Chapter 7 Firms in Perfectly Competitive Markets – Flashcards

A perfectly competitive market is characterized by many buyers and sellers, and identical product, and easy market entry and exit.

In markets with so many buyers and so many sellers, neither buyers nor sellers have any control over price in perfect competition. They must take the going price and hence are called price takers.

An individual seller will not sell at a higher price than the going price, because buyers can purchase the same good from someone else at the going price. They would not knowingly sell below the going price, because they are so small relative to the market that they can sell all they want at the going price.

The position of the individual firm's demand curve varies directly with the market price.

Total revenue is price times the quantity sold. (TR=P X q)

Average revenue is total revenue divided by the quantity sold. (AR=TR / q = P or [P x q] / q)

Marginal revenue is the change in total revenue from the sale of an additional unit of output. In a competitive industry, the price of a good equals both the average revenue and the marginal revenue.

As long as the marginal revenue exceeds marginal cost, the seller should expand production, because producing and selling those units adds more to revenues than to costs; that is, it increases profits. However, if the marginal revenue is less than the marginal cost, the seller should decrease production.

The profit maximizing output level is found by equating MR to MC at q*. If at that output the firm's price is greater than its average total cost it is making an economic profit.

If at the profit maximizing output level, q*, the price is less than the average total cost, the firm is incurring an economic loss.

If at the profit maximizing output level, q*, the price is equal to the average total cost the firm is making zero economic profits.

If the price falls below the average variable cost, the firm is better off shutting down rather than operating in the short run, because it would incur greater losses from operating than shutting down.

Economic profits encourage the entry of new firms, which shift the market supply curve to the right. Any positive economic profits signal resources into the industry, driving down prices and revenues to the firm.

Any economic losses signal resources to leave the industry, leading to supply reduction, higher prices, and increased revenues.

Only at zero economic profits is there no tendency for firms to either enter or exit the industry.

In constant-cost industries, the cost curves of the firm are `not affected by changes in the output of the entire industry. Such industries must be small demanders of resources in the market.

In an increasing-cost industry, the cost curves of the individual firm rise as total output increases. This case is the most common.

A decreasing cost industry has a downward sloping long-run supply curve. Firms experience lower costs as the industry expands.

Productive efficiency occurs in perfect competition because the firm produces at the minimum point of the ATC curve.

Allocative efficiency occurs when P=MC ; production is allocated to reflect consumers' wants.