microeconomics - clutch ch. 11 - perfect...

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MICROECONOMICS - CLUTCH

CH. 11 - PERFECT COMPETITION

CONCEPT: THE FOUR MARKET MODELS

● Market structure describes the environment in which a firm operates, determined by the _________________________

Perfect Competition Monopolistic Competition

Oligopoly Monopoly

Number of Firms

Examples

Barriers to Entry

Profit-Maximizing Quantity

Profitability

Relation of Price (P=AR) and MR

Relation of Price and MC



CONCEPT: CHARACTERISTICS OF PERFECT COMPETITION

● A market is perfectly competitive when:

□ Nature of Good: The goods for sale are __________________________________

□ Setting Price: The buyers and sellers are both _____________________________

- Lots of buyers

- Lots of sellers

- Each market participant has __________ influence on price

□ Entry and Exit: Firms can _______________ enter and exit the market.

□ Example Product:

● The demand curve facing the individual firm is different from the demand curve for the entire industry.

Market for Wheat Individual Firm’s Demand

□ Perfect competition is the only market structure where a firm’s demand curve is ______________



CONCEPT: REVENUE IN PERFECT COMPETITION

● Revenue is the money coming into the firm from sales: ___________________________________

□ Revenues are the ____________________ to the firm

Average Revenue Marginal Revenue

𝐴𝑅 =𝑇𝑅𝑄 =

𝑀𝑅 =∆𝑇𝑅∆𝑄

𝐴𝑣𝑒𝑟𝑎𝑔𝑒𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = __________________

𝐴𝑣𝑒𝑟𝑎𝑔𝑒𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = 𝐷𝑒𝑚𝑎𝑛𝑑𝐶𝑢𝑟𝑣𝑒

In perfect competition, price is fixed (set by market):

∆𝑄 = 1 →Sell one more unit for ______ → ∆𝑇𝑅 = _____

𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = __________________

True for _______________________

True for _______________________

In perfect competition:

𝐴𝑅 = 𝑀𝑅 = 𝑃

EXAMPLE: Numerical example showing constant marginal revenue in perfect competition

Market Price per Bushel of Wheat = $4

Quantity (Q)

Total Revenue (TR)

Total Cost (TC) Profit Marginal

Revenue Marginal Cost Change in Profit

0 $2.50 1 $4.50 2 $7.00 3 $10.00 4 $13.50 5 $18.00 6 $24.00



CONCEPT: PROFIT ON THE GRAPH

● The profit-maximizing quantity will always occur where ________________________

□ Profit-maximizing could also mean __________________________

● The profit or loss is defined by the following formula:

𝑃𝑟𝑜𝑓𝑖𝑡 = (𝑃𝑟𝑖𝑐𝑒 − 𝐴𝑇𝐶) ∗ 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦

Step 1: Find profit-maximizing quantity where MR = MC

Step 2: Find Price (on Demand Curve) and ATC at that quantity

_______________ _______________

□ If P > ATC _________________ □ If P = ATC _________________ □ If P < ATC _________________

1 2 3 4 5 6

1

2

3

4 P = ______ = ______

MC

MC

ATC

P = AR = MR

MC ATC

P = AR = MR



PRACTICE: Use this graph to answer the following questions:

If the firm decreases its production from Q2 to Q1, it will

a) Increase its profit

b) Decrease its profit

c) Reduce its marginal revenue

d) Increase its marginal revenue

If the price is P1, the firm maximizes profit by producing

a) Q1

b) Q2

c) Q3

d) Nothing

If the price is P1, the firm is

a) Suffering an economic loss

b) Earning an economic profit

c) Breaking even

d) None of the above



CONCEPT: SHORT RUN SHUTDOWN DECISION

● A firm might decide to shut down in the short-run due to the current market conditions (i.e. market price, cost levels).

