ECON 102 Chapter 12 (Firms in Perfectly Competitive Markets)

Perfectly competitive market

A market that meets the conditions of (1) many buyers and sellers, (2) all firms selling identical products, and (3) no barriers to new firms entering the market.

Price taker

A buyer or seller that is unable to affect the market price.

A buyer or seller that is unable to affect the market price is called

a price taker.

A price taker is

a firm that is unable to affect the market price.

A firm is likely to be a price taker when

it represents a small fraction of the total market.

Is the following statement correct or incorrect?

"According to the model of perfectly competitive markets, the demand for wheat should be a horizontal line. But this can't be true: When the price of wheat rises, the quantity of wheat demanded falls, the quantity of wheat demanded rises. Therefore, the demand for wheat is not a horizontal line."

Incorrect. The commentator is confusing the market demand for wheat with the demand line facing the representative firm.

For a market to be perfectly competitive, there must be

many buyers and sellers, with all firms selling identical products, and no barriers to new firms entering the market.

In 2017, two beer drinkers in California filed a lawsuit against Kona Brewing Company, which sells Kona beer. The beer drinkers claimed that Kona was marketed as if it were brewed in Hawaii, but the beer is actually brewed in Oregon, Washington, Tennessee, and New Hampshire.

If the market for beer were perfectly competitive, the location of breweries would

not matter to consumers since the product would be homogeneous.

Which of the following is a characteristic of perfectly competitive markets?

There will be many buyers and many firms, all of whom are small relative to the market.

A firm sells 10,000 units of X per month at the market price of $10. There are many other firms in this industry producing the same variety of X. With all firms producing an identical product, each firm is a price taker in this market. Farah Mahmood and her friend Daniela Rodriguez, both students of economics, are debating the impact of a recent increase in the demand for X. Farah feels that the demand faced by each firm will shift to the right. This in turn will increase the market price. Daniela meanwhile is not sure how much the price will rise because she thinks that the immediate response to the higher demand will be a rightward shift in each firm's supply curve.

Farah's claim that each firm's demand curve will shift right is flawed because:

she is confusing the demand curve faced by the firm with the market demand curve.

Profit

Total revenue minus total cost. (TR-TC)

Average revenue (AR)

Total revenue divided by the quantity of the product sold.

Marginal revenue (MR)

The change in total revenue from selling one more unit of a product.

The increase in total revenue that results from selling one more unit of output is

marginal revenue.

What is the relationship between price, average revenue, and marginal revenue for a firm in a perfectly competitive market?

Price is equal to both average revenue and marginal revenue.

A student argues:

"To maximize profit, a firm should produce the quantity where the difference between marginal revenue and marginal cost is the greatest. If a firm produces more than this quantity, then the profit made on each additional unit will be falling."

Is the above statement true of false?

False. Profit is maximized at the output level where marginal revenue equals marginal cost.

Explain why it is true that for a firm in a perfectly competitive market that P = MR = AR.

In a perfectly competitive market, P = MR = AR because

firms can sell as much output as they want at the market price.

Explain why it is true that for a firm in a perfectly competitive market, the profit-maximizing condition MR = MC is equivalent to the condition P = MC.

When maximizing profits, MR = MC is equivalent to P = MC because

the marginal revenue curve for a perfectly competitive firm is the same as its demand curve.

Which of the following best explains why firms don't maximize revenue rather than profit?

At the point where revenue is maximized, the difference between total revenue and total cost may not be maximized.

If a firm decided to maximize revenue, would it be likely to produce a smaller or a larger quantity than if it were maximizing profit?

The firm would produce a ________________ quantity of output.

larger

An article in the Wall Street Journal discussing the financial results for General Electric Co. (GE) for the first quarter of 2017 reported that, compared with the same quarter in the previous year, the firm's revenue had fallen from $27.94 billion to $27.66 billion, while its profit had increased from $228 million to $653 million.

1) It is possible for profits to increase even if revenue decreases if

2) How can GE best maximize its profit?

1) costs decrease more than revenue decreases.

2) Increase revenues and cut costs.

A startup firm in a perfectly competitive market finds that its average total cost is higher than the market price. Since the firm is incurring​ short-run losses, the management is debating whether to continue operations. Alex​ Ferguson, a senior​ manager, feels that this is a temporary phase and the firm should continue operations.

