ECO2023 Test 3 Chapter 9 Price Takers and the Competitive Process Marginal Revenue The incremental change in total revenue derived from the sale of one additional unit of a product Marginal Revenue Change Total Revenue Change Output Shutdown A temporary halt in the operation of a firm Because the firm anticipates operating in the future it does not sell its assets and go completely out of business The firm s variable cost is eliminated by the shutdown but its fixed costs continue Going out of Business The sale of a firm s assets and its permanent exit from the market By going out of business a firm is able to avoid its fixed costs which would continue during a shutdown A firm should continue to operate if it anticipates that a lower market price is only temporary as long as it can cover its variable cost o May choose to produce at output level where P MR MC A firm should shut down temporarily suspend operations when the market price drops below the firm s average variable cost A firm should permanently go out of business when market conditions are not expected to change for the better Profits and Losses are signals to producers of what products consumers value and how they value them o Profits Consumers value the product more o Losses Consumers value the product less o These signals influence producer s decisions to pursue production or to use resources elsewhere Competition in the market makes producers operate efficiently and promotes the use of resources wisely in favor of buyers Why economists like competition o Costs are reduced o Prices are reduced o Firms become more efficient and have a stronger incentive to innovate o Resources are moved from unproductive areas to productive areas Chapter 10 Price Searcher Markets with Low Entry Barriers Competitive Price Searcher Market A market in which the firms have a downward sloping demand curve and entry into and exit from the market are relatively easy Monopolistic Competition Another name for price searcher markets with low entry barriers Key characteristics of competitive price searcher markets o Many sellers o Low entry barriers o Firms have downward sloping demand curve In the Short Run o Sell differentiated but similar products Ex ice cream gas stations fast food Firms have to work hard to sell you their product The same decision rules apply o Close if MR AVC or if TR TVC o Keep producing as long as MR MC But now the firm has some control over price If positive profits exist new firms will enter and steal some customers from existing firms o Demand curve shifts left If negative profits exist some existing firms will exit and surviving firms will gain more customers o Demand curve shifts right As firms exit and enter the industry the firm demand curve shifts until zero profit In the Long Run exists Price Average Total Cost 0 Profit Since each firm produces a differentiated product we don t speak of a market supply or demand curve but only of a firm supply and demand curve Goods and Bads of Competitive Price Searcher market structure A tradeoff exists o Good With more firms in the market product variety is higher o Bad With more firms in the market Average Total Cost is higher o Good With fewer firms in the market Average Total Cost is lower o Bad Product variety is lower with fewer firms in the market Some economists argue that competitive price searcher markets are inefficient because firms do not produce the output rate that would minimize their ATC Evaluating these kinds of markets and economic progress 2 different interpretations o Recall short run dynamics Positive profits new firms enter existing firms lose customers o Recall long run equilibrium Zero profit no entry or exit No entrepreneur will want to settle for this As market conditions begin to reach this point the entrepreneur must get creative to keep positive profits Innovation Invention will keep markets away from long run equilibrium Price Discrimination Price Discrimination A practice whereby a seller charge different prices for the same product or service 3 necessary conditions that allow a firm to price discriminate 1 Firm has a downward sloping demand curve 2 Must be able to separate customers into at least 2 groups a Groups must have different demand elasticities 3 Can prevent customers from re trading the product Firms price discriminate to increase profits and number of sales Firms price discriminate by setting relatively high prices for customers with inelastic demand and lower prices for those with more elastic demand Entrepreneurship An entrepreneur is someone who makes decisions based upon uncertainty discovery and business judgment o These decisions cannot be graphed or modeled Entrepreneurs play a vital immeasurable role in economic progress by discovering new products and services that create wealth Market forces provide incentives and signals for entrepreneurs Chapter 11 Price Searcher Markets with High Entry Barriers An entry barrier is something that prevents you from opening a business in a particular industry 4 primary reasons why barriers can be high 1 Economies of Scale 2 Government licensing and other legal barriers to entry a Oldest and most prevalent form of protecting a business from competitors b Often obtaining licenses are costly and majorly deterring for those attempting to enter an industry 3 Patents a Prevent competitors from using protected products and procedures b Generally lead to higher consumer prices c Encourage research and technological improvement 4 Control over an essential resource a Often insulates a firm from direct competitors Entry barriers create market power o If no new firms can enter the market to steal customers and products the existing firms behave differently Monopoly A market structure characterized by a single seller of a well defined product for which there are no good substitutes and by high barriers to the entry of any other firms into the market for that product A monopoly is most likely to emerge in a market when economies of scale are large relative to market demand firm large from the beginning A true case of monopoly is unusual because no substitute product is an explicit requirement and that s very rarely the case In a monopoly the firm decides the price and the output o The monopolistic firm is the market o Firm sets price according to market demand willingness to pay o Continue to produce as long as MR MC In the short run the firm can earn positive economic profit as there is no competition
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