The Profit Motive and the Behavior of Firms

What do economists use the term “firm” to describe?

Economic actors who are responsible for supplying goods and services in the economy

What do firms combine?

Labor, capital equipment, raw materials, and other inputs

What is used to summarize the action of firms?

The supply curve

According to the law of supply as the price of a good rises what will happen to firms?

Firms will be willing to supply a greater quantity

What do we assume about a firms goal?

We assume a firms goal is to maximize profits

What are profits defined as?

The difference between the firms total revenue and its total costs

What is the meaning of total revenue?

The total quantity of output the firm produces for sale multiplied by the price it receives

What do economic costs include?

The opportunity costs of all resources required for production

Accounting costs will likely only include what?

Actual monetary costs

What are fixed costs?

Costs such as opportunity cost, rent, and equipment, that do not depend of the quantity of product being produced and cannot change in the short run

What are variable costs?

Costs such as labor, and materials, that can be varied in the short run

The increase in costs that occurs when producing an additional unit of output is called what?

Marginal cost

How do you calculate marginal cost?

By dividing the increase in total costs by the increase in quantity of a product being produced

The additional cost is referred to as what?

Marginal cost of production

What is marginal revenue?

The additional revenue that a producer gets from supplying a product

As long as diminishing returns to scale apply, how will marginal cost react?

It will rise as the firms output increases

If diminishing returns to scale apply, what will the profit-maximizing firms supply curve look like?

It will be an upward sloping line

The addition of more producers in a market will shift the supply curve where?

To the right

By more producers entering the market and the supply curve shifting right what will fall?

Equilibrium price

The entry of additional producers in a market will continue as long as what?

There are positive economic profits to be earned in the market

When will entry into a market cease?

When economic profits have reached zero

If economic profits in a market were to fall below zero what would happen?

Producers would begin to leave the market, shifting to other activities that offered greater opportunities

How much economic profits do competitive market business owners earn?

Zero

Why will competitive market business owners be content when they earn zero economic profits?

They are earning their opportunity wage

What important functions does price serve?

Rationing scarce goods, and allocating productive resources between different activities

If prices exceed production costs the existence of economic profits acts as a signal for what?

Additional resources to be deployed to that activity to increase production

Many important products are dominated by what?

A small number of very large firms

What are examples of markets that are dominated by a small number of very large firms?

Commercial airplanes, automobiles, and ride sharing services

What are examples of services that have only one supplier in a community?

Electriticty, water, and cable television

Markets with one or only a few suppliers are called what?

Imperfectly competitive

What are the goals of firms in imperfectly competitive markets?

The same as firms in perfectly competitive markets, to maximize their economic profits

What is the difference between firms in perfects vs imperfect markets?

A firm in an imperfectly competitive market can no longer assume that its decision about how much to supply does not affect the price at which its products can be sold

In an imperfectly competitive market the demand curve slopes where?

Downward

What does the downward sloping curve in a imperfectly competitive market mean?

If it chooses to increase its supply the price it receives will be lower

Firms facing a downward sloping demand curve are said to possess what?

Market power

What does a firm having market power mean?

Instead of taking prices as given they have the ability to choose market prices

What are firms with market power constrained by?

The combinations of price and quantity determined by the market demand