Week 6 - Perfect competition Flashcards
What helps determine the output level firms want to produce to maximise their profit?
determines what market they are in
What are the 5 assumptions of perfect competition?
- the market has many buyers and many sellers
- Homogeneity of output (firms produce identical production)
a) The multiplicity of sellers of identical goods means that no one firm has the power to determine the price, so firms are PRICE TAKERS - No barriers to entry or exit
- Perfect information and low transaction cost
- Perfect competition is the benchmark of Efficiency
What can perfect competition not change in the short run?
the amount of capital employed (and also the number of firms) because it is fixed
What is the profit equation?
Profit = Total Revenue - Total Cost
TR = p x q
TC = c(q)
What does the profit maximisation curve look like?
A n curve
What is the average revenue equation?
AR = Total revenue / quantity sold = Price
What is marginal revenue?
the additional revenue from selling one additional unit of output
What is the marginal revenue equation?
the rate of change of total revenue with respect to quantity sold
MR = d TR / d q
which then equals the price (only true in perfect competiton)
Eg Suppose the price is given at 20 so TR = 20q
What is the AR?
What is the MR?
AR = 20
MR = d TR/ d q
MR = 20
How does a firm maximise profit?
they cant control price, can only control output q
so they compare at marginal benefit and marginal cost
produce until the marginal benefit = marginal cost (when profit is maximised)
marginal benefit is the marginal revenue, so will choose an output where the marginal revenue they get is the same as the marginal cost
marginal revenue in perfect competition is also the price
so choose an output level when the price is the same as the marginal cost
P = MC
What curves are on a perfect competition graph?
MC (nike tick)
AC (U curve)
MR=P straight line
Where is the profit maximising output level on the graph?
P=MR=MC
What is the intersection between MR and MC?
output level
What is the cost of each unit on the graph at the MR=MC output level?
q where MC=MR up to the AC curve
(how much to produce)
What is the revenue from selling each unit on the graph?
where MR=P horizontal line
How to find the profit per unit on the graph?
the difference between where q hits AC and the MR=P curve
How to find the supernormal profit on the graph?
the difference between where q hits AC and the MR=P curve times the total units of quantity
OR
Total revenue (AR x q) - Total costs (AC x q)
AR=MR=P
Where do we find the optimum output level using a supply curve?
make the price (horizontal line) equal to the MC (nike tick) curve
firms supply more output when price is higher
firms supply less output when price is lower
What does a firm lose if they arent producing any output in the short run?
fixed costs
When should a firm shutdown in terms of costs?
p < AVC
What is a firms short-run shut down condition?
when p<AVC
When should a firm keep operating?
As long a TR covers the VC (that is p ≥ AVC)
What should their profit look like to keep operating?
Profit = TR - TC
= TR - FC - VC
What should their profit look like to not keep operating?
Profit = TR - FC - VC
= 0 - FC - 0
How does a firm minimise their losses?
in the short run, a firm may continue production even if it is making a loss so long as it is covering its variable costs
Where is the minimum AVC on the graph?
When MC intersects AVC
What is the industry supply curve?
the horizontal sum of individual firms supply curves
What the industry supply curve looks like
p1 horizontal
S1 supply at q1
S2 supply at q2
S industry at q1+q2
Short run market equilibrium eg
Suppose there are 8 identical firms in the perfectly competitive market of cardboard boxes
The firms total cost function is given by TC = 5 +2q^2
Suppose the market demand is given by Q_d = 10 - 3p
Find the short run market equilibrium
MC = 4q
P = 4q
q = P/4
Q_s = 8 x P/4 = 2P
Q_s = Q_d
2P = 10-3P
5P = 10
P = 2
Q_d = 4
q = 2/4
=1/2
Q_s = 8 x 1/2
Q_s = 4
What do firms want to do in the long run?
also maximise profit but they now have free entry
What is free entry?
the ability of a firm to enter an industry without encountering legal or technical barrier
What are all factors of production in the long run?
variable, firms may enter (attracted by supernormal profits) or leave (owing to losses) the industry
When does long-run competitive equilibrium occur?
at the point where the market price is equal to the minimum average total cost
at the equilibrium, the firms earn zero economic profit (considering opportunity cost)
What happens to the supply (at industry level) since the existence of supernormal profit attracts new entrants into the industry?
supply (at industry level) increases, pushing the price down, thus shifting the demand curve faced by individual firms down until no further supernormal profits are made.
What happens when no further supernormal profits are made?
at this point there is no incentive for further new entry, and so the industry is in long run equilibrium
in this equilibrium each firm produces output at minimum AC, so we have allocative efficiency
