Ch.9&10 Notes

Ch.9&10 Notes - Topic 7. Perfectly Competitive Markets...

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Topic 7. Perfectly Competitive Markets Perfect Competition The behavior of firms and the determination of price and output depend on the market structures. We now consider a market structure called perfect competition. A market is in perfect competition if it satisfies the following conditions: (1) Firms in the market all produce the same product. (2) Each market participant is small enough so that the market price will not be affected by his or her actions. (3) Perfect information. (4) Free entry and exit. Although perhaps no market will completely satisfy these conditions, perfect competition serves as a useful benchmark in economic analysis. Price Determination in the Short-run First, we need to know how an individual firm determines its output. The firm's profit is Π(x) = TR(X) - TC(X) Since the firm takes market price as given, its marginal revenue is equal to p. The profit- maximizing output is the one at which marginal cost is equal to marginal revenue, which is in turn equal to p. What happens if at the profit-maximizing output, the firm is actually having a loss? Should the firm stop production? The answer is that it depends on whether the price is higher than the average variable cost. If price is higher than average variable cost, the firm should produce the output at which marginal cost equals price, and if price is lower than the average variable cost, the firm should shut down. Note that the marginal cost curve passes through the minimum point of the average variable cost curve. This allows us to derive the output supplied by a firm in a market with perfect
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Ch.9&10 Notes - Topic 7. Perfectly Competitive Markets...

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