is possible. This is important to real world application because in their analysis of whether markets are competitive, economists focus on whether barriers to entry exist.

Question 17

Why are rents to superefficient factors of production paid?

Answer 17

Premiums to super-efficient factors of production are paid because firms’ compete to get them.

Question 18

What is the market response to an increase in demand?

Answer 18

Initially price will increase and firms will make an economic profit; however, existing suppliers will supply more and new suppliers will enter the market and final equilibrium will be at a higher market output but at the same (original) price. IMAGE: 11-7.

Question 19

What is a constant-cost industry?

Answer 19

Relates to long-run market supply. A market where factor prices do not increase as industry output increases. The long-run supply curve is perfectly elastic (horizontal) and there are constant returns to scale.

Question 20

What is an increasing-cost industry?

Answer 20

Relates to long-run market supply. It is a market in which factor prices rise as more firms enter the market and existing firms expand production. In this market, production will be expanded at a higher equilibrium price since the price at which zero profit is made will rise. Supply curve will be upward sloping. Factor prices are likely to rise if factors of production are specialized.

Question 21

What is a decreasing-cost industry?

Answer 21

Relates to long-run market supply. A market in which factor prices fall as industry output expands. In this market, the price at zero profit equilibrium will fall and the supply curve will be downward sloping. This condition can exist if new entrants make it more cost-effective for other firms to provide services to all firms in the area; the supply of factors of production expands and reduces the price of inputs to production.

Question 22

How are adjustments made in the long-run vs. the short-run?

Answer 22

The LR supply curve is more elastic in than the SR supply curve because output changes are much less costly in the LR. In the SR, price does more of the adjusting. In the LR, more of the adjustment is done by quantity.