Principles of Economics
Principles of Economics

Principles of Economics

Lead Author(s): Stephen Buckles

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Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

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Only available with supplementary resources at additional cost

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Customizable

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All-in-one Platform

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Pricing

Average price of textbook across most common format

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Up to 40-60% more affordable

Lifetime access on any device

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

$130

Hardcover print text only

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

$175

Hardcover print text only

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

$140

Hardcover print text only

Always up-to-date content, constantly revised by community of professors

Constantly revised and updated by a community of professors with the latest content

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

In-book Interactivity

Includes embedded multi-media files and integrated software to enhance visual presentation of concepts directly in textbook

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

Customizable

Ability to revise, adjust and adapt content to meet needs of course and instructor

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

All-in-one Platform

Access to additional questions, test banks, and slides available within one platform

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

About this textbook

Lead Authors

Stephen Buckles, Ph.DVanderbilt University

Stephen Buckles is a Senior Lecturer at Vanderbilt University, where he also received his Ph.D. in Economics. Buckles has been the recipient of numerous awards, including Madison Sarratt Prize for Excellence in Undergraduate Teaching (Vanderbilt, 2008), Kenneth G. Elzinga Distinguished Teaching Award (Southern Economic Association, 2006), and the Dean’s Award for Excellence in Teaching (Vanderbilt, 2007). His course pack, which this text is based on, has been used by thousands of students and engages the concepts of active learning.

PJ Glandon, PhDKenyon College

PJ Glandon joined Kenyon College as an Associate Professor of Economics after completing his Ph.D. at Vanderbilt University.

Contributing Authors

Benjamin ComptonUniversity of Tennessee

Caleb StroupDavidson College

Chris CotterOberlin College

Cynthia BenelliUniversity of California

Daniel ZuchengoDenver University

Dave BrownPennsylvania State University

John SwintonGeorgia College

Michael MathesProvidence College

Li FengTexas State University

Mariane WanamakerUniversity of Tennessee

Rita MadarassySanta Clara University

Ralph SonenshineAmerican University

Zara LiaqatUniversity of Waterloo

Susan CarterUnited States Military Academy

Julie HeathUniversity of Cincinatti

Explore this textbook

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Chapter 9: Competitive Markets

Figure 9.1: Wheat is a product that is produced in a perfectly competitive market.​ [1]​

After farming wheat for a number of years, Eric knew that as a small farmer, he could not change the price of wheat. Sometimes the price of wheat was high, and he could earn profits from farming. Other years, the price was low, and his business experienced losses. Despite the losses, he still kept producing wheat.

Why could Eric not change the price of wheat? How did the price change if he didn’t change it? Why did he continue to produce if was experiencing losses? How can a firm maximize profits if it can’t determine the price of the good it sells? We will be able to answer these questions by the end of this chapter.

9.1 Objectives

After reading this chapter, answering the questions in the text, and doing the exercises, you will be able to:

  • Explain perfectly competitive market responses in the short and long runs to changes in demand and costs.
  • Explain the role of profits in providing incentives in competitive markets.
  • Analyze changes in a market when profits are greater than what can be earned in similar activities.
  • Use the concept of negative, zero, and positive economic profits in a number of different applications.
  • Determine when a firm that is currently earning losses should continue to produce and when it should simply shut its doors.
  • Understand and use the concepts of allocative and technical efficiency in reference to outcomes of perfectly competitive markets.

In this chapter, we derive the demand for a competitive firm's product and put it together with the costs the firm faces. The result is first a supply curve for a perfectly competitive firm and then a supply curve for the entire market. Then we will explore the short-run equilibrium for the firm and the market, followed by long-run adjustments. We use the resulting analysis to describe the outcomes of a series of possible events in a competitive market. The chapter ends with a discussion of economic efficiency and perfectly competitive markets.

9.2 Types of Markets

Figure 9.2: Commercial airline travel is NOT perfectly competitive.​ [2]​

Markets differ in many ways. In most cases, however, it is the number of competitors in the market which most significantly affects the amount of influence firms have over their prices. When we discussed supply and demand, we discussed markets that had many firms. If a single firm tried to raise the price for its product, buyers would purchase from another firm. The conclusion is that a competitive firm, one with many other firms producing identical goods, has no control over its price. This type of firm is actually rather unusual and is on one end of a spectrum.

