Econ 3 Chapter 8

What conditions define perfect competition?

Many firms produce identical products; Many buyers and sellers are available; Sellers and buyers have all relevant information; Firms can enter and leave the market without restrictions.

What does it mean for a firm to be a 'price taker' in perfect competition?

The firm must accept the prevailing equilibrium price in the market.

What are some examples of markets that approximate perfect competition?

Agricultural commodities (corn, wheat, soybeans, milk, etc.) and mineral resources (crude oil, gold, silver, etc.).

In a perfectly competitive market, what happens if firms are enjoying positive economic profits?

New firms will enter the market.

In a perfectly competitive market, what happens if firms are experiencing negative economic profits?

Existing firms will leave the market.

In a perfectly competitive market, what occurs at equilibrium regarding firms entering or leaving?

No firms wish to leave or enter the market.

In the long run, what level of economic profit do price takers enjoy?

Zero economic profit.

What is the primary decision a perfectly competitive firm must make?

The quantity of product to produce

What does the quantity of product a firm decides to produce determine?

Total revenue, total costs, and profits.

How does a firm decide the quantity of product to produce?

The firm will choose to produce the quantity of product that maximizes its profit.

What is marginal revenue?

The additional revenue gained from selling one more unit of a product.

For a firm in perfect competition, what is unique about its marginal revenue curve?

It is the same as the firm's demand curve.

Why does marginal revenue not change as a firm produces more output in perfect competition?

Because each firm is too small to change the total quantity supplied in the market enough to affect the price.

What is marginal cost?

The additional cost of producing one more unit of a product.

How do firms experiment to find the profit-maximizing level of output?

Firms raise or lower the quantity they produce a little, and see how their profits are affected.

What should a firm do if marginal revenue is greater than marginal cost (MR > MC)?

The firm can increase profit by selling an additional unit of the product, so the firm should increase quantity produced.

What should a firm do if marginal revenue is less than marginal cost (MR < MC)?

The firm can increase profit by selling one fewer unit of the product, so the firm should decrease quantity produced.

What should a firm do if marginal revenue is equal to marginal cost (MR = MC)?

The firm cannot increase or decrease profit by changing output, so the firm should not change quantity produced.

At what point should a perfectly competitive firm stop increasing the quantity of product produced?

Marginal revenue equals marginal cost (MR = MC).

How is profit calculated?

Profit margin (or average profit) = Total Revenue - Total Cost / Quantity ; Therefore, profit = (Price - ATC) * Quantity

If Market price > Firm’s ATC of production for a particular quantity produced, then what is true of the firm's profits?

Firm earns an economic profit.

If Market price = Firm’s ATC of production for a particular quantity produced, then what is true of the firm's profits?

Firm earns zero economic profit.

If Market price < Firm’s ATC of production for a particular quantity produced, then what is true of the firm's profits?

Firm earns a loss.

What is the break-even point?

The quantity of output at which the market price is exactly equal to the firm’s ATC.

How do you know if a firm is profitable?

Price > ATC (Firm earns an economic profit); Price = ATC (Firm earns zero economic profit); Price < ATC (Firm earns a loss).

If P < ATC, a firm earns a loss. Should the firm shut down and produce zero quantity of the product?

Shutting down reduces variable costs to zero, but fixed costs remain; If a firm produces zero quantity, it will still earn losses because it must continue paying fixed costs

If P < ATC, should a firm always shut down immediately?

Not necessarily. If shutting down reduces variable costs to zero but fixed costs remain, the firm may still incur losses if it must continue paying fixed costs.

What is the condition for a firm to shut down in Scenario 1?

P < min(AVC). The firm cannot pay all of its variable costs even if it pays none of its fixed costs.

What is the condition for a firm to continue operating in Scenario 2?

P > min(AVC). The firm can pay all of its variable costs and has some revenue left over to pay some of its fixed costs.

What is the shutdown point?

The price below which the firm will lack enough revenue to cover its variable costs, and will thus shutdown, and it's found at the price at which the MC curve and the AVC curve intersect, and at the price at which AVC is at minimum

What is the simple version of the shutdown rule?

If P < minimum AVC, the firm shuts down. If P > minimum AVC, the firm continues operating.

Why is the firm's supply curve the MC curve at points at or above the minimum point of the AVC curve?

A firm checks the market price and then looks at its MC to determine the quantity to produce (P = MC), but before producing that quantity, the firm makes sure that P > AVC. If P < AVC, then the firm will produce zero quantity!

What is entry in the context of firms?

When new firms enter an industry in response to industry profits.

What is exit in the context of firms?

When existing firms reduce production and/or shut down in response to industry losses.

What conditions define long-run equilibrium for firms?

Firms earn zero economic profits by producing at the output level where P = MR = MC and P = ATC, and no firm has an incentive to enter or leave the market.

What is the formula for profit?

Profit = (price – ATC) * Q

What happens if demand for a product increases, leading to short-run profits?

New firms will be attracted by profits, the market supply curve shifts to the right, the market price decreases until economic profits are zero, which leads to long-run equilibrium.

What happens if demand for a product decreases, leading to short-run losses?

Firms where P < firm’s AVC will shut down, the market supply curve shifts to the left, the market price increases until economic profits are zero, which leads to long-run equilibrium.

What is the zero-profit point?

The point where Total Revenue = Total Costs

What is the impact of entry and exit on prices and average total costs?

Entry and exit of firms pushes price to minimum average total costs, causing all firms to earn zero profit in the long run.

What are the three types of industries based on long-run adjustment?

Constant-cost, Increasing cost, and Decreasing cost industries.

What characterizes a constant-cost industry?

As demand for products increases, the cost of production for firms stays the same due to constant returns to scale.

What characterizes an increasing cost industry?

As demand for product increases, the cost of production for firms increases due to diseconomies of scale.

What characterizes a decreasing cost industry?

As demand for product increases, the cost of production for firms decreases due to economies of scale.

What is productive efficiency?

Given the available inputs and technology, it is impossible to produce more of one good without decreasing the quantity that is produced of another good.

What is allocative efficiency?

The particular combination of goods and services on the productive possibilities curve that society most desires.

How does perfect competition lead to productive efficiency?

Price in the market is equal to the minimum of the LRAC curve in the long run.

How does perfect competition lead to allocative efficiency?

Price will be equal to the marginal cost of production, meaning benefits from producing the good equal the costs of producing the good.

In a perfectly competitive market, what condition ensures allocative efficiency?

P = MC (Price equals Marginal Cost).

Which market structures DO NOT produce productive efficiency or allocative efficiency?

Oligopoly, Monopolistic competition, and Monopoly, because P > MC in these structures