lecturenotes_test3 - START EXAM 3 MATERIAL Perfectly...

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START EXAM 3 MATERIAL Perfectly Competitive Markets Review the three conditions for efficiency: competition, all benefits and costs incorporated into the market, and economic stability. Five Characteristics of Perfect Competition : 1. The price of the product is the same for each buyer and seller; they are price takers. 2. The product is homogeneous, meaning there is no product differentiation. 3. Buyers and sellers have perfect information about prices and product qualities. 4. There are a large number of buyers and sellers- the exit or entry of buyers and sellers does not affect the price of the goods being sold. 5. There is complete freedom of entry into and exodus from the market. In the short run, a firm’s supply behavior is determined by 1) its MC curve, 2) the horizontal demand curve facing the firm, and 3) the desire to maximize profits or minimize losses. SHORT RUN: FIRM CHARACTERISTICS: Horizontal demand curve reflecting a constant MR (the increase in revenue brought about by increasing output (sales) by one unit. If MR exceeds MC, an extra unit of output adds more to revenues than to costs. This happens up to the point where MR=MC, or the profit maximization point. Also, MR = Price of the good. Then, introducing the short run supply curve (i.e. MC curve) gives us one of 4 situations facing the firm: 1) the firm makes economic profits (revenue minus opportunity costs), 2) economic profits are zero, 3) the firm stays in business but produces at a loss, or 4) the firm shuts down temporarily and hopes for the price to rise. Situation 1 occurs when price exceeds minimum ATC; Situation 2 occurs when price = ATC; Situation 3 occurs when price is below ATC but above AVC; Situation 4 occurs when price is equal to or below minimum AVC. At the latter point, the firm will close down to avoid more losses. When economic profits are zero, the firm is still earning a normal profit (revenue – costs). The competitive firm’s supply curve is its MC curve above the AVC curve! Draw the example from page 93- show why demand = price = MR; show how AFC, AVC, and ATC are related (especially how MC intersects AVC and ATC at their minimum points) SHORT RUN INDUSTRY CHARACTERISTICS The market supply curve = the sum of the profit-maximizing outputs of every firm at each price. It is the horizontal summation of each firm’s MC curves above AVC. The market demand curve = the sum of the horizontal demand curves for each firm; this forms the downward sloping market (industry) demand curve.
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LONG RUN ADJUSTMENTS In the long run, firms can freely enter and exit the market. If current firms continue to make economic profits (when prices are higher than ATC), then outside firms have an incentive to enter the market. The same is true for economic losses (that firms have an incentive to leave the market). Therefore, long run equilibrium occurs when firms no longer wish to leave or enter the market/industry.
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