Which of the​ following, if​ true, would support​ Alex's argument?

The current price of the product covers the variable cost of production.

In the short run, a firm experiencing a loss has two choices:

1) Continue to produce

2) Stop production by shutting down temporarily

Fixed costs

Costs that remain constant as output changes.

Total revenue

The total amount of funds a seller receives from selling a good or service, calculated by multiplying price per unit by the number of units sold.

Variable cost

Costs that change as output changes.

Sunk cost

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

Shutdown point

The minimum point on a firm's average variable cost curve; if the price falls below this point, the firm shuts down production in the short run.

What is the relationship between a perfectly competitive firm's marginal cost curve and its supply curve?

A firm's marginal cost curve is equal to its supply curve for prices above average variable cost.

Suppose you decide to open a copy store. You rent store space (signing a one-year lease), and you take out a loan at a local bank and use the money to purchase 10 copiers. Six months later, a large chain opens a copy store two blocks away from yours. As a result, the revenue you receive from your copy store, while sufficient to cover the wages of your employees and the costs of paper and utilities, doesn't cover all of your rent and the interest and repayment costs on the loan you took out to purchase the copiers.

Should you continue operating your business?

Yes, because you are covering your variable costs.

How is the market supply curve derived from the supply curves of individual firms?

The market supply curve is derived

by horizontally adding the individual firms' supply curves.

What is the difference between a firm's shutdown point in the short run and its exit point in the long run?

1) In the short run, a firm's shutdown point is the minimum point on the

2) Why are firms willing to accept losses in the short run but not in the long run?

1) average variable cost curve, while in the long run, a firm's exit point is the minimum point on the average total cost curve.

2) There are fixed costs in the short run but not in the long run.

Economic profit

A firm's revenues minus all its costs, implicit and explicit.

Economic loss

The situation in which a firm's total revenue is less than its total cost, including all implicit costs.

Long-run competitive equilibrium

The situation in which the entry and exit of firms has resulted in the typical firm breaking even.

In a perfectly competition, long-run equilibrium occurs when the economic profit is

zero.

Long-run supply curve

A curve that shows the relationship in the long run between market price and the quantity supplied.

In 2017, Apple reported that since its iTunes App Store had opened in 2008, third-party app developers had earned more than $60 billion and currently employed 1.4 million people. Yet, as we've seen, because of intense competition, many game developers can only break even on the games they develop.

If game companies can only break even on the mobile games they develop, in the long run, we would expect them to

continue to develop mobile games because they can cover all costs of production if they break even.

In a perfectly competitive industry with constant costs, the long-run supply curve will be

horizontal.

In a perfectly competitive industry with increasing average costs, the long-run supply curve will be

upward sloping.

When are firms likely to enter an​ industry? When are they likely to​ exit?

Economic profits attract firms to enter an​ industry, and economic losses cause firms to exit an industry.

A study analyzed a pharmaceutical firm's costs to develop a prescription drug and receive government approval. An article in the Wall Street Journal describing the study noted that included in the firm's costs was "the return that could be gained if the money [used to develop the drug] were invested elsewhere."

This return should

be included in the firm's costs because it is the opportunity cost of not investing those funds elsewhere.

Productive efficiency

A situation in which a good or service is produced at the lowest possible cost.

"In a perfectly competitive market, in the long run consumers benefit from reductions in costs, but firms don't."

Don't firms also benefit from cost reductions because they are able to earn greater profits?

No. Because short-run profits encourage entry, firms earn zero economic profit in the long run.

Which of the following terms best describes the result of the forces of competition driving the market price to the minimum average cost of the typical firm?

productive efficiency

Allocative efficiency

A state of the economy in which production is in accordance with consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to society equal to the marginal cost of producing it.

Which of the following terms best describes a state of the economy in which production reflects consumer preferences?

allocative efficiency

Long-run equilibrium in perfect competition results in

- allocative efficiency

- productive efficiency

- Both A and B

- Neither A nor B

Both A and B

Why are consumers so powerful in a market system?

Because it is consumers' demand that influences the market price and dictates what producers will supply in the market.

How does perfect competition lead to allocative and productive efficiency?

Prefect competition leads to allocative and productive efficiency

- because prices reflect consumer preferences.

- because firms are motivated by profit.

- under the direction of association of firms.

- under the planning of government bureaucrats.

- both a and b.

- both a and b.