Week 6 - Perfect competition

Question 1

What helps determine the output level firms want to produce to maximise their profit?

Answer 1

determines what market they are in

Question 2

What are the 5 assumptions of perfect competition?

Answer 2

1. the market has many buyers and many sellers
2. 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
3. No barriers to entry or exit
4. Perfect information and low transaction cost
5. Perfect competition is the benchmark of Efficiency

Question 3

What can perfect competition not change in the short run?

Answer 3

the amount of capital employed (and also the number of firms) because it is fixed

Question 4

What is the profit equation?

Answer 4

Profit = Total Revenue - Total Cost

TR = p x q
TC = c(q)

Question 5

What does the profit maximisation curve look like?

Answer 5

A n curve

Question 6

What is the average revenue equation?

Answer 6

AR = Total revenue / quantity sold = Price

Question 7

What is marginal revenue?

Answer 7

the additional revenue from selling one additional unit of output

Question 8

What is the marginal revenue equation?

Answer 8

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)

Question 9

Eg Suppose the price is given at 20 so TR = 20q
What is the AR?
What is the MR?

Answer 9

AR = 20
MR = d TR/ d q
MR = 20

Question 10

How does a firm maximise profit?

Answer 10

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

Question 11

What curves are on a perfect competition graph?

Answer 11

MC (nike tick)
AC (U curve)
MR=P straight line

Question 12

Where is the profit maximising output level on the graph?

Answer 12

P=MR=MC

Question 13

What is the intersection between MR and MC?

Answer 13

output level

Question 14

What is the cost of each unit on the graph at the MR=MC output level?

Answer 14

q where MC=MR up to the AC curve
(how much to produce)

Question 15

What is the revenue from selling each unit on the graph?

Answer 15

where MR=P horizontal line

Question 16

How to find the profit per unit on the graph?

Answer 16

the difference between where q hits AC and the MR=P curve

Question 17

How to find the supernormal profit on the graph?

Answer 17

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

Question 18

Where do we find the optimum output level using a supply curve?

Answer 18

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

Question 19

What does a firm lose if they arent producing any output in the short run?

Answer 19

fixed costs

Question 20

When should a firm shutdown in terms of costs?

Answer 20

p < AVC

Question 21

What is a firms short-run shut down condition?

Answer 21

when p<AVC

Question 22

When should a firm keep operating?

Answer 22

As long a TR covers the VC (that is p ≥ AVC)

Question 23

What should their profit look like to keep operating?

Answer 23

Profit = TR - TC
= TR - FC - VC

Question 24

What should their profit look like to not keep operating?

Answer 24

Profit = TR - FC - VC
= 0 - FC - 0

Question 25

How does a firm minimise their losses?

Answer 25

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

Question 26

Where is the minimum AVC on the graph?

Answer 26

When MC intersects AVC

Question 27

What is the industry supply curve?

Answer 27

the horizontal sum of individual firms supply curves

Question 28

What the industry supply curve looks like

Answer 28

p1 horizontal S1 supply at q1 S2 supply at q2 S industry at q1+q2

Question 29

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

Answer 29

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

Question 30

What do firms want to do in the long run?

Answer 30

also maximise profit but they now have free entry

Question 31

What is free entry?

Answer 31

the ability of a firm to enter an industry without encountering legal or technical barrier

Question 32

What are all factors of production in the long run?

Answer 32

variable, firms may enter (attracted by supernormal profits) or leave (owing to losses) the industry

Question 33

When does long-run competitive equilibrium occur?

Answer 33

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)

Question 34

What happens to the supply (at industry level) since the existence of supernormal profit attracts new entrants into the industry?

Answer 34

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.

Question 35

What happens when no further supernormal profits are made?

Answer 35

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