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URI ECN 201 - Chapter 12: Perfect Competition

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Econ 201 1st Edition Lecture 14Outline of Last Lecture I. Supply CurvesII. Marginal ProductsIII. Diminishing ReturnsIV. Average CostsV. Return to ScaleOutline of Current LectureI. Perfect CompetitionII. Production and ProfitsIII. Marginal RevenueIV. ProfitabilityCurrent LectureChapter 12: Perfect Competition1. There are many buyers and sellers. This means- Each seller with a small market share.- Both sellers and buyers are price- takers; their actions have no effect on price.- Each participant is a drop in the bucket.2. The product is standardized across sellers.- Standardized product (“commodity” ): Consumers regard different sellers’ products as equivalent.3. Free entry and exit- New producers can easily enter into an industry and existing producers can easily leave that industry.Production and Profits-Firm’s goal: maximize profitsProfit = total revenue – total costProfit = TR – TCUnder perfect competition- each firm is a price-taker- each firm’s total revenue will be equal to:price × quantity sold, or TR = P × QMarginal Revenue-Marginal revenue: change in total revenue generated by an additional unit of output.- MR = changeTR/changeThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.- For price-taking firms, MR is simply the good’s market price in the competitive market. MR = PWhy profit is maximized at MR = MC?-Each time the firm produces another unit, there are extra costs and extra revenues.-If producing another unit adds more to revenue than cost, profit will increase.- Because if MR > MC, producing more will add to profit.- And if MR < MC, producing more will shrink profit.-Optimal output rule: Profit is maximized by producing the quantity of output at which the MR of the lastunit produced is equal to its MC- Since MR = P for competitive firms, the profitmaximizing rule is- Choose the quantity of output where P = MC.When is Production Profitable?-Recall we are using economic profit, which includes implicit costs. It is normal for a firm’s economic profit to be zero.- If TR = TC, the firm breaks even.- If TR > TC, the firm is profitable.- If TR < TC, the firm incurs a loss.Calculating Total Costs and Profit-������ = �� − �� = ( ��/�–��/� ) × �-� = ��� , ��� = ��/�-������ = (� − ���) × �-Break-even price: ������ = 0-� = ���Profitability and the Market Price-If the price is just high enough to cover ATC and if it chooses the Q where MR = MC, the firm will break even.-A firm should stay open in the short run if it can cover its variable costs.-Losses don’t mean immediate shutdown. Remember, fixed costs must be paid whether or not the firm produces in the short run.-Firms will choose to produce (even at a loss) if they can cover their variable AND SOME of their fixed costs.-Shut-down price: minimum average variable cost.-A firm will produce at every price above minimum ATC where price intersects the MC curvebut will stop producing in the short run if the market price falls below the shutdown priceso the MC curve (above shut-down price) is the firm’s supply curve.Should I stay or should I go?-Summary:- In the short run, a firm will produce if P > shutdown price (min AVC).- A firm will NOT produce if P < min AVC.-A higher price attracts new entrants in the long run, raising industry output and lowering price.-A fall in price induces producers to exit in the long run, reducing industry output and raising price.-The long -run industry supply curve is always flatter—more elastic —than the short -run industry supply


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