S10 Test 3 Review - Characteristics of Perfect Competition...

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5/5/11 FIRMS IN COMPETITIVE 11 Characteristics of Perfect Competition 1. Many buyers and many sellers. 2. The goods offered for sale are largely the same. Firms can freely enter or exit the § Because of 1 & 2, each buyer and seller is a price taker ” – takes the price as given. 0
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5/5/11 FIRMS IN 22 MR = P for a Competitive A competitive firm can keep increasing its output without affecting the market price. So, each one-unit increase in Q MR = P is only true for firms in competitive markets. 0
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5/5/11 FIRMS IN 33 Profit Maximization What Q maximizes the firm’s profit? To find the answer, “ think at the margin .” If increase Q by one unit, revenue rises by MR , cost rises by MC . If MR > MC , then increase Q to raise 0
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5/5/11 FIRMS IN 44 P 1 M R MC and the Firm’s Supply Decision At Q a , MC < MR . So, increase Q to raise profit. At Q b , MC > MR . So, reduce Q to raise profit. At Q 1 , MC = MR . Changing Q would lower profit. Q Costs M C Q 1 Q a Q b Rule: MR = MC at the profit-maximizing Q . 0
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5/5/11 FIRMS IN 55 Shutdown vs. Exit Shutdown : A short-run decision not to produce anything because of market conditions. Exit : A long-run decision to leave the market. A key difference: 0
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5/5/11 FIRMS IN 66 A Firm’s Short-run Decision to Shut Down Cost of shutting down: revenue loss = TR Benefit of shutting down: cost savings = VC (firm must still pay FC ) So, shut down if TR < VC Divide both sides by Q : TR / Q < Shut down if P < AVC 0
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5/5/11 FIRMS IN 77 The firm’s SR supply curve is the portion of its MC curve Q Costs A Competitive Firm’s SR Supply Curve M C AT C AV C If P > AVC , then firm produces Q where P = MC . If P < AVC , then firm shuts down (produces Q = 0). 0
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5/5/11 FIRMS IN 88 The Irrelevance of Sunk Costs Sunk cost : a cost that has already been committed and cannot be recovered Sunk costs should be irrelevant to decisions; you must pay them regardless of your choice. FC is a sunk cost: The firm must pay its fixed costs whether it produces or 0
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5/5/11 FIRMS IN 99 A Firm’s Long-Run Decision to Exit Cost of exiting the market: revenue loss = TR Benefit of exiting the market: cost savings = TC (zero FC in the long run) So, firm exits if TR < TC Divide both sides by Q to write the firm’s decision rule as: Exit if P < ATC 0
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5/5/11 FIRMS IN 1010 A New Firm’s Decision to Enter Market In the long run, a new firm will enter the market if it is profitable to do so: if TR > TC . Divide both sides by Q to express the firm’s entry decision as: Enter if P > ATC 0
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5/5/11 FIRMS IN 1111 The firm’s LR supply curve is the portion of its MC curve Q Costs The Competitive Firm’s Supply Curve M C LRAT C 0
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5/5/11 FIRMS IN 1212 In the LR, the number of firms can change due to entry & exit. If existing firms earn positive
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This note was uploaded on 05/05/2011 for the course ECON 2023 taught by Professor Martin during the Spring '10 term at University of Arkansas for Medical Sciences.

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S10 Test 3 Review - Characteristics of Perfect Competition...

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