Competition and Market Structures

Flashcards covering key concepts related to competition, profit measurement, and market structures, especially perfect competition.

Competitive Market

A market where more than one seller offers the same or a similar product; the more sellers and the closer the substitutes, the greater the competition.

Ways firms differentiate products

Building better relationships with customers, encouraging purchasing habits, and providing high levels of customer and aftersales service.

Competitive firms

Price takers, market supply is closely linked to firms’ costs.

Characteristics of highly competitive markets

Large number of buyers and sellers, homogenous goods and services, free entry or exit for firms, perfect knowledge from buyers and sellers.

Profit Maximization

Output level where Marginal Cost equals Marginal Revenue.

P = AR = MR

Under highly competitive conditions, Price equals Average Revenue equals Marginal Revenue.

Shutdown (Short Run)

A short run decision not to produce anything during a specific period of time because of current market conditions.

Exit

A long run decision to leave the market.

Shutdown Decision Rule

Shut down if Price is less than Average Variable Cost (P < AVC).

Sunk Cost

A cost that has already been committed and cannot be recovered.

Sunk Costs Implications

You should ignore them when making decisions.

Long Run Exit Decision Rule

Exit if Total Revenue is less than Total Cost (TR < TC) or Exit if Price is less than Average Total Cost (P < ATC).

Short Run Profit

The area of the shaded box between price and average total cost.

Long run Equilibrium

Firms will enter or exit the market until economic profit is driven to zero and In the long run, P equals the minimum of ATC.

Zero Profit Explained

Profit equals total revenue minus total cost, and total cost includes all the opportunity costs of the firm.

Normal Profit

The minimum amount required to keep the factors of production in their current use.

Perfectly Competitive Model Implications

The long run equilibrium has firms producing where price equals marginal cost and making zero or normal profit. Firms cannot yield market power. In the long run the model implies allocative and productive efficiency.

Relevance of Perfectly Competitive Model

The model provides a benchmark as to the costs and benefits of markets to be used by decision makers such as regulators and governments.

Productive Efficiency

Occurs when the firm is operating at the minimum point on its long-run average cost curve (min LRAC).

Allocative Efficiency

Achieved when Price equals Marginal Cost (P = MC).