Ch11 - Chapter 11 Perfect Competition I What Is Perfect...

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C h a p t e r   1 1 :   P e r f e c t   C o m p e t i t i o n I. What Is Perfect Competition? A. Perfect competition describes an industry in which: 1. Many firms sell identical products to many buyers. 2. There are no restrictions to entry into the industry. 3. Established firms have no advantages over new ones. 4. Sellers and buyers are well informed about prices. B. Perfect competition arises when: 1. Perfect competition occurs when the firms’ minimum efficient scale are small relative to demand for the good or service, and 2. when each firm is perceived to produce a good or service that has no unique characteristics, so consumers don’t care from which firm they buy. C. In perfect competition, each firm is a price taker. 1. A price taker   is a firm that cannot influence the market price and sets its own price at the market price. 2. Each firm produces a tiny proportion of the entire market and consumers are well informed about the prices charged by other firms. 3. Each firm’s output is a perfect substitute for the output of the other firms, so the demand for each firm’s output is perfectly elastic. D. Economic Profit and Revenue The goal of each firm is to maximize economic profit , which equals total revenue minus total cost. 1. A firm’s total cost is the opportunity cost of production, which includes a normal profit—the return that the entrepreneur can expect to receive on the average in an alternative business . 2. A firm’s total revenue equals price, P , multiplied by quantity sold, Q , or P × Q . 3. A firm’s marginal revenue is the change in total revenue that results from a one-unit increase in the quantity sold. In perfect competition the price remains the same as the quantity sold changes, which means that marginal revenue equals the market price. 4. Figure 11.1 illustrates a firm’s revenue concepts. a) Figure 11.1(a) shows how the market demand and supply determine the equilibrium market price that the firm must take. b) Figure 11.1(b) shows the demand curve for the firm’s product, which is also its marginal revenue curve. The firm’s demand curve is perfectly elastic. c) Figure 11.1(c) shows the firm’s total revenue curve, with total revenue increasing as a constant rate. II. The Firm’s Decisions in Perfect Competition A. A perfectly competitive firm faces two types of constraints: 1. A market constraint is summarized by the market price and the firm’s revenue curves.
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2. A technology constraint is summarized by firm’s product curves and cost curves (from Chapter 10). B. The perfectly competitive firm must make two sequential decisions in the short run and two sequential decisions in the long run : 1. In the short run, each firm has a given plant size and the number of firms in the industry is fixed.
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