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Perfect competition
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Occurs in an industry when that industry is made up of many small firms producing homogeneous products, when there is no impediment to entry or exit of firms, and when full information is available
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Price taker
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A firm that has no choice but to accept the price that has been determined in the market
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Variable cost
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A cost who total amount changes when the quantity of output of the supplier changes
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Supply curve of a firm
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Shows the different quantities of output that the firm would be willing to supply at different possible prices during some period of time
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Supply curve of an industry
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Shows the different quantities of output that the industry would supply at different possible prices during some given period of time
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Economic profit
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Equals net earnings, in the accountant's sense, minus the opportunity costs of the capital and of any other inputs supplied by the firm's owners
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1. There are numerous small firms and customers
2. The product of all the firms is homogeneous
3. Firms are free to enter and exit the industry
4. Each firm and each customer is well informed about conditions in the industry (i.e., perfect information)
2. The product of all the firms is homogeneous
3. Firms are free to enter and exit the industry
4. Each firm and each customer is well informed about conditions in the industry (i.e., perfect information)
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When does perfect competition exist? (4)
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Small firms and customers
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In order for perfect competition to exist their needs to be numerous?
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Homogeneous
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In order for perfect competition to exist products of all firms need to be?
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-Cereal
-Coffee
-Tomatoes
-Coffee
-Tomatoes
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Examples of homogeneous products
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-Agriculture
-Stock exchange
-Stock exchange
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What is the two examples of perfect competition?
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Enter and exit the industry
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In order for perfect competition to exist firms need to be free to?
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Informed about conditions in the industry (i.e., perfect information)
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In order for perfect competition to exist firms and each customer is well?
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A price taker (the firm has no choice but to accept the price that has been determined by the market)
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What is a firm, in regards to price, under perfect competition?
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The firm has no choice but to accept the price that has been determined by the market
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What does it mean to be a price taker (under perfect competition)?
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The demand curve is horizontal (it can sell as much as it wants at the market price)
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What does the demand curve of a perfectly competitive firm look like?
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It can sell as much as it wants at the market price
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Since the demand curve of a perfectly competitive firm is horizontal, what can it do?
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The firm is a price taker
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What can you assume about a firm who's demand curve is horizontal?
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They earn 0 economic profit (earning just enough money to cover their costs)
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What are the profits like for perfectly competitive firms?
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They are all the same:
-Demand curve
-Average revenue curve
-Marginal revenue curve
-Demand curve
-Average revenue curve
-Marginal revenue curve
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Since the demand curve is horizontal in perfect competition, what happens to all the other curves?
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They are the same as the demand curve
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Since the demand curve is horizontal in perfect competition, what happens to the average revenue curve and marginal revenue curve?
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MC = P = AR = MR
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What is the profit maximizing level of output for a perfectly competitive firm?
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Firms should produce when MR is larger than or equal to MC (MR >/= MC)
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Using the marginal revenue and marginal cost method, where should a perfectly competitive firm produce?
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As long as MR is greater than MC, profit is being made on that last unit produced and sold
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Why should a firm continue to produce as long as MR > MC?
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At any unit of output where MR < MC, the firm incurs a loss (the firm should stop producing when MR < MC)
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Why will a firm not produce any unit where MR < MC?
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MR = AR
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A firm's demand =
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Whether the firm is making profit or incurring a loss
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What does the MC = P condition not tell us?
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We must compare price (which, for a perfectly competitive firm is equal to average revenue) with average cost
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Since the MC =P condition does not tell us whether the firm is making a profit or incurring a loss, how do we find this?
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The intersection point of the MR and MC curve
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Where would price be found on the graph of a perfectly competitive firm?
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AR = MR = MC (profit maximizing level of output)
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P =
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-Total profit method (TR - TC)
-Marginal analysis method (MR >/= MC)
-Marginal analysis method (MR >/= MC)
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What are the two methods to determine how many units to produce? (most optimal or profit maximizing output)
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Yes, but if so it is the minimum possible loss
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Can the profit-maximizing output lead to a loss?
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Shutdown and break-even analysis
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Rule 1: The firm will make a loss if total revenue (TR) is less than total cost (TC). In that case, it should plan to shut down, either in the short run or the long run.
Rule 2: The firm should continue to operate in the short run if total revenue (TR) exceeds total short-run variable cost (TVC).
