Week 8 More Week 7 accidentally put in macroeconomics Flashcards
The graph on the right shows the marginal revenue, marginal cost, and average total cost curves for a firm in a perfectly competitive market.
If this firm produced at the profit-maximizing output level, what would be the size of this firm’s profits or losses?
1.) Using the rectangle drawing tool, illustrate the size of this firm’s profits or losses if it produces at the profit-maximizing output level. Label the area appropriately.
Carefully follow the instructions above and only draw the required object.
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If firms in a perfectly competitive market are earning profits or incurring losses in the short run, then in the long run these profits or losses will either cause new firms to enter or existing firms to leave the market.
This will result in a shift in the
For a perfectly competitive industry that is initially in long-run equilibrium, a short-run shock to the market may cause firms to earn profits or incur losses in the short run.
In the long run, these profits or losses will either cause new firms to enter or existing firms to leave the market. This will result in a shift in the industry supply curve until profits are zero.
Given the long-run adjustment process that takes place after a supply or demand shock, we know that the industry supply curve must be
horizontal, since the supply curve shifts until price is back to its original level and profits are back to zero.
In assessing the performance of a perfectly competitive market, we can say that
any departure from the equilibrium necessarily reduces social surplus.
price efficiently allocates goods and services to buyers and sellers.
no individual can be made better off without making someone else worse off.
In a monopolistically competitive market, a firm earning negative economic profit in the short run will ____________.
The decision rule for a monopolistically competitive market operating in the short run is exactly the same as for a monopoly and a competitive firm. The firm should continue to operate if total revenue covers all of the variable costs and some of the fixed costs. However, if total revenues do not cover the variable costs, shut down is optimal. That is, the firm should produce if price is greater than average variable cost.
What happens in a monopolistically competitive market when firms exit the market?
In a monopolistically competitive market, firms can earn economic profits in the short run. However, this can lead to the entry of new firms in the market. As the new firms enter, the demand curve for each monopolistically competitive firm becomes flatter and shifts inward with entry, until there are no longer positive economic profits.
With the growth of the Internet, there are a large number of online retailers as well as buyers in the online retail market.
One might think that different firms would charge very similar prices for the same good because
The cost of searching online is low
In the online retail market, consumers have more or less perfect information as the costs of searching for a good are very low. It is also easier for sellers to adjust their prices based on competitors’ pricing. The fact that there are many sellers means that, for identical products, competition should force prices down to marginal cost.
John Maynard Keynes (a famous British economist) said “In the long run we are all dead.” An important message in this chapter is, to paraphrase Keynes, “In the long run, all profits in a monopolistically competitive market are dead.”
Consider a monopolistically competitive industry earning positive economic profits in the short run.
In the long run, a monopolistically competitive industry earns zero economic profits because
new firms enter, shifting a firm’s demand curve to the left.
Monopolistically competitive firms might earn positive economic profits in the short run due to
product differentiation.
Consider the market for college textbooks. Assume this market is monopolistically competitive. A representative firm’s demand (D), marginal revenue (MR), marginal cost (MC), and average cost (AC) curves are illustrated in the figure on the right.
This industry ____________.
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Monopolistically competitive firms maximize profit by producing where marginal revenue equals marginal cost. This occurs at 5 thousand textbooks. The corresponding profit-maximizing price, according to the demand curve, is $65.00. The average cost of producing 5 thousand textbooks is less than the $65.00 price, so the firm is earning profits. If firms are earning profits, then new firms will enter in the long run, and if firms are incurring losses, then some existing firms will exit in the long run. In this example, firms are earning profits, which will result in firms entering, so the industry is not in long-run equilibrium.
How is performance (market efficiency) determined
By conduct (firm behaviour) which is in turn determined by industry structure
A competitive market, sometimes called a perfectly competitive market, has these characteristics:
- There are many buyers and many sellers in the market;
- They are all small;
- The goods offered by the various sellers are the same (homogeneous);
Therefore, each buyer and seller is a price taker.
- Firms can freely enter or exit the market in the long run.
Price taker
A buyer or seller who takes the price as given by market conditions, they have no market power.
Imperfect competition
Imperfect competition is a source of market failure. Therefore, this perfectly competitive market structure is not associated with market failure.
Perfect competition Structure: revenue measures and revenue curves
TR AR MR
Total revenue (TR) = P x Q
Average revenue (AR) = TR / Q = P
Marginal revenue (MR) = ∆ TR / ∆ Q
8.1.1. Perfect Competition Structure: revenue measures and revenue curves
As the firm is a price taker, it has a perfectly elastic (flat) demand (D) curve at the existing market price (P).
TR = P × Q and P is fixed for a competitive firm. Therefore, when Q rises by one unit, TR rises by P. For perfectly competitive firms, MR = P.
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What is the difference between short run and long run
In the short run at least one input is fixed whereas in the long run all inputs are variable
Perfect competition profit maximisation
Add the cost curves (MC, ATC, AVC) to the revenue curve.
At Q1, MR > MC. If the firm increased production by one unit, the additional revenue (P) would exceed the additional costs (MC1). The firm should increase production.
At Q2, MR < MC. The firm should reduce production.
The profit maximising quantity is Qmax
(where MC = MR).
Therefore, a profit maximising firm will produce quantity of output Qmax.
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Perfect competition firm supply
The competitive firm’s profit maximising quantity is found at the intersection of the price and marginal cost curves.
When the price is P1, the firm produces quantity Q1.
When the price rises to P2, the new profit maximising quantity is Q2.
Because the firm’s MC curve determines how much the firm is willing to supply at any price, the MC curve is also the competitive firm’s supply curve.
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Perfect competition
Shutdown
A short run decision by a firm to produce nothing for a specific period of time because of current market conditions. In some circumstances the firm will decide to close its doors and not produce anything at all.
Perfect competition
Exit
A long run decision by a firm to leave the market completely.
Perfect competition
short run shutdown
To decide whether to shutdown in the short run, the firm compares the loss it will make if it stays open and continues production (production loss) to the loss it will make if it shuts down ( = loss on its expenditure on fixed inputs) (shutdown loss)
Perfect competition effects of shutdown
If the firm shuts down, it loses all revenue from the sale of its product. But it saves the variable costs of making its product. Therefore, the firm follows the rule:
Shutdown if TR < VC