□ When a firm shuts down, they produce no output ___________________

□ When a firm exits the market, they produce no output ________________

● The relevant costs in a short-run shutdown decision are __________________________

□ In the short-run, fixed costs must remain fixed costs

□ A sunk cost is a cost that ______________ be recovered

- No refunds

- Contractually committed

EXAMPLE: A farmer paid $1,000 to rent a field for the season. Seeds cost $200. Should the farmer produce this season?

Revenue from sales = $500 Revenue from sales = $100

No Production: Production: No Production: Production:

Best Scenario:

Best Scenario:

● The firm shuts down if price falls below the ___________________ of the ____________ curve.

□ The minimum of the AVC curve is called the shutdown point

Shutdown if:

𝑇𝑅 < 𝑉𝐶

Divide by Q:

Shutdown if:

Summary of Short Run Output and Profit

Should firm produce? Yes, if P > AVC No, if P < AVC

If yes, what quantity? Produce where MR = MC

Economic profit? Yes, if P > ATC No, if P < ATC

● The AVC is only relevant for our short-run shutdown decision!

MC ATC

AVC



PRACTICE: The makers of edible underpants are faced with the following production costs:

Quantity Total Fixed Costs Total Variable Costs

0 100 0

1 100 50

2 100 70

3 100 90

4 100 140

5 100 200

The price for a pair of edible underpants is $50. In the short-run, the firm should:

a) Shut down because price is less than average total cost.

b) Shut down because it cannot make a profit.

c) Produce one unit because, at this output, marginal revenue equals marginal cost.

d) Produce four units because, at this output, the loss is minimized.

The price for a pair of edible underpants is $50. In the short-run, the firm’s total revenue is:

a) $0

b) $50

c) $200

d) None of the above

The price for a pair of edible underpants is $50. In the short-run, the firm’s profit (or loss) is:

a) $200 profit

b) $40 loss

c) $100 loss

d) Break-even




The firm shuts down at any price below:

a) P1

b) P2

c) P3

d) P4

What is the least amount of output, assuming the firm does not shut down?

a) 5 units

b) 8 units

c) 10 units

d) 11 units

If the price falls from P4 to P3, then output will decrease by

a) 0 units

b) 1 unit

c) 2 units

d) 3 units



CONCEPT: LONG RUN EXIT/ENTER DECISION

● A firm will exit the market if it ____________ earn a profit. A firm will enter the market if it ____________ earn a profit.

□ When a firm shuts down, they produce no output __________________

□ When a firm exits the market, they produce no output _______________

● The relevant costs in a long-run exit decision are _____________________

□ In the long-run, all costs are __________________

□ There are no _________________ in the long run.

EXAMPLE: A farmer is considering if he should continue to rent a field for the upcoming season at a price of $1,000. Seeds

cost $200. Should the farmer produce this season?

Revenue from sales = $500 Revenue from sales = $100

No Production: Production: No Production: Production:

Best Scenario:

Best Scenario:

● The firm shuts down if price falls below the _____________________ of the ______________ curve.

□ The minimum of the ATC curve is the “entry/exit point”

Exit if:

𝑇𝑅 < 𝑇𝐶

Divide by Q:

Exit if:

Enter if:

Price Profit Short-Run Production

Long-Run Production

MC ATC

AVC



CONCEPT: INDIVIDUAL SUPPLY CURVE IN THE SHORT RUN AND LONG RUN

● A firm does not shut down when price is ______________________

□ The firm’s short-run supply curve in perfect competition is the portion of __________ above __________

● A firm does not exit the market when price is ____________________________

□ The firm’s long-run supply curve in perfect competition is the portion of _______ above ________

MC ATC

AVC

MC ATC

AVC



CONCEPT: MARKET SUPPLY CURVE IN THE SHORT RUN AND LONG RUN

● In the short-run, the number of firms in the market is _______________

□ The market’s short-run supply curve in perfect competition is the _________ of individual firm’s _______ curves.