The other extreme is a market with only one firm – a monopoly. A monopolist has a good bit of influence over its price. But not total influence. As price increases, the quantity demanded will still decrease as buyers switch not to other direct competitors, but to other goods and services.

There are other characteristics besides the number of competitors which can create differences in markets. We can also examine the product. Are the firms’ products homogenous (identical), such as corn? If you’re from a farming community, you may have seen one farmer’s corn harvest dumped on top of another farmer’s corn after both were weighed and sold. The corn is identical. This means that one corn farmer can’t command a different price for his corn than any other farmer at the market. On the other hand, pizza is differentiated (similar, but not identical). You may be able to think of many restaurants that serve a food called “pizza,” but it will differ across restaurants in terms of size, taste, quality, appearance, ingredients, etc. This differentiation in the product allows the restaurants to charge different prices to some extent. One restaurant in town may have slightly higher pizza prices if consumers feel the food is of a better taste and quality.

One other way in which markets can differ is the existence of barriers to entry. Some markets are considered to have “free entry.” This means that there is no serious impediment for a newcomer to start a business and compete. Examples could be opening up a sandwich shop, becoming a photographer, or even starting a tutoring business in a subject area in which you are an expert. Note that “free entry” does NOT mean “costless entry.” It will almost always cost money to start a business – whether renting a building, paying a franchise fee, hiring workers, or buying ingredients. But as long as these costs are not prohibitively expensive, you could open a new business. However, some markets have entry barriers, which make it difficult or impossible for newcomers to enter the market. Examples could include extremely high setup costs (you probably couldn’t start your own oil exploration company or commercial airline) or legal barriers (you can’t create and sell a good which is already patented by another business).

In between perfect competition and monopoly, there are many possibilities. In markets with only a few competitors (oligopoly), firms may have more influence over prices than firms in markets with many competitors. We can have markets with many competitors, a smaller number of competitors, and only a single firm. In some industries, there are many firms (so we describe the market as “competitive”), but each firm produces a differentiated product. Each firm has a “monopoly” on their own differentiated product. We describe those markets as having monopolistic competition.

Table 9.1: A comparative summary of market structures.​


9.3 Demand in a Competitive Market

To determine how much a perfectly competitive business will decide to produce, we now turn to the nature of the firm's market and the demand for the firm’s product. In a perfectly competitive market, there are many competing buyers and sellers, all of which are small relative to the entire market and all have knowledge of market prices and costs. They all produce the same product. Their consumers have a great deal of knowledge about prices and qualities of products. And finally, existing firms can easily exit the market, and new firms can enter.

While there are many competitors in this type of market, the actions of firms and level of competition can’t be described as “cutthroat” or “fierce,” where firms are actively going against each other. For example, one farmer isn’t actively competing with his neighbor over corn output or prices. With the huge market and homogenous good, each is a drop in the bucket compared to the size of the market. In other words, your neighbor’s corn output will not affect the price at which you sell your corn, so you are not directly concerned with his behavior. However, you both must sell your corn at the market price, as all buyers and sellers are assumed to have perfect information regarding prices of goods being traded.

Question 9.01

Question 9.01

Can you think of examples of perfectly competitive markets?

Hover here to see the hint for Question 9.01.
Click here to see the answer to Question 9.01.

We will also assume that the firms have as a primary goal the maximization of profits. That is, given the market and given the firm's resources, the firm wants to select a rate of output, levels of inputs, and prices that will provide the highest possible profits for the firm.

In reality, firms have a variety of goals. Sometimes it is producing the highest quality product, being a leader in research and technology, having the biggest share of the industry, or doing good in the community. Not all of these have to conflict with profit maximization, but the potential is there. In any case, the profit maximization assumption is a reasonable assumption about most behavior. In our model of firms, we will assume that profit maximization is the goal, and this will help guide our predictions about firm behavior.

