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Chapter 8 Perfect Competition

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Market Structure Analysis
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By observing a few industry characteristics such as number of firms in the industry or the level of barriers to entry, economists can use this information to predict pricing and output behavior of the firm in the industry.
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Perfect Competition
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A market structure with many relatively small buyers and sellers who take the price as given, a standardized product, full information to both buyers and sellers, and no barriers to entry or exit. -Many buyers and sellers -Homogeneous -No barriers to market entry or exit -No long-run economic profit -No control over price
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Price taker
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Individual firms in perfectly competitive markets get their prices from the market because they are so small they cannot influence market price. For this reason, perfectly competitive firms are price takers and can produce and sell all the output they produce at market-determined prices.
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Monopolistic Competition
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-Many buyers and sellers -Differentiated products -No barriers to market entry or exit -No long-run economic profit -Some control over price
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Oligopoly
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-Fewer firms (such as auto industry) -Mutually interdependent decisions -Substantial barriers to market entry -Potential for long-run economic profit -Shared market power and considerable control over price
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Monopoly
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-One firm -No close substitutes -Substantial barriers to market entry -Potential for long-run economic profit -Shared market power and considerable control over price
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Marginal Revenue
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The change in total revenue from selling an additional unit of output. Because competitive firms are price takers, P=MR for competitive firms.
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Profit Maximizing Rule
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Firms maximizing profit by producing output where where MR=MC. No other level of output produces higher profits.
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Normal Profits
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Equal to zero economic profits where P=ATC
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Shutdown Point
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When price in the short run falls below the minimum point on the AVC curve, the firm will minimize losses by closing its doors and stopping production. Because P<AVC, the firm's variable costs are not covered, therefore by shutting down the plant, losses are reduced to fixed costs only.
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Short-run Supply Curve
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The marginal cost curve above the minimum point on the average variable cost curve.
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Increasing Cost Industry
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An industry that, in the long run, faces higher prices and costs as industry output expands. Industry expansion puts upward pressure on resources (inputs), causing higher costs in the long run.
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Decreasing Cost Industry
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An industry that, in the long run, faces lower prices and costs as industry output expands. Some industries enjoy economies of scale as they expand in the long run, typically the results of technological advances.
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Constant cost industry
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An industry that, in the long run, races roughly the same prices and costs as industry output expands. Some industries can virtually clone their operations in other areas without putting undue pressure on resource prices, resulting in constant operating costs as they expand in the long run.
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Economists categorize industries using the following characteristics
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Nature of the industry’s product, barriers to entry, and extent to which firms can control prices.
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The cotton industry is experiencing less than normal profits. You can expect some firms to:
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leave the industry in the long run
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Which sequence describes the long-run adjustment process in a competitive market when firms are earning short-run economic profits
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New firms enter, industry supply increases, market price falls
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When new firms enter a perfectly competitive market, it will cause an
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increase in supply
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If a firm produces where marginal revenue exceeds marginal costs, the firm
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is not maximizing its profits
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The perfectly competitive model assumes that consumers will base their decisions purchases solely on:
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Price
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Market structure analysis allows economists to
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Predict the behavior of firms
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A perfectly competitive firm
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has output that is so small, relative to market supply, that it cannot influence the market price.
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If a competitive firm can sell a bushel of soybeans for $25 and it has an average variable cost of $24 per bushel and the marginal cost is $26 per bushel, the firm should
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reduce output
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Normal profits are equal to
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Zero economic profits
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The perfectly competitive firm will
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produce in the short run if the price is above the minimum of the AVC
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A perfectly competitive firm in the short run will make a profit as long as price is
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greater than average total cost
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If a perfectly competitive market is in equilibrium, then the market is
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both productively and allocatively efficient
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The profit-maximizing rule states that a perfectly competitive firm:
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should produce that level of output at which MR=MC
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Consider the corn industry (a perfectly competitive industry). The price per bushel is $2 and there are constant returns to scale. If the long-run, minimum ATC is $1.50 per bushel, it should follow that (ceteris paribus):
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The long run price will be $1.50 per bushel
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In the short run, if a firm in a perfectly competitive market is producing where price exceeds marginal cost, the firm
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should increase its output
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If a perfectly competitive firm can sell a bushel of soybeans for $25 per bushel and it has an average variable cost of $20 per bushel, and the marginal cost is $22 per bushel, it should
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expand output
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All market structures experience some type of control over price, EXCEPT
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perfect competition. Unlike monopoly, oligopoly, and monopolistic competition
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_____ is a market where there is no close substitute for the product, potential for long-run economic profit, and nearly impossible barriers to entry
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Monopoly
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In which market structure can mutual interdependent decision-making occur?
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Oligopoly
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When perfectly competitive firm X sells three units of product Z, its marginal revenue is $4.67. When it sells 100 units marginal revenue is $4.67. We can conclude that the price
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is $4.67
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When perfectly competitive firms are earning short-run economic profits, all of the following happens
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-supply increases -market prices fall -firms are attracted to the industry by profits the number of firms in the industry will NOT fall