units 3 & 4

ecf

price mechanism

a system in the market economy where forces of supply and demand determine the prices and quantities of goods and services

perfect competition

a market with many buyers and sellers, identical products, no barriers to entry, and perfect information

sellers are price takers

price taker

takes prices determined by total demand and total supply in the market

because it is too small to influence the market price

What is the relationship between P, AR, and MR in perfect competition?

P = AR = MR

what is the profit maximizing rule?

the output level where MR = MC

supernormal profit

total revenue > total cost (TR>TC)

when does supernormal (economic) profit occur?

when P > AC

normal profit is also known as…

break-even or zero profit

subnormal profit (loss) (TR<TC) occurs when…

P < AC

the shutdown point is when…

P = AVC

a firm should shut down when…

P < AVC

why continue production when P + AVC?

because the firm covers variable costs but not total costs

what outcomes are possible in the short run?

profit, break-even, or loss

what profit occurs in the long run?

only normal profit (P = AC)

why do only normal profits exist in the long run?

firms enter when profits exist, and exit when losses occur, driving profit to zero

total revenue (TR)

TR = P × Q

profit formula

Profit = TR − TC

average revenue (AR)

AR = TR ÷ Q = P

marginal revenue (MR)

MR = change in TR ÷ change in Q

oligopoly

a market with a few sellers, each having significant market power

oligopoly characteristics

few firms

high barriers to entry

high startup costs

firms are price makers

increase revenue predominantly through raising prices

what happens to efficiency in an oligopoly?

loss of allocative efficiency

what type of profits do oligopolies usually earn?

mostly supernormal profits in the short run and long run.

monopoly

a market structure in which there is only one supplier of a commodity or service

there are no close substitutes

how does a monopoly increase revenue?

mainly through raising prices

monopoly demand curve:

downward sloping and inelastic (AR = P = D)

where is MR relative to AR?

MR is below AR

what types of profits can monopolies earn?

supernormal, normal, or subnormal

monopolistic competition

a market with many firms selling differentiated products

Characteristics of monopolistic competition

• Many buyers & sellers

• Differentiated products

• Weak barriers to entry

• Limited pricing power (influence on price)

consumer surplus

the difference between what consumers are willing to pay and what they actually pay for a good/service

measured by increase or decrease in surplus.

producer surplus

the difference between the amount a producer receives vs the price they were willing to sell at

deadweight loss

inefficiency created in a market when the eq outcome is altered by an external factor

eg. taxes, subsidies, price controls, or monopolistic practices