Individual Firm Market Supply with 1,000 firms

● In the long-run, firms earn ___________ economic profit

𝑃𝑟𝑜𝑓𝑖𝑡 𝑜𝑟 𝐿𝑜𝑠𝑠 = (𝑃 − 𝐴𝑇𝐶) ∗ 𝑄

□ Short-run profits (P > ATC) __________________________ _________

□ Short-run losses (P < ATC) __________________________ _________

□ Long-run Equilibrium __________________________

Individual Firm: Zero Profit Long-run Market Supply

100 200

$5

$10

$5

$10

MC

Q

P Market Supply

Market Supply

MC

ATC

Q

P

Q

P

Q

P



CONCEPT: CHANGES IN DEMAND AND LONG RUN EQUILIBRIUM

● Shifts in the demand curve can create short-run profits or losses, but eventually return to the same long-run equilibrium.

□ In the short run, firms can earn economic profit or loss. In the long run, firms earn no economic profit.

Market Firm

Q (market) Q (firm)

Q (market) Q (firm)

Q (firm) Q (market)

P1 P1 Long-run

Supply

Short-run

Supply

Demand

Long-run

Supply

Short-run

Supply

D1

D2

MC ATC

In Long-Run

Equilibrium

Increase in

Demand

Short-Run

Profit Leads

Firms to

Enter

Long-run

Supply

S1

D1

D2

P1 P1

MC ATC

S2 MC

ATC

P1

P = ____ = ____




If the price is P1, the firms are

a) Earning an economic profit and some firms will exit

b) Suffering an economic loss and some firms will exit

c) Earning an economic profit and some firms will enter

d) Suffering an economic loss and some firms will enter

Suppose the cost curves apply to all firms in the industry. If the initial price is P1, in the long run, the market

a) Supply will decrease

b) Demand will decrease

c) Supply will increase

d) Demand will increase

PRACTICE: A new study shows that eating raw garlic keeps vampires away (vampires have become a huge problem). This

news shifts the demand curve for raw garlic to the right. In response, new firms enter the garlic market. While firms are

entering the market, the price of raw garlic ____________ and the profit of each existing firm _____________.

a) Falls; rises

b) Rises; falls

c) Rises; rises

d) Falls; falls



CONCEPT: PERFECT COMPETITION AND EFFICIENCY

● Perfectly competitive markets ____________ both productive efficiency and allocative efficiency.

□ Productive Efficiency – producing at the _____________________________

- The lowest possible cost is ____________________

- In the long run, perfect competition forces firms to produce at ______________________

□ Allocative Efficiency – production represents ______________________________

- Producing means producing up to the point that the _______ = _______

Allocative Efficiency in Perfect Competition 1. The price of a good represents the MB to consumers of the last unit sold. (P = MB)

2. In perfect competition, firms produce up to the point where the price (MR) equals marginal cost. (P = MC)

3. Thus, firms produce up to the point where MB to consumers equals MC to producers. (P = MB = MC)

MC ATC



PRACTICE: Use the following graphs to answer the questions below:

Single Firm Market

The firm is a price taker because:

a) It has a U-shaped ATC curve

b) The profit-maximizing point occurs where MC equals ATC

c) The MC curve has an upward slope

d) The MR curve is horizontal

When this firm is producing the profit-maximizing output:

a) Total revenue is equal to total cost

b) It earns an economic profit

c) Only allocative efficiency is reached (i.e. no productive efficiency)

d) Only productive efficiency is reached (i.e. no allocative efficiency)

When P = MC = minimum ATC for individual firms, in the entire market:

a) Consumer surplus is larger than producer surplus

b) Producer surplus is larger than consumer surplus

c) Supply and demand are the same

d) Total surplus is at a maximum

P

MC ATC

MR

P = MC = minimum ATC

Qf

D

Qm

S



CONCEPT: FOUR MARKET MODEL SUMMARY

Perfect Competition

Number of Firms

Examples

Barriers to Entry

Profit-Maximizing Quantity

Long-Run Profitability

Relation of Price (P=AR) and MR

Relation of Price and MC



microeconomics - clutch ch. 11 - perfect...

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