Figure 9.3: Not all firms have the primary goal of profit maximization. The Wikimedia Foundation is an example of a non-profit organization. The goal of the foundation is to “…encourage growth, development and distribution of free, multilingual, educational content, and to providing the full content of these wiki-based projects to the public free of charge.” [3]​


Similar to the examples shown earlier, markets that are closest to being "perfectly" competitive are many of the agricultural products that make up so much of our consumption activity. Wheat, corn, and soybeans are grown by large numbers of farmers. All farmers are relatively small compared to the entire market. Qualities of products are relatively homogeneous. Prices are well known and appear in the Wall Street Journal and other publications every day. The farmers are "price-takers."  Another example could be the stock market. For highly-traded stocks such as Bank of America (BAC), the trading volume can reach in the tens of millions daily. There are many buyers and sellers, each share of stock is identical, and price information is kept updated (to the second) on various trading platforms and finance websites such as CNBC or Yahoo Finance.

It is worth noting, however, that “real life” examples of perfect competition are few and far between, due to the number of restrictive assumptions we put on the model. Even the farming and stock market examples may not always be perfectly competitive. For example, farming today may require a lot of land, as well as large and expensive equipment. Obtaining the land and capital to start a farm of profitable size may require hundreds of thousands (if not millions) of dollars. This can certainly be considered an entry barrier, meaning the market is no longer perfectly competitive. In the stock market, there are often large institutional investors or mutual funds that buy huge numbers of shares at a time. Their purchases are large compared to the trading size of the day, and their actions do affect the price, meaning they are not truly price-takers. While it is worth noting these considerations, it is still certainly valuable for us to use the model to study perfect competition in order to understand profit maximization, firm behavior, and even consumer behavior. Doing so will help us understand firm behavior in all types of markets.

Question 9.02

A single firm in a perfectly competitive market is a _________.

A

Price-taker

B

Price-maker

C

Quantity-taker

D

Quality-maker


Question 9.03

Which of the following is a characteristic of perfect competition?

A

Differentiated products

B

A small number of firms competing

C

Easy entry for firms

D

None of the above


Question 9.04

Why can't a single firm in a perfectly competitive industry influence the market price?

A

Its costs are too high

B

It is not allowed to advertise

C

Its production level is too small to affect the market

D

It is a price maker


Question 9.05

Consider the market structure of perfect competition. What does the lack of entry barriers indicate?

A

All firms will end up producing a unique and different product

B

There are no significant obstacles preventing firms from entering and leaving the industry

C

No new firms can enter an already-established industry

D

Firms can enter the industry easily but cannot exit the industry easily

9.4 Demand Facing a Competitive Firm

Figure 9.4: Market for sweet corn and an individual sweet corn producer.​

Let us consider the market for sweet corn, depicted in Figure 9.4 as an example of a perfectly competitive market. The demand curve for a perfectly competitive firm’s product is a special case. On the right graph, we see that the demand curve faced by an individual competitive firm is a horizontal line at the market price. This means that the firm can sell as much as it wants (or at least a lot more than it is currently producing) at the going market price of $25. This means there is no benefit to lowering the price. If the firm raises its price, the quantity demanded will fall to zero. How is this price determined? We can see on the left graph in Figure 9.4 that the intersection of market supply and market demand determine the equilibrium market price, which is the price that all firms face.

Graphing Question 9.01

9.5 The Decision About How Much to Produce

Think back to our discussion of a firm's short-run cost conditions. A set of cost conditions is shown in Table 9.2 and graphed in Figure 9.5.

Table 9.2: Output, total cost, average cost, and marginal cost for a single sweet corn farmer​.​​


Figure 9.5: Average total cost and marginal cost for a single sweet corn farmer.​​

We now know enough to begin discussing how a firm decides how much to produce. Suppose the market demand curve and the market supply curve presented a price to this sweet corn farmer of $25 per bushel. What should the farmer do?

The answer begins by reminding ourselves about the magic of marginal analysis. Let's ask whether the firm should produce one more unit of output. The  firms’ profit-maximizing decision boils down to deciding how much to produce. And to answer that question, we should compare the marginal benefits gained from that choice to the marginal costs incurred from that same choice.

