Economics Chapter on Competitive Firms

Podcast

Play an AI-generated podcast conversation about this lesson

Questions and Answers

What characterizes a competitive firm as a price taker?

It faces a horizontal demand curve at the market price. (correct)

It has brand loyalty that supports higher pricing.

It operates in a market with few buyers and sellers.

It can influence market price by adjusting its output.

Which of the following is NOT a feature of a perfectly competitive market?

All market participants have full information.

Many small buyers and sellers exist.

Firms can easily enter and exit the market.

Firms produce differentiated products. (correct)

What assumption does perfect competition NOT rely on?

Free entry and exit for firms.

Presence of strong barriers to entry. (correct)

Product homogeneity among firms.

Price taking behavior of firms.

What happens when a firm in a perfectly competitive market increases its price?

It loses all its customers. Signup and view all the answers

Which of the following barriers to entry can deter new firms from entering a market?

High start-up costs. Signup and view all the answers

What should a firm determine first to maximize its profit?

The output level that maximizes profit Signup and view all the answers

How does product homogeneity influence pricing in a competitive market?

No firm can charge more than the market price without losing business. Signup and view all the answers

Which output decision rule states that a firm should set output where marginal revenue equals marginal cost?

Rule 3 Signup and view all the answers

In a perfectly competitive market, what shape does the demand curve faced by an individual firm have?

Horizontal Signup and view all the answers

What effect does easy entry and exit have on existing firms in a market?

It makes firms behave as if there are more competitors than there actually are. Signup and view all the answers

Which scenario is most aligned with a competitive firm behavior in regards to pricing?

A firm accepts the market price and adjusts its output accordingly. Signup and view all the answers

How is marginal revenue defined in the context of profit maximization?

The change in revenue from selling one more unit Signup and view all the answers

If a firm continues to produce as long as marginal revenue is greater than marginal cost, what is the necessary condition for profit maximization?

Marginal revenue should equal marginal cost Signup and view all the answers

What happens if a perfectly competitive firm increases its price by even a small amount?

It will sell nothing at all Signup and view all the answers

What is the profit equation for a firm?

Profit = Total revenue minus total cost Signup and view all the answers

How does the second-order condition for profit maximization state regarding the slopes of marginal revenue and marginal cost?

The slope of marginal revenue must be less than the slope of marginal cost Signup and view all the answers

What is the condition for a firm to continue operating in the short run?

P > AVC Signup and view all the answers

What determines a firm's short-run supply curve?

The portion of the MC curve above AVC Signup and view all the answers

Why should sunk costs be considered irrelevant in decision-making?

They must be paid regardless of the decision. Signup and view all the answers

Under what condition should a firm exit the market in the long run?

When P < ATC Signup and view all the answers

What is the relationship between marginal cost and price when a firm is maximizing output?

P = MC Signup and view all the answers

If a restaurant's fixed costs do not change with production, what is the implication when deciding to operate during lunch hours?

The restaurant should evaluate only variable costs. Signup and view all the answers

What happens to a firm's total revenue and total costs when it exits the market?

Both revenue and costs fall. Signup and view all the answers

At what point does a firm decide to shut down in the short run?

When P < AVC Signup and view all the answers

Under what condition does a restaurant owner shut down at lunchtime?

If revenue does not cover variable costs Signup and view all the answers

What criterion must a new firm meet to enter the market in the long run?

Total Revenue must be greater than Total Costs Signup and view all the answers

When a firm is breaking even, which of the following is true?

Price equals Average Total Cost Signup and view all the answers

Which of the following indicates that a firm is experiencing losses?

Price is less than Average Total Cost Signup and view all the answers

What does the firm’s long-run supply curve represent?

The portion of the MC curve above LRATC Signup and view all the answers

If a firm has a total profit expressed as Profit = (P - ATC) × Q, what does this formula indicate?

Profit increases with higher prices and higher output Signup and view all the answers

In the formula Profit = (P × Q) - TC, which variables determine the total profit?

Price and Quantity Signup and view all the answers

If the price for a competitive firm is set at $10, which average cost value indicates a profit?

$6 Signup and view all the answers

What is the formula to calculate total profit for a competitive firm?

Total profit = (P – ATC) x Q Signup and view all the answers

If a firm's average total cost (ATC) is $5 and the price (P) is $3, what is the loss per unit?

$2 Signup and view all the answers

In the short run, when will each firm produce its profit-maximizing quantity?

