Price Takers and the Competitive Process 04 04 2013 Determine when a firm will temporarily or permanently go out of Explain the process of competition and identify the effects on consumers and producers 2 Learning Goals business Competition Reduces costs and prices Induces firms to produce the goods consumers want o Recourses moved from unproductive areas to productive areas Spurs innovation and the expansion of new markets Competition as Dynamic Process o Puts the profit motive of sellers to work for buyers o Provides consumers with alternative suppliers Discipline Sellers Price Taker Markets Price Takers Identical Products o Ex Wheat corn soybeans Small firm relative to market Price market equilibrium price No barriers to entry exit Purely competitive REMEMBER If price taker is earning ZERO economic profit all other firms must be as well since price taker operates at market equilibrium In a price taker market a all firms in the market charge different prices depending upon their respective costs of production b there are generally a small number of very large firms c the firms all produce identical products d firms will usually make economic losses in the long run Historically most economists have referred to markets where firms are price takers as a purely competitive markets b monopoly markets c open door markets d price searcher markets If a firm in a price taker market is earning zero economic profit it a will shut down in the long run but not the short run o Decision made based on fixed costs variable costs and total b will also be earning zero accounting profit c is doing as well as typical firms in other markets d will shut down in the short run How they maximize profit 1 Decide to open or close revenue Close can t pay variable costs 1 MR AVC 2 TR TVC 2 If open decide how much to produce o If MR MC keep producing o MC Marginal Price Shut down rules o Temporary Close can cover variable costs in near future o Permanent Close cannot cover variable costs in near future To maximize profits a firm should always produce the level of output where a marginal cost equals average total cost b average total cost equals price c marginal cost equals marginal revenue d marginal revenue equals price If you were the owner of a price taker firm operating at an output level where the marginal cost of producing another unit was 5 and the market price was 7 then you a could increase your profit by expanding output b could increase your profit by decreasing output c are maximizing your profit at your current output level d will be able to earn positive economic profits in the long run If marginal revenue exceeds marginal cost at the current level of output profit will increase when output is expanded because a other firms in the industry will shut down as the firm expands output b the market price will rise as the firm expands output c producing and selling an additional unit will add more to total revenue than it adds to total cost d marginal cost will decline as output is expanded Which of the following is true a When firms in a price taker market are earning zero economic profit they will shut down b When firms in a price taker market are earning positive economic profits new firms will enter the industry causing the market price to fall until the firms in the industry are earning only zero economic profit c When firms in a price taker market are earning economic losses some firms will exit the industry causing the market price to rise until the remaining firms are earning zero economic profit d Both b and c are true If the market price in a price taking industry was currently above the average total cost of production for firms in the industry a firms in the industry would earn short run economic profits that would be offset by longrun economic losses b new firms would enter the industry which would drive price down to the average total cost of production in the long run c firms in the industry would earn positive economic profits in the long run d most firms in the industry would shut down in the long run A price taker market tends toward a state of long run equilibrium in which firms earn only a normal rate of return zero economic profits because a firms will keep their prices low under fear of government regulation b with firms able to enter and leave the industry freely competition will drive prices down to the level of production costs c by definition production costs always rise to equal the market price d mismanagement on the part of owners generally results in the firms not equating marginal revenue and marginal cost You are the owner of an ice cream shop that earns a profit most of the year except during the cold winter months During the month of December your rent and other fixed costs amount to a total of 200 If you remain open your total variable costs workers ice cream cones etc will amount to 300 If you would be able to sell 100 ice cream cones at 4 each during December then a to maximize profits you should remain open in December b to maximize profits you should shut down in December c you will be able to avoid making a loss by shutting down in December d you should go out of business in the long run if there is any single month in which you do not earn a profit FYI Sanitation is currently eight months into a year long lease contract on a garbage truck at a cost that averages 500 per month Variable costs fuel workers etc for operating the truck amount to 300 per month If the monthly revenue from operating the truck is 400 and these conditions are expected to continue into the future to maximize its profit FYI Sanitation should a stop operating the truck immediately and not renew the lease for next year b continue operating the truck then renew the lease for next year c continue operating the truck until the lease expires then not renew the lease for next year d stop operating the truck now but renew the lease and begin operating the truck again next year Total Cost 25 65 95 140 195 255 Output 0 1 2 3 4 5 The schedule of total cost for a firm in a price taker market is given in the table If the market price for this product is 50 which of the following output levels should this firm produce if it wants to maximize its profit a 1 b 2 c 3 d 4 Difference between TAKER and SEARCHER Price Searcher Markets With Low Entry Barriers Learning Goals 04 04 2013 Characterize and explain the output decisions of competitive price searcher markets Bring out the role of the entrepreneur in
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