Lecture 5

question

Three assumptions of model of perfect competition

answer

Price Taking
Price Homogeneity
Free Entry and Exit

question

Price Taking

answer

Because each individual firm sells a sufficiently small proportion of total market output, its decisions have no impact on market price. A firm that has no influence over market price and thus takes the price as given

question

Product Homogeneity

answer

When the products of all of the firms in a market are perfectly interchangeable with one another —no firm can raise the price of its product above the price of other firms without losing most or all of its business.

question

Free Entry and Exit

answer

Condition under which there are no special costs that make it difficult for a firm to join an industry

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firms are making zero economic profit means

answer

firms are making as much profit as they could if they were investing in the best alternative they have.

question

the question facing the perfectly competitive firm is how much to produce or what price to charge? Why?

answer

How much to produce

Because you don't gain from increasing or decreasing your price

question

Output decision

answer

If the firm produces, what output level, q*, maximizes its profit or minimizes its loss?

question

Shutdown decision

answer

- Is it more profitable to produce q* or to shut down and produce no output?

question

Three equivalent rules to choose how much output to produce

answer

Set output where profit is maximized

Set quantity where marginal profit is zero.

Set output where marginal revenue is equal to marginal cost

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marginal profit

answer

change in the profit the firm gets from selling one more unit of output

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marginal profit must equal BLANK when profit is maximized

answer

zero

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For perfectly competitive firms MR=P becuase

answer

additional revenue a firm would get if they sell one more unit (MR) is just the market price

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Output rule for short-run profit maximization by a competitive firm

answer

if a firm is producing any output, it should produce at the level at which marginal revenue equals marginal cost

question

to maximize profit the firm selects the output for which the difference between revenue and cost is (short run)

answer

the greatest

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at the output where the difference between revenue and cost is the most, marginal revenue is (equal to, less than or greater than) marginal cost (short run)

answer

equal to

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if the price of the product is below its total cost should the company continue operating? (short run)

answer

they should continue operating as long as it can cover variable costs

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in order for a firm to keep operating at a loss it must be able to (short run)

answer

pay at least its variable costs

question

Firm should shut down if the price of the product is (short run)

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less than the average variable cost of production at the profit maximizing output

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Long run output decisions

answer

choose quantity that maximizes profit like the short run

picks quantity that maximizes long run profit, the difference between revenue and long-run cost

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in the long run firm will shut down if

answer

it would make an economic loss by operating

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Zero economic profit

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the firm is earning normal - i.e., competitive - return on that investment.

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opportunity cost of using its money to buy capital rather than investing it elsewhere

answer

normal return

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A long-run competitive equilibrium occurs when three conditions hold:

answer

1. All firms in the industry are maximizing profit.

2. No firm has an incentive either to enter or exit the industry because all firms are earning zero economic profit.

3. The price of the product is such that the quantity supplied by the industry is equal to the quantity demanded by consumers

1 of 23

question

Three assumptions of model of perfect competition

answer

Price Taking
Price Homogeneity
Free Entry and Exit

question

Price Taking

answer

question

Product Homogeneity

answer

question

Free Entry and Exit

answer

Condition under which there are no special costs that make it difficult for a firm to join an industry

question

firms are making zero economic profit means

answer

firms are making as much profit as they could if they were investing in the best alternative they have.

question

the question facing the perfectly competitive firm is how much to produce or what price to charge? Why?

answer

How much to produce

Because you don't gain from increasing or decreasing your price

question

Output decision

answer

If the firm produces, what output level, q*, maximizes its profit or minimizes its loss?

question

Shutdown decision

answer

- Is it more profitable to produce q* or to shut down and produce no output?

question

Three equivalent rules to choose how much output to produce

answer

Set output where profit is maximized

Set quantity where marginal profit is zero.

Set output where marginal revenue is equal to marginal cost

question

marginal profit

answer

change in the profit the firm gets from selling one more unit of output

question

marginal profit must equal BLANK when profit is maximized

answer

zero

question

For perfectly competitive firms MR=P becuase

answer

additional revenue a firm would get if they sell one more unit (MR) is just the market price

question

Output rule for short-run profit maximization by a competitive firm

answer

if a firm is producing any output, it should produce at the level at which marginal revenue equals marginal cost

question

to maximize profit the firm selects the output for which the difference between revenue and cost is (short run)

answer

the greatest

question

at the output where the difference between revenue and cost is the most, marginal revenue is (equal to, less than or greater than) marginal cost (short run)

answer

equal to

question

if the price of the product is below its total cost should the company continue operating? (short run)

answer

they should continue operating as long as it can cover variable costs

question

in order for a firm to keep operating at a loss it must be able to (short run)

answer

pay at least its variable costs

question

Firm should shut down if the price of the product is (short run)

answer

less than the average variable cost of production at the profit maximizing output

question

Long run output decisions

answer

choose quantity that maximizes profit like the short run

picks quantity that maximizes long run profit, the difference between revenue and long-run cost

question

in the long run firm will shut down if

answer

it would make an economic loss by operating

question

Zero economic profit

answer

the firm is earning normal - i.e., competitive - return on that investment.

question

opportunity cost of using its money to buy capital rather than investing it elsewhere

answer

normal return

question

A long-run competitive equilibrium occurs when three conditions hold:

answer

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Lecture 5

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