Firms in Perfectly Competitive Markets
Firms in Perfectly Competitive Markets ARE 1150
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Popular in Agricultural & Resource Econ
This 4 page Class Notes was uploaded by Caitrín Hall on Sunday May 1, 2016. The Class Notes belongs to ARE 1150 at University of Connecticut taught by Emma Bojinova in Spring 2016. Since its upload, it has received 25 views. For similar materials see Principles of Agriculture & Resource Economics in Agricultural & Resource Econ at University of Connecticut.
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Date Created: 05/01/16
Chapter 12 Firms in Perfectly Competitive Markets Firms in perfectly competitive industries are unable to control the prices of their products and are unable to earn an economic profit in the long run because: o Many buyers and sellers o Firms in these industries sell identical products o It is easy for new firms to enter these industries 3 key characteristics of any industry: The number of firms in the industry The similarity of the good or service produced by the firms in the industry The eases with which new firms can enter the industry 12.1 Perfectly Competitive Markets A Perfectly Competitive Firm Cannot Affect the Market Price Price taker – a buyer or seller that is unable to affect the market price The individual producer’s demand curve is a horizontal line at the market price because there are so many small shares; therefore, the producer must accept the market price Market price is determined by the intersection of market demand & market supply 12.2 How a Firm Maximizes Profit in a Perfectly Competitive Market Profit – total revenue minus total cost Profit = TR – TC To maximize profit, produce the quantity of goods where the difference between TR and TC is as large as possible Revenue for a Firm in a Perfectly Competitive Market Average revenue – total revenue divided by the quantity of the product sold For any level of output, a firm’s average revenue is always equal to the market price This is true because total revenue equals price times quantity TR = P x Q and AR = TR/Q So AR = TR/Q = (P x Q)/Q = P Marginal revenue – the change in TR from selling one more unit of a product MR = ∆TR/∆Q In a completely competitive market, price = average revenue = marginal revenue Determining The Profit-Maximizing Level of Output Profit is maximized where the vertical distance between TR and TC is the largest Profit is maximized by producing wheat up to the point where the marginal revenue of the last bushel produced is equal to its marginal cost; MR = MC o Both of these conclusions are true for any firm (whether or not it is in a perfectly competitive industry) In a perfectly competitive industry, price is equal to marginal revenue; MR = MC = P 12.3 Illustrating Profit or Loss on the Cost Curve Graph Because profit = TR – TC, and TR is price x quantity: Profit = (P x Q) – TC Divide both sides by Q Profit/Q = (P x Q)/Q – TC/Q Profit = (P – ATC) x Q This tells us that a firm’s total profit is equal to the quantity produced times the difference between price and average total cost Showing the Profit on a Graph When output equals zero, total cost equals fixed cost When a firm actually makes a profits at the level of output where MR = MC depends on the relationship of price to average total cost 3 possibilities: 1. P > ATC firm makes profit 2. P = ATC firm breaks even (its total cost = its total revenue) 3. P < ATC firm experiences loss 12.4 Deciding Whether to Produce or to Shut Down in the Short Run In the short run, a firm experiencing loss has two choices: 1. Continue to produce 2. Shut down temporarily Sunk cost – a cost that has already been paid and cannot be recovered; should be treated as irrelevant when making decisions about future choices For any firm, whether total revenue is greater or less than variable costs is the key to deciding whether to shut down The Supply Curve of a Firm in the Short Run A perfectly competitive firm’s marginal cost curve also is its supply curve If a firm is experiencing a loss, it will shut down if: TR < VC (P x Q) < VC P < AVC The firm’s marginal cost curve is its supply curve only for prices at or above AVC Shutdown point – the minimum point on a firm’s average variable cost curve; if the price falls below this point, the firm shuts down production in the short run
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