Chapter 8
Perfect competition
Total and marginal revenue
Revenue curve
Total cost
Economic vs. accounting profit
Perfectly competitive firms are price takers.TR = p*q, where p does not vary. Can we plot TR? Yes, we can plot it on the same graph where we plot TC.
Whereas TC will be curved and will not start at the origin (why is that), TR will be straight and start at the origin. Why?
What will the slope be?
What is the difference btw TR and TC? Profit.
We can also calculate marginal revenue.
What will the MR
for a firm in a perfectly competitive world be? Since p doesn’t change, it will simply
be p.
In order to maximize profit, firms will produce where MR=MC (where MR=p in this case), which will determine Q.
Why won’t they sell more?
Because if p<MC then they are not going to cover their additional cost from the last unit of production.
Can we show that point on the two graphs?
When will a firm choose not to produce at all (Q=0)?
This depends on whether we are talking about the long or the short run.
When a firm cannot cover its variable costs.
Why does this make sense?
Because the loss is smaller than if the firm were to shut down completely.
Firms do not take into account fixed costs in the SR, because those costs are sunk.
It turns out that just as the MB curve represents the individual’s demand curve, the MC curve represents the firm’s supply curve.
What happens in the long run?
In the long run a firm must somehow be able to cover its costs. If the price is below its ATC, then the firm has to make the decision to either close down production (exit) or change its production process (which will in turn change its fixed costs.)
Because some firms will stay in the market in the short run, even though they are not covering all their costs, the SR supply curve is more inelastic than the LR curve.
Also, because it takes time for firms to enter a market if the price rises, this will make SR supply more inelastic.
Economists believe that in the long run firms will enter a market until the economic profits are zero.
Does this mean the firm is not making any profit?
There is a difference btw economic and accounting profit. Economic profit excludes the entrepreneur’s payment.
Put another way, accounting profit minus opportunity cost equals economic profit.
Firms may also receive economic rents – if they are more efficient than all other firms, they will have lower costs and can thus receive economic profits, even if econimic profit for an industry is zero.
But in general, the situation with perfect competition is as follows:
To maximize profit, firms set MC=MR, but in this case MR=p, so p (given) = MC tells us the firm's Q.
If profits >0, firms will enter. If profits <0, firms will exit.
In the short run firm will produce Q>0 as long as p> AVC.
In the long run, profits for most firms will be 0 and the p=min ATC = MC.