Microeconomics Topic 8: Perfect Competition by

MR=MC

ronaldoyee_161 — 2017-07-18 21:04:24 UTC

When MR=MC, it means that selling more units of output does not increase profit.
When MR>MC, it means that selling more units of output does increase profit.
When MRTherefore, when MR=MC, the profit is the highest (Provided the MC is rising)

ronaldoyee_161 — 2017-07-18 21:04:24 UTC

Demand Curve = Price Curve = Marginal Revenue Curve = Average Revenue Curve

ronaldoyee_161 — 2017-07-18 21:04:24 UTC

The demand curve is also the price curve.
The perfectly competitive firm must sell at the ongoing market price. Therefore, it must sell every additional unit of output at the market equilibrium price. This means marginal revenue is equal to the price (the additional revenue earned from selling one more output is the price)
Average Revenue is total revenue divided by quantity sold, equivalent to the price charged.

Perfectly Elastic Demand curve

ronaldoyee_161 — 2017-07-18 21:04:24 UTC

The firm can only sell the output according to the market equilibrium price. Should it sell at a price higher than that, it will reduce its quantity sold to 0 because the buyers have perfect knowledge about the price. (Nobody wants to buy the exact same item at a higher price)
The firm should not set a selling price lower than the market equilibrium price because it reduces its revenue and profit.

Perfectly Competitive firms are price takers

ronaldoyee_161 — 2017-07-18 21:04:24 UTC

A price taker is a seller with no control over the price of the product it sells.
The seller will set the price according to the market equilibrium price

Number of sellers

ronaldoyee_161 — 2017-07-18 21:04:24 UTC

Many small firms operate in the perfectly competitive market. Each firm has a small market share regardless of the quantity of output sold. Each firm acts independently as well

Types of products sold

ronaldoyee_161 — 2017-07-18 21:22:42 UTC

All firms produce identical products. Therefore, it makes no difference which firm the buyers buy from. There is hence no reason why firms should advertise

Barriers to entry and exit

ronaldoyee_161 — 2017-07-18 21:23:58 UTC

No barriers to entry and exit in a perfect competition market. Firms can easily enter or exit the market. This result in the firms being able to make only zero economic profit in the long run.

Perfect knowledge

ronaldoyee_161 — 2017-07-18 21:27:33 UTC

It is assumed that a perfectly competitive market is operating in an environment full of certainty. Both the buyers and sellers are fully aware of information such as price, availability of resources, output and production techniques

Economic Profit

ronaldoyee_161 — 2017-07-19 00:14:26 UTC

Economic profit occurs when the total revenue exceeds total cost.
The firm will stay in business in a case of economic profit

Zero Economic Profit

ronaldoyee_161 — 2017-07-19 00:15:23 UTC

Zero economic profit occurs when the total revenue equals total cost.
This is called breaking even where all the total revenue covers up all the total cost
The firm will stay in business in the case of zero economic profit
Price = Minimum ATC for a zero economic profit

Economic Loss

ronaldoyee_161 — 2017-07-19 00:16:42 UTC

Economic loss occurs when the total revenue is less than the total cost.
Whether or not the firm should continue operation or cease operation depends on the average variable cost. Bear in mind that the fixed cost will be incurred regardless of operation; variable cost will only be incurred during operations
If the Price > AVC, the firm should continue operation. This is because the total revenue earned can cover up all of the Variable cost and a small portion of the Fixed cost. Stopping operations will incur the full fixed cost which is higher in this situation
If the Price < AVC, the firm should caese operation. This is because the total revenue can only cover up a portion of the Variable cost. By stopping operation, the business incurs only the Fixed cost, which is lesser than incurring the fixed cost plus a portion of the variable cost if the business continues operation
If Price = AVC, the firm can decide whether or not it should cease operation because the total revenue will cover up the variable cost exactly, leaving the fixed cost. Without operation, the firm incurs the fixed cost as well. This is called the shutdown point. It occurs when price = minimum AVC

Decreasing profits in a perfectly competitive firm

ronaldoyee_161 — 2017-07-19 00:24:05 UTC

Profits can decrease because of a fall in the market equilibrium price which in turns decrease total revenue or because of an increase in the cost of production.

Firm's supply curve

ronaldoyee_161 — 2017-07-19 00:26:16 UTC

The perfect competition firm's supply curve is he marginal curve above the minimum AVC (Shutdown point)
This is because the intersection of the MR curve and MC curve is the output level where the firm will produce.
The firm will not produce below the minimum AVC because the loss incurred would be greater than the Fixed cost. Hence, it is better to cease operation.

Industry supply curve

ronaldoyee_161 — 2017-07-19 00:28:52 UTC

The industry short run supply curve is the horizontal summation of all firm's MC curves above each firm's shutdown point

Recall: Short run equilibrium

ronaldoyee_161 — 2017-07-19 00:30:24 UTC

occurs when MR=MC

Long run equilibrium

ronaldoyee_161 — 2017-07-19 00:30:54 UTC

All perfectly competitive firms will only earn zero economic profit in the long run
This is because there is no barriers to entry and exit
In a situation where the firms are making economic profit, it will attract more firms to enter the market as it seems profitable. However, this will shift the industry supply curve rightwards, decreasing the equilibrium price. This will reduce the profits made by each firms until it reaches a zero economic profit
On the other hand, when firms are making economic losses, some of them will leave the market as it is not profitable. This will shift the supply curve to the left, increasing the market price which decreases the loss made by the firms until it reaches a zero economic profit