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CHAPTER 12: PERFECT COMPETITION I. WHAT IS PERFECT COMPETITION? a. A market in which: many firms sell identical products to many buyers, there are no restrictions on entry into the market, est. firms have no advantage over new ones, & sellers and buyers are well informed about prices b. Examples: farming, fishing, paper milling, grocery retailing, painting… c. How Perfect Competition Arises c.i. If the minimum efficient scale (MES) of a single product is small relative to the market demand for the good or service c.ii. Room for many firms in the market d. Price Takers d.i. Firms in perfect competition are price takers-a firm that can’t influence the market price bc its production is an insignificant part of the total market e. Economic Profit and Revenue e.i. Total revenue-the price (of output) x quantity sold (of output) e.ii. Marginal revenue-ΔTR (total revenue) from a one unit increase is quantity sold e.ii.1. Bc firms in perfect competition are price takers, Δ TR that results from a one-unit increase in Q sold = market price e.iii. Demand for Firm’s Product e.iii.1. Firm can sell any quantity it chooses at the market price so demand curve is horizontal=perfectly elastic demand (demand for firm’s product is perfectly elastic) e.iii.2. Market demand for a product is NOT perfectly elastic bc its elasticity depends on the substitutability of the product w/ other goods and services f. The Firm’s Decision f.i. Goal of competitive firm is to maximize economic profit: f.i.1. How to produce at min. cost f.i.2. What quantity to produce f.i.3. Whether to enter or exit a market II. THE FIRM’S OUTPUT DECISION a. Economic profit = Total Revenue (TR) – Total Cost (TC) b. When the firm makes zero economic profit- break even point c. Marginal Analysis & the Supply Decision c.i. Marginal analysis-compares marginal revenue (MR) with marginal cost (MC) c.ii. MR>MC, revenue from selling one more unit exceeds cost of producing it… increase in output will increase economic profit c.iii. MR<MC, revenue from selling one more unit is less than producing it… decrease in output will increase economic profit c.iv. MR=MC, revenue from selling one more unit = cost to produce it… economic profit is maximized & either an or in output will DECREASE economic profit c.v. A firm’s profit-maximizing output is its quantity supplied at the market price
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c.v.1. Foundation of the law of supply: c.v.1.a. Other things remaining the same, the higher the market price of a good, the greater is the quantity supplied of that good d. Temporary Shutdown Decision d.i. Loss Comparisons d.i.1. A firm’s economic loss = TFC+(AVC-P) × Q d.i.2.
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