Profit Maximization Quiz & Flashcards: Perfect Competition

Profit Maximization Under Perfect Competition in the Long Run

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Study Notes

Production in Perfect Competition

Perfectly competitive firms produce at the point where marginal cost equals marginal revenue, achieving allocative efficiency.
In the long run, firms only earn normal profits due to the entry and exit of firms in the market.

Monopoly Power

Monopoly power refers to the ability of a firm to set prices above marginal cost, limiting competition and controlling market supply.
It enables a single firm to influence market conditions due to lack of substitutes and high barriers to entry.

Characteristics of a Monopoly

A monopoly is defined by a single seller in the market, offering a unique product with no close substitutes.
High barriers to entry prevent other firms from entering, maintaining the monopolist's market dominance.

Profit Generation under Monopoly

A monopolist earns profit as long as the price exceeds average total cost, allowing for supernormal profit.
Profits can persist in the long run due to barriers to entry that prevent competitors from entering the market.

Demand Curves

The demand curve for firms in perfect competition is perfectly elastic, indicating they are price takers.
In contrast, a monopolist faces a downward-sloping demand curve, allowing them to set higher prices.

Supernormal Profits and Long Run Dynamics

Monopolists can sustain supernormal profits in the long run due to the absence of competition and the ability to set their prices.
If firms experience losses in the short run, prices may decrease as firms exit the market, helping to restore normal profit conditions.

Societal Optimal Point of Production

The optimal production point for society is where the social welfare is maximized, corresponding to the intersection of social marginal cost and social marginal benefit.

Normal Profits in Long Run Competition

Perfectly competitive firms earn only normal profits in the long run because any supernormal profit attracts new entrants, increasing supply and lowering prices.

Achieving Productive Efficiency

Productive efficiency is achieved when firms operate at the lowest point on their average total cost curve, minimizing costs for the quantity produced.

Price Adjustments with Supernormal Profits

If supernormal profits exist in the short run, new firms are incentivized to enter the market, increasing supply and driving prices down in the long run.

Eliminating Supernormal Profits

The presence of free entry and exit in perfectly competitive markets eliminates the possibility of long-term supernormal profits, as new entrants decrease market prices.

Description

Learn about profit maximization in the long run under perfect competition where all factors of production are variable and firms can enter or leave the industry. Understand how supernormal profits in the short run attract more firms leading to price decreases in the long run.