Lecture 5 - Custom Scholars
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# Lecture 5

question
Three assumptions of model of perfect competition
Price Taking
Price Homogeneity
Free Entry and Exit
question
Price Taking
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
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
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
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?
How much to produce

Because you don't gain from increasing or decreasing your price
question
Output decision
If the firm produces, what output level, q*, maximizes its profit or minimizes its loss?
question
Shutdown decision
- 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
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
change in the profit the firm gets from selling one more unit of output
question
marginal profit must equal BLANK when profit is maximized
zero
question
For perfectly competitive firms MR=P becuase
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
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)
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)
equal to
question
if the price of the product is below its total cost should the company continue operating? (short run)
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)
pay at least its variable costs
question
Firm should shut down if the price of the product is (short run)
less than the average variable cost of production at the profit maximizing output
question
Long run output decisions
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
it would make an economic loss by operating
question
Zero economic profit
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
normal return
question
A long-run competitive equilibrium occurs when three conditions hold:
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
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question
Three assumptions of model of perfect competition
Price Taking
Price Homogeneity
Free Entry and Exit
question
Price Taking
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
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
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
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?
How much to produce

Because you don't gain from increasing or decreasing your price
question
Output decision
If the firm produces, what output level, q*, maximizes its profit or minimizes its loss?
question
Shutdown decision
- 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
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
change in the profit the firm gets from selling one more unit of output
question
marginal profit must equal BLANK when profit is maximized
zero
question
For perfectly competitive firms MR=P becuase
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
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)
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)
equal to
question
if the price of the product is below its total cost should the company continue operating? (short run)
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)
pay at least its variable costs
question
Firm should shut down if the price of the product is (short run)
less than the average variable cost of production at the profit maximizing output
question
Long run output decisions
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
it would make an economic loss by operating
question
Zero economic profit
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
normal return
question
A long-run competitive equilibrium occurs when three conditions hold:
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

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