Banerjee Chapters 9 and 10

Banerjee Chapters 9 and 10 - Chapter 9 Competitive Firms In...

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Chapter 9 Competitive Firms In this chapter, we analyze how firms behave in the short and the long run in a single market under perfect competition . Perfect competition is an ideal- ized market structure characterized by many potential sellers for a product that has many potential buyers. The primary behavioral assumption on the part of all traders (whether consumers or producers) is that each economic agent considers herself to be a price taker , i.e., she behaves as if she is un- able to influence the current market price through her consumption or pro- duction behavior. Whether the inability to affect the price is real (e.g., when each consumer or producer is one of many, so a single agent’s consumption or production is a tiny fraction of the total quantity traded in the market) or not (as would be the case in a two-person Edgeworth box economy where a single agent is responsible for a large fraction of the quantity traded), what is important is that each agent be haves as if she were un able to in flu ence the mar ket price. Additionally, there are no market frictions: all changes are instantaneous and all relevant information permeates through the economy without agents having to incur any cost in gathering them. In particular, there are no exclu- sive technology or patents that confer an advantage to any firm. The best technology and business practices are commonly known. Thus any varia- tion in costs across producers are generally small and mainly due to man- agerial efficiencies or differing opportunity costs of the entrepreneurs. The production of agricultural commodities arguably fit this description. Finally, there is complete mobility of firms. Existing firms may leave the industry in the medium to long run if they find that to be advantageous, or new entrepreneurs may enter the market. We assume that there are no 143
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144 Chapter 9 substantial costs or difficulties in making entry or exit decisions. 9.1 Defining Profits The profit of a firm, π , is defined as the difference between total revenue ( TR ) which is the earnings from sales, and total cost ( TC ): π = TR - TC . Here TR = p × q where q units of output are sold at a per-unit price of p , and TC = c ( q ) is the firm’s cost function. We will assume that the cost function includes a normal profit margin which is the smallest compensation that an entrepreneur needs in order to remain in business, i.e., the entrepreneur’s opportunity cost. With this in- cluded in the TC , it follows that if π = 0, then the revenues earned are just enough to pay for the operating expenses (the cost of variable inputs as such labor and raw materials), the overhead (cost of fixed inputs, such as salaries of managers, the cost of hosting the firm’s website, the firm’s property taxes, etc.) as well as the entrepreneur’s compensation. Therefore when π = 0, we will say that the firm makes normal profits ; if π > 0, we say that the firm makes supernormal profits , while π < 0 signifies losses.
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