Econ 201 - Lesson 13 Teacher Study Guide

Perfect competition

An industry with many firms, each selling an identical good; many buyers; no restrictions on entry into the industry; no advantage for existing firms over new firms; and sellers and buyers are well informed about prices.

Perfect competition occurs

When the minimum efficient scale of a firm is small relative to demand.

Minimum efficient scale of a firm

The smallest quantity of output at which the long-run average total cost is at its lowest level.

Price taker

Cannot affect the price of the good. Every perfectly competitive firm.

Perfectly competitive firm’s demand curve

Horizontal-perfectly elastic-demand curve at the going price.

Economic profit equals

Total revenue minus total opportunity ycost.

Total revenue equals

The price of the output times the number sold.

Total revenue formula

TR = P X q, with P the price and q the amount the firm produces.

Marginal revenue equals

The change in total revenue from a one-unit increase in the quantity sold.

A perfectly competitive firm’s marginal revenue curve

Is the same as its demand curve and both are horizontal at the market-determined price.

Firm’s decisions in perfect competition in the short run

Whether to produce or to shut down, if it produces, how much to product.

Firm’s decisions in perfect competition in the long run

Whether to change its plant size and whether to enter or exit an industry.

To maximize its profits in the short run

The firm produces the quantity of output at which marginal revenue = marginal cost.

In the short run, perfectly compeititve firms can make

An economic profit, a normal profit, or an economic loss.

P > ATC

The firm earns an economic profit.

P = ATC

The firm earns a normal profit and zero economic profit (firm breaks even).

P < ATC

Firm has an economic loss.

If P < AVC

The firm shuts down temporarily.

Shutdown point

The output and price for which total revenue just equals total variable cost and is reached when P equals the minimum AVC.

Short-run industry supply curve

Shows the quantity supplied by the industry at each price when the number of firms and their plant size is fixed. The sum of the amounts supplied by each firm.

Economic profits bring entry by new firms

Industry supply curve shifts rightward and reduce the market price. The fall in price reduces economic profit and decreases the incentive to enter the industry. New firms enter until it is no longer possible to earn an economic profit.

Economic losses lead to exit by existing firms

Shifts the industry supply curve leftward. The price rises, and the higher price reduces economic losses. Firms exist until no firms incur an economic loss.

Long-run competitive equilibrium 3 conditions satisfied

MR (=P) = MC – The firm maximizes its profits. P = minimum short-run average cost (SRAC)—The firm’s economic profit is zero. P = minimum LRAC – The firm’s plant size cannot be changed in order to increase its profits.

Resources are used efficiently when we

Produce the goods and services valued most highly. No one can be made better off without making someone else worse off.

Consumers’ demands reflect

Their efforts to get the most value from their incomes. The demand curve is consumers’ marginal benefit curve.

Producers’ supplies reflect

The firm’s efforts to maximize their profits. The supply curve is producers’ marginal cost curve.

If there are no external benefits and no external costs

Perfect competition is efficient.

Factors that can lead to inefficiency

Presence of external costs or benefits, monopoly, or public goods.

Profit maximization rule

Requires producing where MR= MC.

A firm maximizes its

Total profit. Does this by producing any unit of output for which the revenue from the unit exceeds the cost of producing the unit.

Why do firms operate with zero economic profit?

When total revenue equals total cost, the owners are earning the same profit they could obtain elsewhere. Even though the ____, by earning a normal profit the firm is earning just as much profit as it could anywhere else and owners are content to continue producing in the same industry.