When P ≥ AVC Signup and view all the answers

What happens to the market supply in the long run when firms can enter and exit freely?

It becomes variable Signup and view all the answers

How is total loss calculated when average total cost (ATC) exceeds price (P)?

Total loss = (ATC – P) x Q Signup and view all the answers

If a competitive firm produces 50 units at a profit of $4 per unit, what is the total profit?

$200 Signup and view all the answers

Which of the following is NOT an assumption about market supply?

All firms face different costs Signup and view all the answers

What determines the market quantity supplied at each price level?

The sum of quantity supplied by each firm Signup and view all the answers

Study Notes

Competitive Firms and Price-Taking

A competitive firm is a price taker because it faces a horizontal demand curve at the market price.
This means the firm can sell as much as it wants at the market price, but cannot sell anything if it raises the price.
It has no incentive to lower its price because it can sell all it wants at the current price.
Perfect competition is characterized by many buyers and sellers, homogenous goods, easy entry and exit, and perfect information.

Perfect Competition Assumptions

Price-taking: Individual firms have no impact on the market price due to their small size.
Product homogeneity: All firms produce identical goods, making price differences difficult to sustain.
Free entry and exit: Firms can enter or exit the market without significant barriers or costs, leading to a more competitive landscape.

Barriers to Entry

High start-up costs can delay entry and limit competition.
Brand loyalty can make it difficult for new firms to gain market share.
Government restrictions can limit competition and protect incumbent firms.

Profit Maximization

Firms aim to maximize profit by optimizing their output decision and shutdown decision.
Output decision: Determining the output level that maximizes profit or minimizes losses.
Shutdown decision: Whether to produce or shut down based on profit potential.

Output Rules

Firms use three key rules to determine output levels:
- Profit maximization: Setting output where profit is highest.
- Zero marginal profit: Setting output where marginal profit is zero.
- Equality of marginal revenue and marginal cost: Setting output where marginal revenue (MR) equals marginal cost (MC).

Revenue in a Perfectly Competitive Market

Average revenue (AR): Total revenue divided by the quantity sold.
Marginal revenue (MR): Change in total revenue from selling one more unit.
In a perfectly competitive market, MR is equal to the market price.

Profit Maximization in the Short Run

A firm maximizes profit by producing at the output level where MR = MC.
The second-order condition ensures that the firm is at a maximum point, not a minimum.

The Demand Curve for a Perfectly Competitive Firm

A perfectly competitive firm faces a horizontal demand curve.
This means it can sell any quantity at the market price but cannot sell anything above it.
It can sell as much as it wants at the given market price.

Shutdown Decision in the Short Run

A firm will shut down in the short run if the price (P) is less than the average variable cost (AVC).
This is because the firm cannot cover its variable costs, and shutting down minimizes losses.

Short-Run Supply Curve

A firm's short-run (SR) supply curve is the portion of its marginal cost (MC) curve above the average variable cost (AVC) curve.
It represents the quantity the firm will supply at each market price.

Sunk Costs

Sunk costs are already incurred and cannot be recovered, so they should not influence decisions.
Fixed costs are an example of sunk costs in the short run.
Shutdown decisions should be based on covering variable costs, not fixed costs.

Long-Run Decision to Exit the Market

A firm should exit the market in the long run if the price (P) is less than the average total cost (ATC).
This indicates that the firm cannot cover its total costs, making it more profitable to exit.

Long-Run Decision to Enter the Market

A firm should enter the market in the long run if the price (P) is greater than the average total cost (ATC).
This indicates that the firm can cover its total costs and earn a profit, making entry desirable.

Illustrating Profit or Loss

Profit is calculated as total revenue minus total cost (TR - TC).
It can also be expressed as the difference between price (P) and average total cost (ATC) multiplied by the quantity (Q) sold: (P - ATC) x Q.
Profit is positive when P > ATC, zero at P = ATC, and negative when P < ATC.

Market Supply Assumptions

All firms have identical costs, including potential entrants.
Costs remain stable regardless of entry or exit.
The number of firms is fixed in the short run (due to fixed costs) and variable in the long run (due to free entry and exit).

Short-Run Market Supply Curve

At prices above AVC, each firm will produce its profit-maximizing quantity where MR = MC.
The market supply is the sum of all individual firm supplies at each price.

Studying That Suits You

Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

Description

Explore the essentials of competitive firms and price-taking in this quiz. Understand the principles of perfect competition, including the assumptions around price determination and barriers to entry in the market. Test your knowledge on how these elements interact to shape economic landscapes.