At a production level of one bushel, producing one more bushel would raise costs by $4 (the marginal cost of the second bushel) and our revenue would increase by $25, the price of the good sold. Our profit would rise by $21 ($25 - $4), and since the objective is to maximize profit, the farmer should produce a second bushel. What about a third, or a fourth bushel? As long as the additional revenue earned from selling the unit is greater than the marginal cost of producing the unit, the farmer should produce it. It is important to remember in perfect competition that the additional revenue received earned from selling another unit of output is simply equal to the market price.

Because of the law of diminishing marginal returns, marginal cost will eventually rise as we expand production. As the firm expands output, we will eventually reach a point where marginal cost will equal the price. We will not want to expand beyond that point. If we produce at output levels where the marginal cost is greater than the price, we will reduce our profits.

In this case, we would see that the farmer would want to keep producing all the way up to 8 bushels. The marginal cost of producing the eighth bushel is $23, but the firm can still sell the corn for $25. He should produce this bushel. However, the marginal cost of producing the ninth bushel is $33. Since he can only sell the corn for $25, he should not produce this bushel.

Question 9.06

Question 9.06

Why is there an upward-sloping marginal cost curve?

Hover here to see the hint for Question 9.06.
Click here to see the answer to Question 9.06.

Drawing Question 9.02

9.6 A New Concept: Marginal Revenue

Total revenue is the total amount received as firms sell their products. It is the number of goods sold per time period times the price received. Marginal revenue is the change in total revenue as a firm sells one more unit of a good or service. If a perfectly competitive firm sells one more unit of a good, its total revenue will change by the price received for that unit.

For a competitive firm, then, marginal revenue is equal to the price. This is because, in perfect competition, the individual firm faces a horizontal demand function and the price of the good does not change if the firm changes output.

Average revenue is simply the average amount received per unit – the total revenue divided by the number of goods sold.

Algebraically, we can express these three revenue concepts as follows:

Where TR is total revenue, P is price, q is the quantity produced by a single firm, MR is marginal revenue, AR is average revenue, and ∆, the Greek letter delta, means “change.” In the general notation describing perfect competition, we often use lowercase q for a single firm’s quantity and capital Q for the market quantity.

Question 9.07

In perfect competition, the demand curve for an individual’s firm product is _________.

A

Downward sloping

B

Relatively elastic

C

Perfectly inelastic

D

Perfectly elastic

Question 9.08

Question 9.08

Assume that a perfectly competitive firm can sell as much of its product as it wants at a market price of $20. Calculate total revenue and average revenue at production levels of 1000 and 1001 and marginal revenue as the firm goes from 1000 to 1001. Describe the relationship between the variables.

Hover here to see the hint for Question 9.08.
Click here to see the answer to Question 9.08.

9.7 Choosing the Profit-Maximizing Output Level

The goal of a firm is to maximize profits. This can be done by choosing the output level where MR = MC. Why does this output level result in profit maximization? When MR > MC, it means the firm can increase profits by producing more. Intuitively, it means that producing (and selling) more units will increase revenue by more than costs increase. Thus, profits go up. If MR < MC, it means that producing and selling more will increase costs more than revenues, so the firm should not operate at these output levels. Thus, as long as marginal costs are below market price, the firm should increase production until MR = MC. Recall from earlier that for a perfectly competitive firm, P = MR. Thus, the perfectly competitive firm can find the output level where P = MC in order to maximize profits.

This is illustrated in the figure below. A perfectly competitive firm’s cost functions (ATC and MC) are shown, as well as different three different market prices, P1, P2, and P3.

Figure 9.6: A competitive firm’s cost functions.​

In Figure 9.6, it is straightforward to find where each price is equal to  marginal cost. It is simply the point at which the marginal cost function intersects the dotted line representing each price. These intersections give us the profit-maximizing quantity for the given price. Thus, in Figure 9.7 below, we can see that, for example, if the market price is P3, the firm will produce quantity q3. We can do the same analysis for prices P2 and P1.

