Econ Ch 8- competitive firms and market

What are the characteristics of perfect competition?

1) Large market of buyers and sellers, 2) Firms produce identical products, 3) Full information about products and prices, 4) Negligible transaction costs, 5) Free entry and exit.

How does a competitive firm maximize profit?

producing the amount of output where its marginal cost equals the market price.

What is the two-step decision-making process for a firm in the short run?

1) Determine the level of output that maximizes profit, 2) Decide whether to produce the profit-maximizing quantity or shut down.

What is the shutdown decision for a competitive firm?

if the market price is less than the minimum of its short-run average variable cost (AVC) curve.

What happens if the minimum AVC is greater than the market price

the firm shuts down and incurs a loss equal to total fixed costs (TFC).

If the market price is above the minimum AVC but below the average total cost (ATC)

the firm produces at the level where marginal cost equals price, resulting in a loss less than TFC.

What is the short-run supply curve based on?

the part of the MC curve that lies above the average variable cost (AVC).

What determines a firm's long-run production decisions?

a firm will stay in the industry if the price is greater than the minimum long-run average cost (LRAC) and will exit if the price is less than the minimum LRAC.

What is the role of entry and exit in a competitive market?

Firms enter the market if they can make long-run profits and exit to avoid long-run losses.

What is consumer surplus?

the monetary difference between what a consumer is willing to pay for a good and what the good actually costs, represented by the area under the demand curve above the market price.

How is producer surplus defined?

the difference between the revenue received from selling a good and the variable costs of producing it, represented by the area above the supply curve and below the market price.

What is total surplus in an economy?

is the sum of consumer surplus and producer surplus, indicating the overall economic well-being in a competitive equilibrium.

What is deadweight loss (DWL)?

the reduction in total surplus that occurs when the quantity produced is less than the competitive equilibrium quantity, leading to inefficient allocation of resources.

What causes market failure?

occurs when there is inefficient production or consumption, often because the price exceeds marginal cost.

What are the effects of government intervention in markets?

can shift supply or demand curves and create a wedge between price and marginal cost, leading to inefficiencies.

What is a barrier to entry?

an explicit restriction or cost that applies to potential new firms, such as large sunk costs that deter entry into the market.

How can sunk costs affect market entry?

Large non-recoverable costs can make new firms hesitant to enter the market, especially if financing is difficult or success is uncertain.

price = MC, as long as?

P >= AVC

why does the short run supply curve the MC curve that lies above the AVC curve?

In the short run, some costs are fixed (like rent or equipment) and some are variable (like labor or materials). A firm will only produce if the price (P) covers its variable costs, because it can't avoid fixed costs in the short run