Economics Terms Chapter 22-26

perfect competition

a market structure in which the decisions of individual buyers and sellers have no effect on market price

• many buyers and sellers, each sells a homogenous product

perfectly competitive firm

a firm that is such a small part of the total industry that it cannot affect the price of the product or service it sells

price taker

a perfectly competitive firm that must take the price of its product as given because the firm cannot influence its price

characteristics of perfect competition

• there are large numbers of buyers and sellers

• the product sold by the firms in the industry is homogenous (indistinguishable across firms)

• both buyers and sellers have access to all relevant information

• any firm can enter or leave the industry without serious impediments

the demand curve for the product of an individual firm in a perfectly competitive industry…….

is perfectly elastic at the going market price.

• sell all units at market price

• will sell no units at a higher price

profit-maximization model

assumes firms attempt to maximize their total profits (positive difference = total revenues - total costs)

total revenue

the price per unit times the total quantity sold & is the same as total receipts from the sale of output

profit-maximizing rate of production

• the rate of production that maximizes total profits (= total revenues - total costs)

• is also the rate of production where marginal revenue = marginal costs (this is when profit maximization occurs, MR = MC)

marginal revenue

the change in total revenues divided by the change in output

marginal cost

the change in total cost divided by the change in output

short-run profits

• in the short run, a perfectly competitive firm can make either economic profits or economic losses.

• economic profits = profit-per unit x units produced

• to find profit of producers in the short run: determine excess of price above average total cost (ATC)

the short-run break-even price and the short-run shutdown price

if price per unit sold exceeds the average variable cost per unit produced, the profits of the firm’s owners will be higher only IF it continues in the short run rather than shut down

short-run break-even price

• the price at which a firm’s total revenues = its total costs

• at the first break-even price, the firm is just making a normal rate of return on its capital investment

• means the firm is covering its implicit and explicit costs

short-run shutdown price

• the price that just covers average variable costs

• occurs just below the intersection of the marginal cost curve and the average variable cost curve

a firm goes out of business when vs a firm temporarily shuts down when

• out of business → the owners sell its assets

• temporarily shuts down → it stops producing but is still in business

accounting profits vs economic profits

• when economic profits are zero, a firm can still have positive accounting profits

• ATC curve includes the full opportunity cost of capital and all factors of production

the perfect competitors short-run supply curve

• a firm’s short-run supply curve in a competitive industry is its marginal cost curve at & above the point of intersection within the average variable cost curve

industry supply curve

• the set of points showing the minimum prices at which given quantities will be forthcoming

• also called the market supply curve

factors that influence the industry supply curve (determinants of supply)

• individual firm’s productivity

• factor prices (wages, prices of raw materials

• per-unit taxes and subsidies

• number of sellers

how is the market price established in a competitive market

established by the interaction of all the suppliers (firms) and all the demanders (consumers)

the market-clearing price

is the exact price of a good, service, or asset at which the quantity supplied by producers equals the quantity demanded by consumers (equilibrium price)

• competitive price = the intersection of the market demand curve and the short-run industry supply curve.

if firms incur losses, supply curve does what?

supply curve shifts upwards

• some firms cease production (exit the industry) which causes this

if firms make economic profits, supply curve does what?

supply curve shifts outwards

• new firms enter the industry which causes this

in the long run (competitive situation) firms will…

be making zero profits

exit and entry of firms, key to remember

• economic profits

  • signals resources to enter the market

• economic losses

  • signals resources to exit the market

in the long run, capital will…

• flow into industries where profitability is highest

• flow out of industries in which profitability is lowest

allocation of capital

price system allocates capital according to the relative expected rates of return on alternative investments

market signals

investors and other suppliers of resources respond to market signals about their highest-valued opportunities

signals

ways of conveying information needed to make decisions to economic decision makers

• effective signal: conveys info AND provides an incentive to react appropriately

• ex. economic profits and losses

tendency toward equilibrium

• at break-even, resources will not enter or exit the market

• competitive long-run equilibrium = firms make zero economic profits

there is a tendency toward equilibrium, but firms adjust constantly to changes in their cost curve and the market demand curve

long-run industry supply curve

A market supply curve showing the relationship between prices and quantities after firms have been allowed time to enter or exit from an industry

• depends on whether there have been positive or negative economic profits

constant-cost industry

industry whose total output can be increased in the long run without an increase in prices

• long run supply curve is horizontal

increasing cost industry

industry in which a long-run increase in industry output = an increase in input prices

• long run supply curve slopes upward

decreasing-cost industry

industry in which an increase in output in the long run leads to a reduction in input prices

• long run supply curve slopes downward

in the long run, a competitive firm….

produces where price, marginal revenue, marginal cost, and average cost (minimum, short-run, and long-run) are equal.

marginal cost pricing

system of pricing in which the price charged = the opportunity cost to society of producing one more unit of the good or service in question

