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Market Structure
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The environment whose characteristics influence a firm's pricing and output decisions
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Perfect Competition
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A theory of market structure based on 4 assumptions:
1) There are many sellers and buyers
2) The sellers sell a homogeneous good
3) Buyers and sellers have all relevant information
4) Entry into, and exit from, the market is easy
1) There are many sellers and buyers
2) The sellers sell a homogeneous good
3) Buyers and sellers have all relevant information
4) Entry into, and exit from, the market is easy
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Price Taker
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(Perfectly Competitive Firm) a seller that does not have the ability to control the price of its product ("takes" the price determined in the market)
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When an equilibrium price has been established, a single perfectly competitive firm faces a...
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horizontal (flat, perfectly elastic) demand curve at the equilibrium price
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The equilibrium price is the only relevant price for the perfectly competitive firm
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...
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In a perfectly competitive market setting...
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there are many substitutes for the firms product, so many that the firm's demand curve is perfectly elastic
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Marginal Revenue (MR)
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The change in total revenue (TR) that results from selling one additional unit of output (Q)
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MR =
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change in TR/ change in Q
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For a perfectly competitive firm, P =
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MR
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For a perfectly competitive firm, Demand curve = Marginal Revenue curve if...
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the price is = to the MR
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A market that does not exactly meet the assumptions of perfect competition may...
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approximate the assumptions to a degree that is behaves as if it were a perfectly competitive market
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Profit Maximization Rule
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Profit is maximized by producing the quantity of output at which MR=MC
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In perfect competition, profit is maximized when...
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P=MR=MC
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Resource Allocative Efficiency
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The situation in which firms produce the quantity of output at which price equals marginal cost (P=MC)
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For a perfectly competitive firm, if price is above the average total cost, the firm maximizes profit by...
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producing a quantity of output at which MR=MC
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If price is below average variable cost (AVC), the perfectly competitive firm minimizes losses by...
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choosing to shut down - that is, by not producing
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If price is below average total cost (ATC) but above AVC, the perfectly competitive firm minimizes its losses by...
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continuing to produce in the short run instead of shutting down
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P > AVC =
P < AVC =
TR > TVC =
TR < TVC =
P < AVC =
TR > TVC =
TR < TVC =
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firm produces
firm shuts down
firm produces
firm shuts down
firm shuts down
firm produces
firm shuts down
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Short-run (firm) supply curve
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The portion of the firm's marginal cost curve that lies above the average variable cost curve
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Short-run market (industry) supply curve
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The horizontal sum of all existing firms' short-run supply curves
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Because of the law of diminishing marginal returns, MC curves are...
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upward sloping and because MC curves are upward sloping, so are market supply curves
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Long-run competitive equilibrium
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The condition is which P = MC = SRATC = LRATC. Economic profit is zero, firms are producing the quantity of output at which price is equal to marginal cost, and no firm has an incentive to change its plant size
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Long-run competitive equilibrium exists when firms have no incentive to do any of the following:
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1. enter or exit the industry
2. produce more or less output
3. change their plant size
2. produce more or less output
3. change their plant size
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Productive Efficiency
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The situation in which a firm produces its output at the lowest possible per-unit cost (lowest ATC)
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Long-run (industry) supply (LRS) curve
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A graphic representation of the quantities of output that an industry is prepared to supply at different prices after the entry and exit of firms are completed
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Constant-Cost Industry
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An industry in which average total costs do not change as (industry) output increases or decreases when firms enter or exit the industry, respectively
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In an increasing-cost industry...
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ATC (unit costs) increase as firms enter the industry and output increases. ATC decrease as firms exit the industry and output decreases
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If market demand increases for a good produced by firms in an increasing-cost industry, price will initially...
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rise and then finally fall to a level above its original level
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In an increasing-cost industry, as firms purchase more inputs to produce more output, some input prices rise and cost curves shift. As industry output increases, profits are caught in a two-way squeeze: price is coming down, and costs are rising.
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...
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If costs are rising as price is falling, then price will...
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not have to fall to its original level before zero economic profits rule once again
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In an increasing-cost industry, price will not have to fall as far to restore long-run competitive equilibrium as it will in a...
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constant-cost industry
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Increasing-Cost Industry
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An industry in which average total costs increase as output increases and decrease as output decreases when firms enter and exit the industry, respectively
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In a decreasing-cost industry, average total costs decrease as new firms enter the industry, so price...
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must fall below its original level to eliminate profits
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Decreasing-Cost Industry
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An industry in which average total costs decrease as output increases and increase as output decreases when firms enter and exit the industry, respectively
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A rise in costs incurred by one of many firms does not mean...
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that consumers will pay higher prices
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