Chapter 11 Study Guide

Chapter 11 Study Guide - 11 Firms in Perfectly Competitive...

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Chapter 11 Firms in Perfectly Competitive Markets Chapter Summary Economists group industries into one of four market structures: Perfect competition, monopolistic competition, oligopoly, and monopoly. In Chapter 11, you will learn about the first market structure – perfect competition. In a perfectly competitive market, there are many buyers and many firms, all of whom are small relative to the size of the total market. Products sold by these firms are identical and there are no barriers to new firms entering the market. Firms in a perfectly competitive market are price takers , meaning that they are unable to control the prices of goods they sell and are unable to earn economic profits in the long run. Consumers are also price takers in a perfectly competitive market. Prices in perfectly competitive markets are determined by the interaction of market demand and market supply. The objective of the firm is to maximize profit. Profit is the difference between total revenue and total cost. The firm will produce the output for which the marginal revenue ( MR ) equals the marginal cost ( MC ). For perfectly competitive firms, price is equal to marginal revenue. In the short run, the firm’s price: a. will exceed its average total cost ( ATC ) which means it will make an economic profit , or b. will equal ATC so its total cost will equal total revenue, which means the firm breaks even and earns no economic profit, or c. will be less than ATC , which means the firm experiences an economic loss . Remember that economic costs include all opportunity costs as well as explicit accounting costs. A firm experiencing losses can continue to produce, stop production by shutting down temporarily, or go out of business. The first two are short-run options, while the third is a long-run option. In the short run, if by producing the firm would lose an amount greater than its fixed cost, the firm will shut down temporarily. If the firm’s losses are less than the amount of its fixed cost, it will continue to produce. The firm will produce output even though total profits remain negative if total revenue is greater than total variable cost. This is identical to saying that the price of its output ( P ) must exceed average variable cost ( AVC ). The quantity where P = AVC is called the shutdown point . When firms earn short-run profits, other firms will enter the industry. Entry of new firms shifts the industry supply curve to the right and lowers the market price. Entry continues until economic profits are zero. When firms suffer short-run losses, some firms will exit the industry. The exit of firms shifts the industry supply curve to the left and the market price increases. Exit continues until economic profits are zero. In a long-run competitive equilibrium , entry and exit of firms causes the typical firm to earn zero economic profits. The long-run supply curve in a perfectly competitive market shows the relationship between market price and quantity supplied. In the long run, firms will supply the quantity that consumers
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Chapter 11 Study Guide - 11 Firms in Perfectly Competitive...

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