Theme 4 - Competitive Supply

Question 1

What are the conditions for perfect competition?

Answer 1

1. Large number of firms and consumers
2. Identical product sold across firms (product homogeneity)
3. Free entry and exit in the market
4. Perfect information
5. No transaction costs

Question 2

We say that in perfect competition, firms are price ** , what does it mean? (find the word **)

Answer 2

Firms are price takers

It means that a firm has no influence over the market price because the demand is perfectly elastic

If the firm increase it’s price, the firm will loose all it’s costumers.
If they try to decrease their prices, they won’t maximise their profits.

Question 3

How does the firm choose its selling price in a perfect competition?

Answer 3

A firm in a perfectly competitive market maximizes profits by choosing q* such that P= MC(q)

R = Pq -> MR(q) = P
If the profit maximization competition is MR(q) = MC(q), it implies that MC(q) = P

P = MC(q) = MR(q)

Question 4

In the short-run, does a firm needs to shut down if its profits are negative? If not, when should it shutdown?

Answer 4

In the short-run, a firm should continue to operate even if its profits are negative (below the breakeven price (the price where the firm’s profits = 0)).
Pbreakeven = minAC(q*)

However, the firm should shut down if its revenue are not enough to cover its variable costs (below the shutdown price).
Pshutdown = minAVC(q*)

Question 5

In the long-run, when should a firm shutdown?

Answer 5

In the long-run, a firm should shutdown when its profits = 0.

Pbreakeven = Pshutdown = minAClong-run(q*)

Question 6

Draw the firm’s supply curve in the short-run and in the long-run

Answer 6

Answer in the PP on theme 4 diapo 38 (I can’t insert images)

(Firm’s supply curve = MC curve)

Question 7

How is the short-run market supply curve obtained?

Answer 7

The market supply curve is obtained by adding, for any given price P, the quantities supplied by all firms at that price.

The market supply curve is then the horizontal sum of individual firm’s supply curves.

Question 8

In a competitive environment, what happens in the long-run with the market supply curve when profits are positive? And when they are negative?

Answer 8

When profits are positive, new firms enter the market and the market supply curve shifts to the right

When profits are negative, firms exit the market and the market supply curve shifts to the left.