Ch15: Firms in Perfectly Competitive Markets and Market Equilibrium

What defines a perfectly competitive market?

Many buyers and sellers, trading identical products, price takers, and free entry and exit.

What is total revenue (TR)?

TR = Price (P) × Quantity (Q)

What is average revenue (AR)?

AR = Total Revenue (TR) / Quantity (Q)

What is marginal revenue (MR)?

MR = Change in Total Revenue (∆TR) / Change in Quantity (∆Q)

What is the relationship between AR, P, and MR for competitive firms?

For competitive firms, AR = P = MR.

How does a competitive firm determine the profit-maximizing quantity?

By comparing marginal revenue (MR) with marginal cost (MC); profit is maximized where MR = MC.

What happens if MR > MC?

The firm should increase quantity (Q) to raise profit.

What happens if MR < MC?

The firm should decrease quantity (Q) to raise profit.

What is the short-run decision to shut down?

A firm decides to produce Q = 0 if total revenue (TR) is less than variable costs (VC).

What is the long-run decision to exit the market?

A firm exits the market if it can no longer cover its total costs in the long run.

What is the firm's short-run supply curve?

The portion of the marginal cost (MC) curve above the average variable cost (AVC).

What are sunk costs?

Costs that have already been incurred and cannot be recovered; should be ignored in decision-making.

What is the cost of shutting down in the short run?

The revenue loss equals total revenue (TR).

What is the benefit of shutting down in the short run?

Cost savings equal variable costs (VC), as fixed costs (FC) must still be paid.

What is the profit-maximizing quantity (Q) for a firm?

The quantity where marginal revenue (MR) equals marginal cost (MC).

If the market price increases, what happens to the profit-maximizing quantity?

The profit-maximizing quantity increases.

What is the formula for profit?

Profit = Total Revenue (TR) - Total Cost (TC).

What is the difference between short-run shutdown and long-run exit?

Shutdown is temporary (Q = 0), while exit is permanent (leaving the market).

What should a firm do if price falls below average variable cost (AVC)?

The firm should shut down in the short run.

What is the significance of the marginal cost (MC) curve for a firm?

The MC curve determines the firm's supply at any price.

What is the relationship between fixed costs (FC) and sunk costs?

In the short run, fixed costs are considered sunk costs and should not affect shutdown decisions.

How should a firm price a sunk cost when reselling an item?

The price should reflect only the new costs, ignoring the sunk cost.

What is the marginal cost (MC) at the profit-maximizing quantity?

At the profit-maximizing quantity, MC equals MR.

What happens to a firm's supply curve if the market price rises?

The profit-maximizing quantity supplied increases.

What is the formula for total cost (TC)?

TC = Fixed Costs (FC) + Variable Costs (VC).

What is the condition for a firm to continue operating in the short run?

If total revenue (TR) is greater than variable costs (VC).

What is the market supply curve in the short run?

It is the sum of all individual firms' supply curves.

What is the market supply curve in the long run?

It reflects the entry and exit of firms until economic profits are zero.

What is the cost of exiting a market in the long run?

Revenue loss, which equals total revenue (TR).

What is the benefit of exiting a market in the long run?

Cost savings, which equals total cost (TC) since fixed costs (FC) are zero in the long run.

When should a firm exit the market?

If total revenue (TR) is less than total cost (TC), or P < ATC.

When should a firm enter the market?

If total revenue (TR) is greater than total cost (TC), or P > ATC.

What defines a competitive firm's long-run supply curve?

It is the portion of the marginal cost (MC) curve that is above the average total cost (ATC).

How is profit calculated using price and average total cost?

Profit = (P - ATC) × Q.

What happens when a firm incurs losses?

Some firms exit the market, causing the short-run market supply to shift left.

What is the zero-profit condition in long-run equilibrium?

When price (P) equals minimum average total cost (min ATC), resulting in zero economic profit.

Why do competitive firms stay in business even with zero profit?

Because total revenue equals total cost, including implicit costs, leading to positive accounting profit.

What is the long-run market supply curve's characteristic?

It is horizontal at P = minimum ATC, indicating zero profit for typical firms.

What is the significance of the efficient scale?