• opportunity cost is the marginal cost to society

• economically efficient: impossible to increase the output without lowering the value of the total output produced in the economy

market failure

unrestrained market operation leads to either too few or too many resources going to a specific economic activity

short run

the time period when one input is fixed (like plant size

plant size

the size of the facilities that a firm owns/operates to produce its output

• defined by square footage, maximum capacity, and other measures of the scale of productions of goods or service

long run

the time period in which all factors of production can be varied

production

the conversion of raw materials into goods

production function

the relationship between inputs and maximum output

• specifies the minimum amount of inputs necessary to produce a given level of output

average product

total product

———————- = average product

variable input

marginal product

the output that is due to one more additional unit of a variable factor of production

the law of diminishing marginal product

As successive equal increases in a variable factor of production are added to fixed factors of production —> there will be a point beyond which the extra one, or marginal, product that can be provided to each additional unit of the variable factor of production will decline

diminishing marginal product example

marginal product for labor increases at the beginning, but it begins to diminish as more workers are hired (they have nothing to do/less equipment to work with = zero productivity)

point of saturation

given the amount of fixed inputs, there is no further positive use for more of the variable input

• = the region of negative marginal product

total costs

the sum of total fixed costs and variable costs (TC = TFC + TVC)

fixed costs

costs that do not vary with output and are fixed for a certain period of time → ex. rent on a building

variable costs

costs that vary with the rate of production → ex. wages paid to workers/purchases of materials

average: fixed costs vs variable costs vs total costs

• average fixed costs (AFC): total fixed costs / # of units produced (output - Q)

• average variable costs (AVC): total variable costs / # of units produced (output - Q)

• average total costs (ATC): total costs / # of units produced (output - Q)

output

the number of units produced

marginal costs

change in total costs due to a one-unit change in production rate (does not include fixed costs)

• MC = change in total cost / change in output = wage / marginal product

marginal costs curve intersects average…..

• average total cost curve at its minimum

• average variable cost curve at its minimum

planning horizon

the long run, during which all inputs are variable

long run average cost curve

represents the minimum unit cost of producing any given rate of output, given current technology and resource prices

planning curve

the long-run average cost curve

• is u-shaped because of economies of scale, constant returns to scale, and diseconomies of scale

economies of scale

decreases in the long-run average costs resulting from increases in output

• reasons include: specialization (increased divisions of tasks or operations, dimensional factor (large-scale firms often require proportionately less input per unit of output, and improved productive equipment (the larger the enterprise, the more the firm can take advantage of larger-volume types of machinery

largest firm can produce at the lowest average total cost

constant returns to scale

no change in long-run average costs when output increases

diseconomies in scale

increases in long-run average costs that occur as output increases

• reasons why: limits to the efficient functioning of management or as the firm begins to grow, the layers of supervision grow and the costs of information and communication grow more than proportionately

minimum efficient scale (MES)

the lowest rate of output per unit time at which long-run average costs for a particular firm are at a minimum

monopolist

the single supplier of a good or service for which there is no close substitute

• constitutes the whole industry → ex. google

it’s a price-searcher

• a firm that must determine the price-output combination that maximizes profit because it faces a downward-sloping demand curve

natural monopoly

a monopoly that comes from peculiar production characteristics in an industry

one firm can produce at a lower average cost than can be achieved by multiple firms

barriers to entry

restrictions on who can start, as well as stay in business

• allow firms to make long-run economic profits

• ex. economies of scale , legal or governmental restrictions

legal or governmental restrictions

licenses, franchises, and certificates of convenience

• ex. electrical utilities, pipelines, radio and television broadcasting, transmission of natural gas

patents:

• intellectual property

regulation:

• government enforcement of safety and quality

tariffs:

• taxes on imported goods

demand curve for monopolists

downward sloping

• monopolists face the industry demand curve for the entire market because the monopolist is the entire industry

perfect competition vs monopoly

• if monopolist wants to sell more, the price they charge must be lower on the last unit sold (downward sloping demand curve)

• perfect competitor does not have to worry about price changes, the firm can sell all of its output at the same price

marginal revenue for perfect competition vs monopoly

if a firm faces a perfectly elastic demand curve (perfect competitor) it’s a price-taker

• supply and demand in the market decide it’s price per unit → marginal revenue, average revenue, and price are all the same

to induce consumers to buy more of a particular product, the monopoly must lower the price on all units sold

• marginal revenue is always less than price,

table for monopolies versus perfect competition

see image attached

the total revenues - total costs approach: price searching to maximize monopoly profits

maximize the positive difference between total revenues and total costs

the marginal revenue - marginal cost approach: price searching to maximize monopoly profits

profit maximization = when marginal revenue equals marginal cost, which is where the greatest positive difference between total revenue and total cost occurs

formula to calculate monopoly profit

total revenues (P × Q) minus total costs (ATC × Q)

• if ATC is everywhere above demand, no price-output combination allows the monopolist to cover costs

price discrimination

selling a given product at more than one price, with the difference being unrelated to differences in marginal cost

price differentiation

establishing different prices for similar products to reflect differences in marginal cost in providing those commodities to different groups of buyers

necessary conditions for price discrimination

• firm must face a downward-sloping demand curve

• firm must be able to readily (and cheaply) identify buyers or groups of buyers with predictably different elasticities of demand

• firm must be able to prevent the resale of the product or service among customers