Rule 2: The firm should continue to operate in the short run if total revenue (TR) exceeds total short-run variable cost (TVC).
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When total revenue (TR) is less then total cost (TC). In this case, the firm should plan to shut down, either in the short run or the long run.
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When will a perfectly competitive firm make a loss?
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The firm will make a loss and should plan to shut down, either in the short run or the long run
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What happens if total revenue (TR) < total cost (TC)?
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When total revenue (TR) < total cost (TC)
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When should a firm shut down, either in the short run or the long run?
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-Profit > 0, when P > AC
-Profit < 0, when P < AC
-Profit = 0, when P = AC
-Profit < 0, when P < AC
-Profit = 0, when P = AC
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Positive profit?
Negative profit?
Zero economic profit or "normal profit"?
Negative profit?
Zero economic profit or "normal profit"?
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If total revenue (TR) exceeds total short-run variable cost (TVC)
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When does a firm continue to operate in the short run?
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The firm should continue to operate in the short run
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What happens if total revenue (TR) > total short-run variable cost (TVC)?
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Look at slide 14,16,17, 23, & 24 on powerpoint.
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Look at slide 14,16,17, 23, & 24 on powerpoint.
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Price lies above the minimum point on the average variable cost (AVC) curve (or MC curve lies above the AVC curve)
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The perfectly competitive firm will produce nothing in the short-run unless?
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-The firm is earning profit (P > AC)
-The firm is incurring a loss (P < AC)
-The firm is incurring a loss (P < AC)
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If profit max price is above the AC (average cost) curve then? However, if profit max price is below the AC (average cost) curve then?
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Shut down in long-run:
-If TR < TC, or P < ATC
Stay open in long-run:
-If TR > TC, or P > ATC
-If TR < TC, or P < ATC
Stay open in long-run:
-If TR > TC, or P > ATC
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When should a firm shut down or stay open in the long-run?
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Shut down in the short-run:
-If TR < TVC, P < AVC
Stay open in the short-run:
-If TR > TVC , P > AVC
-If TR < TVC, P < AVC
Stay open in the short-run:
-If TR > TVC , P > AVC
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When should a firm shut down or stay open in the short-run?
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Loss amount = TC - TR
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What is the loss amount if the firm continues to produce (or does not shut down) in the short-run when TR < TVC?
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Loss amount (non-variable cost) = TC - TVC
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What is the loss amount if the firm shuts down in the short-run when TR < TVC?
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TVC = AVC * Q because AVC = TVC/Q
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How do you find total variable cost (TVC)? (short-run rule)
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TR = price * quantity (Q)
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How do you find total revenue (TR)?
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TVC < TR
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TC - TR < TC - TVC
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AVC < P
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AVC x Q < P x Q
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The portion of the marginal cost curve that lies above the (short-run) average variable cost curve
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What is the short-run supply curve for a perfectly competitive firm?
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They operate within a perfectly competitive firm
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Why are farmer's price takers?
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Perfectly competitive short-run supply curve of an industry
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Sum of the perfectly competitive short-run supply curves of all the firms in the industry
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In the short-run (but in the long run they will lose that because more firms enter into the industry and the market becomes more competitive)
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In a perfectly competitive market, when can a firm sometimes earn excess profit?
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Yes; in the short run sometimes the firms can earn excess profit but in the long run they will lose that because more firms enter into the industry and the market becomes more competitive
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Can economic profit for perfectly competitive firms differ in the short-run and in the long-run?
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Zero
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What is the profit in the long run for a firm in a competitive market?
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The "no profits" conclusion of competition refers to economic profits-there is no excess rate of return to the typical firm. However, each firm is able to earn sufficient accounting profits to cover the opportunity cost of invested factors and to continue operating. The source of the confusion is failing to distinguish between accounting and economic profits.
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If there are no profits in competitive equilibrium, why do firms produce? How can they stay in business?
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Earning a positive accounting profit
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Despite a firm in a perfectly competitive market earning an economic profit of zero, the firm may still be?
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Short-run:
-When supply equal demand
Long-run:
-When P = MC = AC
-When supply equal demand
Long-run:
-When P = MC = AC
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What is the competitive equilibrium of an industry in the short-run? long-run?
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D = AR =MR = MC =AC
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When is a firm making zero economic profit in the long-run?
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Because economic costs include opportunity costs
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Zero economic profit means that firms are earning the normal, economy-wide rate of profit in the accounting sense
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