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12-Perfect Competition (II)

12-Perfect Competition (II) - Agenda Course Overview Short...

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1 Agenda Course Overview Short run Market Equilibrium Long run entry and production decisions Long run Market Equilibrium Application: Effect of changes on Market equilibrium What To Take Away Microeconomics The Structure of the Course Consumers and Producers Market Interaction Today’s lecture Uncertainty Perfect competition Monopoly and Pricing strategies Competitive Strategy Auctions Information in Markets and Agency Game Theory Introduction to Markets Consumer Theory and Demand Technology and Production
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2 Agenda Course Overview Short run Market Equilibrium Long run entry and production decisions Long run Market Equilibrium Application: Effect of changes on Market equilibrium What To Take Away The Competitive Firms’ Production Decision Since each firm in a competitive industry sells a small fraction of the entire industry output, competitive firms behave as if their choice of how much to sell will not affect the market price (they behave as “price takers”) In other words, competitive firms behave as if they face an infinitely demand curve at the market price. Since selling one more unit has no impact on market price the marginal revenue of a perfectly competitive firm is simply equal to the price it faces. Thus for a perfectly competitive firm, profit maximizing output satisfies ( ) MC q MR P P MR
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3 In the short run, capital is fixed and firm must choose levels of variable inputs (labor and materials) to maximize profits. The firm (typically) also incurs a fixed cost of production. If this cost is not sunk it can be avoided by shutting down. The firm needs to decide whether to produce any output or shut down . In case the firm decides to produce, it needs to decide how much to produce. If a firm is producing any output, it should produce at the level at which marginal revenue equals marginal cost. The Short run Production Decision of the Firm Shut down decision : If the firm cannot cover the costs of production ( not including sunk costs ) with the revenue they obtain they should shut down operations. For a competitive firm this is the case when the price of its product is less than the average economic cost of production. If a firm has incurred a large sunk cost then it should remain in operation if the price of its product is greater than its average economic cost of production (that does not include, of course, this sunk cost). The Short run Production Decision of the Firm
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4 Part of the firm’s fixed costs can be avoidable (i.e. they are not sunk) or unavoidable (i.e. they are sunk). Economic cost only considers avoidable costs. The firm should produce when the average economic cost<P.
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