Module 9 Study Guide Flashcards
What are the characteristics or assumptions of the perfect competition model?
Perfect competition is a scenario where we have nothing but competition. In perfect competition or pure competition, we have the most basic form of competition because we take a lot of our real world complexity out. In perfect competition, all firms are producing the exact the same product. There’s free entry and exit, no restrictions. SO many buyers and sellers that no one or group of firms or consumers have control over the price (all firms and consumers are price takers). Existing firms have no advantage over new entrants (because all firms are the same), and everyone has complete and full information on prices. So we don’t suffer from some of those market failures because everybody has full and complete info.
(Monopoly is the exact opposite of this.)
Perfectly competitive firms are very idealized and don’t really ever happen.
Farming is typically the example used but it only really applies to small family farms in the 1800s.
How do firms set prices under perfect competition?
They have no control over the price - only price takers. The only choice firms can really make (since they can’t choose the price) is choosing what output will maximize their process (choosing quantity).
Two ways that data can be used to maximize those profits:
- accounting profit
- economic profit (includes implicit costs- Are they making the best decision?)
- Choose the quantity where the difference between total costs (including implicit costs) and total revenue are the greatest.
- Find the quantity where our marginal revenue is equal to our marginal cost.
Total revenue is always the money that the firm is bringing in (from Module 4) Always Total Revenue - Total Cost (money payed out by the firm and their implicit costs) (costs will rise with output because total cost includes both fixed and variable costs)
In this first method we’re going to maximize our profit by determining what quantity produced where our total revenue minus total cost is the largest. (Usually if it isn’t hurting us to produce an additional unit, we’ll produce the additional unit.) (Keep producing until profit is maximized.)
Define marginal revenue and average revenue. Explain their relationship to price in perfect competition
Marginal revenue is the CHANGE in total revenue. (Like marginal cost is change in total cost)
Average total revenue is just the total revenue cost per unit.
(total revenue = price x quantity)
Average total revenue is = price
marginal revenue is only equal to price in perfect competition
How would a perfectly competitive firm use the marginal decision rule to determine the profit-maximizing quantity of output?
the marginal decision rule holds that a profit-maximizing firm should increase output until the marginal benefit of an additional unit equals the marginal cost.
Under what conditions would a perfectly competitive firm choose to shut down in the short run?
If price falls below average variable cost, the firm will shut down in the short run, reducing output to zero. The lowest point on the average variable cost curve is called the shutdown point.
