Chapter 8 Perfect Competition

1. Chapter 8Perfect Competition • Key Concepts • Summary • Practice Quiz • Internet Exercises ©2000 South-Western College Publishing

2. In this chapter, you will learn to solve these economic puzzles: Why is the demand curve horizontal for a firm in a perfectly competitive market? In the long-run, can alligator farms earn an economic profit? Why would a firm stay in business while losing money?

3. Who was Adam Smith? The father of modern economics who wrote The Wealth of Nations, published in 1776

4. What did Adam Smith say about Competitive Forces? They are like an “invisible hand” that leads people who simply pursue their own interests to serve the interests of society

5. What is the purpose of this chapter? To explain how competitive markets determine prices, output, and profits

6. What isMarket Structure? A classification system for the key traits of a market, including the number of firms, the similarity of the products they sell, and the ease of entry and exit

7. What isPerfect Competition? 1. many small firms 2. homogeneous product 3. very easy entry and exit 4. price taker

8. What doesHomogeneous mean? Goods that cannot be distinguished from one another; for example, one potato cannot be distinguished from another potato

9. What is a Price Taker? A seller that has no control over the price of the product it sells

10. What determines price? Supply and demand

11. P Market Supply and Demand $140 $130 S $120 $100 $80 $60 $40 D $20 Q 5 10 15 20 25 30 35 40 45

12. What determines the individual firm’s Demand Curve? A horizontal line at the market price

13. $140 $130 $120 Individual firm demand D $100 $80 $60 $40 $20 5 10 15 20 25 30 35 40 45

14. Why is this horizontal line the firm’s Demand Curve? If the firm charges more than this price, it will not sell anything, and it has no incentive to charge less than this price

15. Why does the firm have no incentive to charge less than the market price? It can sell everything it brings to market at the market price

16. What does the Perfectly Competitive Firm control? The only thing it controls is how many units it produces

17. How many units should this firm produce? The number of units whereby it will maximize its profits, or at least minimize its losses

18. What are the two methods to determine how many units to produce? • TR and TC • MR and MC

19. Using the Total Revenue - Total Cost method, where should a firm produce? Where the distance between TR and TC is the greatest

20. P TR $500 Maximize Profit TC $400 $300 $200 $100 Quantity of Output Q 1 2 3 4 5

21. P Maximize Profit Output $150 $100 TR $50 0 -$50 Quantity of Output Q 1 2 3 4 5

22. What isMarginal Revenue? MR = TR / 1 output

23. What isMarginal Cost? MC = TC / 1 output

24. Using the Marginal Revenue and Marginal Cost method, where should a firm produce? MR = MC

25. Why should a firm continue to produce as long as MR > MC? As long as MR is > than MC, money is being made on that last unit

26. Why will a firm not produce that unit where MR < MC? At the unit of output where MR < MC, money is being lost on that last unit

27. Why does P = AR in Perfect Competition? Each additional unit sold is adding the market price to TR and TR divided by P = AR

28. ATC $80 MR=MC MC $70 P = MR = AR $60 Profit AVC $50 Price & Cost per unit $40 $30 $20 $10 1 2 3 4 5 6 7 8 9

29. P MR=MC MC $70 ATC $60 AVC $50 Price & Cost per unit Loss $40 P=MR=AR $30 $20 $10 Q 1 2 3 4 5 6 7 8 9

30. P Short-Run Shutdown MC $70 ATC $60 $50 AVC Price & Cost per unit Loss $40 $30 P=MR=AR $20 $10 MR=MC Q 1 2 3 4 5 6 7 8 9

31. Firm will shut down Price (MR) is below minimum average variable cost

32. What is the Perfectly Competitive Firm’s Short-Run Supply Curve? The firm’s marginal cost curve above the minimum point on its average variable cost curve

33. P Firm’s Short-Run Supply Curve MC ATC $70 MR3 $60 AVC MR2 $50 $40 MR1 $30 $20 $10 Q 1 2 3 4 5 6 7 8 9

34. What is the Industry’s Supply Curve? The summation of the individual firm’s MC curves that lie above their minimum AVC points

35. Industry Equilibrium P S = MC $130 $120 $100 $80 $60 $40 $20 Q 5 10 15 20 25 30 35 40 45

36. What is a Normal Profit? The minimum profit necessary to keep a firm in operation

37. In the long-run, what happens when Economic Profits are made? When firms make more than a normal profit, firms enter the industry, as supply increases, a downward pressure is put on prices

38. In the long-run, what happens when Losses are made? When firms make less than a normal profit, firms leave the industry, as supply decreases, an upward pressure is put on prices

39. In the long-run, where is Equilibrium? At the market price that enables firms to make a normal profit

40. What exists at long-run perfectly competitive equilibrium? P = MR = SRMC = SRATC = LRAC

41. Long-Run Competitive Equilibrium P SRMC Equilibrium $70 SATC $60 $50 LRAC $40 MR $30 $20 $10 Q 1 2 3 4 5 6 7 8 9

42. Industry Equilibrium P S = MC $130 $120 $100 $80 $60 $40 D $20 Q 5 10 15 20 25 30 35 40 45

43. What different types of industries can exist in the long-run? • Constant-cost • Decreasing-cost • Increasing-cost

44. What is aConstant-cost Industry? An industry in which the expansion of industry output by the entry of new firms has no effect on the firm’s cost curves

45. What does the long-run supply curve look like in a Constant-cost industry? It is perfectly elastic, which is horizontal

46. Increase in demand sets a higher equilibrium price Entry of new firmsincreases supply Initial equilibriumprice is restored Perfectly elastic long-runsupply curve

47. What is a Decreasing-cost Industry? An industry in which the expansion of industry output by the entry of new firms decreases the firm’s cost curves

48. What does the long-run supply curve look like in a Decreasing-cost industry? It is downward sloping

49. Increase in demand sets a higher equilibrium price Entry of new firmsincreases supply Equilibrium priceand ATC decrease Downward sloping long-runsupply curve

50. What is an Increasing-cost Industry? An industry in which the expansion of industry output by the entry of new firms increases the firm’s cost curves