It is the output level where average total cost (ATC) is minimized.

What should a firm do if price is less than average variable cost (AVC)?

Shut down in the short run.

What is the role of marginal revenue (MR) in profit maximization?

A firm maximizes profit where marginal revenue (MR) equals marginal cost (MC).

What happens to market supply when existing firms earn positive economic profit?

New firms enter the market, shifting the short-run market supply curve to the right.

What is the shut-down point for a firm?

It occurs when price (P) equals average variable cost (AVC).

How do firms determine their profit-maximizing quantity?

By finding the quantity where marginal revenue (MR) equals marginal cost (MC).

What is the relationship between price (P), marginal cost (MC), and average total cost (ATC) in long-run equilibrium?

In long-run equilibrium, P = MC = ATC.

What does it mean when P < ATC?

The firm is incurring a loss.

What does it mean when P > AVC?

The firm should continue producing in the short run.

What is the implication of identical cost curves for firms in a market?

All existing firms and potential entrants have the same cost structure.

What occurs to market quantity supplied at each price level?

The market quantity supplied is the sum of quantities supplied by all firms.

What is the impact of fixed costs on the number of firms in the short run?

The number of firms is fixed in the short run due to fixed costs.

What is the effect of free entry and exit in the long run?

The number of firms can vary, allowing for market adjustments.

What does the term 'economic profit' refer to?

The profit that exceeds all implicit and explicit costs.

What is the significance of the average total cost curve in determining firm behavior?

It helps firms decide whether to enter or exit the market based on profit conditions.

What is the condition for a firm to be in long-run equilibrium?

MR = MC at the minimum average total cost (ATC).

What happens to a firm in the short run when demand increases?

The price rises, leading to short-run profits as P > ATC.

What is the long-run effect of an increase in demand on market supply?

New firms enter the market, shifting supply to the right and restoring zero profits.

What does the long-run supply curve look like if all firms have identical costs?

It is horizontal.

When might the long-run supply curve slope upward?

If firms have different costs or if costs rise as firms enter the market.

What is the relationship between price (P), marginal cost (MC), and marginal revenue (MR) in perfect competition?

P = MR = MC.

What is the condition for a firm to shut down temporarily in the short run?

If price (P) is less than average variable cost (AVC).

What should a firm do in the long run if price (P) is less than average total cost (ATC)?

Exit the market.

What is the outcome of free entry and exit in a competitive market in the long run?

Economic profit is driven to zero.

What is the competitive equilibrium condition for maximizing total surplus?

P = MC.

What does it mean for a firm to be a price taker?

The firm's revenue is proportional to the amount of output it produces (P = MR = AR).

What is the short-run response of a firm to an increase in demand?

The equilibrium price rises, leading to increased quantity sold.

What happens to profits in the long run after new firms enter the market?

Profits return to zero as price returns to the minimum of average total cost.

What is the significance of the marginal-cost curve for a firm?

It represents the firm's supply curve.

What happens to the market equilibrium when demand decreases?

Prices lower, leading to losses for firms.

What is the initial condition of a market in long-run equilibrium?

Each firm makes zero profit, and price equals minimum ATC.

What does an upward-sloping long-run supply curve indicate?

Costs rise as firms enter the market or firms have different costs.

What is the role of average total cost (ATC) in determining firm behavior?

It helps determine whether firms will enter or exit the market based on profitability.

What is the effect of an increase in demand on the short-run equilibrium?

Equilibrium moves from point A to point B, with a price increase.

What is the long-run equilibrium point after an increase in demand?

Point C, where price returns to P1 and quantity sold increases to Q3.

What is the relationship between price and marginal cost in a competitive market?

In equilibrium, price equals marginal cost.

What is the significance of the competitive equilibrium?

It maximizes total surplus in the market.

What happens to the supply curve when new firms enter the market?

The supply curve shifts to the right.

What is the impact of a decrease in demand on firms in the short run?

It leads to lower prices and potential losses.

What does it mean for a firm to operate at efficient scale?

It produces at the minimum average total cost.

What is the significance of the concept of 'zero-profit equilibrium'?

It indicates that firms are earning just enough to cover their costs in the long run.