Figure 9.7: Alternative cost options.​

Upon closer inspection, we see that when the firm chooses the output where P = MC, the price will either be above, equal to, or below average total cost at that quantity. We can examine this comparison. If P > ATC, the firm will be making a profit. At price P3, the firm will certainly want to produce and sell output.

But what about price P2? Here, the intersection of P = MC also results in P = ATC. Thus, the firm is breaking even, earning zero economic profits. The firm should still produce at this price. One reason is that if production stops, the firm will still have fixed costs, but zero revenue, and would thus be experiencing losses. We will detail why in the next section.

Perhaps more intriguing yet is price P1. Clearly, at quantity q1, we have P < ATC, and thus the firm is experiencing losses. So is it best if the firm chooses not to produce (thus not having output q1) and producing zero output? Actually, it depends. In this case, we know that prices and revenues are not enough to cover total costs. But we need to examine whether they cover variable costs.

9.8 A Shutdown Decision and Short-run Equilibrium

Figure 9.8: A firm will shut down in the short run and exit the industry in the long run if it cannot generate enough revenue to cover its variable costs.​ [4]​

If a firm is producing an output where marginal cost equals marginal revenue and yet the price is below average cost, the firm is earning a loss. Should it quit producing? The rule is that if the marginal revenue is greater than the average variable cost, the firm would be better off producing than not producing. If the marginal revenue is greater than average variable cost, the firm can still reduce losses by producing more. The additional revenue will cover all marginal costs of production, and the “leftover” revenue can start to pay for the fixed costs. In other words, it is better to pay some of your fixed costs than none of your fixed costs, if possible. Also, recall that fixed costs will exist even if the firm produces zero output in the short run.

Firms still try to do the best they can in terms of profits. If profits are not possible, it’s better to have a small loss than a big loss. Here’s a simple numerical example: Suppose a firm has fixed costs of TFC = $1,200. If the firm can produce output where MR = MC, it can generate total revenues TR = $2,500 but will incur variable costs of TVC = $2,000. If the firm chooses to produce this output level, total costs are TC = $3,200, so the firm will take a $700 loss. However, if the firm chooses not to produce at all, it will incur a loss of $1,200.

A Short-Run Equilibrium

A short-run equilibrium for competitive firms has two conditions:

1. Should the firm produce at all? Firms consider the shut-down point:

   If price < AVC, then the firm should shut down.
   If price > AVC, then the firm should produce.

2. If producing, then how much should the firm produce? The firm produces at the output level where MR = MC.

Both conditions also apply to all firms in all different types of markets.

Question 9.09

Question 9.09

If a firm has fixed costs, why should it stop producing when its marginal revenue is less than its average variable cost?

Hover here to see the hint for Question 9.09.
Click here to see the answer to Question 9.09.

Question 9.10

Consider a perfectly competitive firm. When the market price is greater than both the firm’s marginal cost and average variable cost, the firm ________.

A

Is maximizing profits

B

Should shut down

C

Should increase its level of output

D

Should reduce its level of output


Question 9.11

Calculate the economic losses for Firm 1 if they decide to produce: $____.

question description


Question 9.12

Calculate the economic losses for Firm 1 if they decide not to produce -$____.

question description

Question 9.13

Question 9.13

Should Firm 1 produce? Why or why not?

Hover here to see the hint for Question 9.13.
Click here to see the answer to Question 9.13.

Question 9.14

Calculate the economic losses for Firm 2 if they decide to produce -$____.

question description


Question 9.15

Calculate the economic losses for Firm 2 if they decide not to produce -$____.

question description

Question 9.16 

Question 9.16

Should Firm 2 produce? Why or why not?

Hover here to see the hint for Question 9.16.
Click here to see the answer to Question 9.16.

Question 9.17 

Question 9.17

Why does a Colorado ski resort continue to stay open during the summer? Suppose the costs of a ski resort are as follows:

Fixed costs per month (for 12 months) $1,000,000

Total variable costs per month in winter $4,000,000

Total variable costs per month in summer $50,000

What would revenues per month in the winter season have to be for the resort to rationally stay open during the winter?

What would revenues per month in the summer season have to be for the resort to rationally stay open during the summer?

Now assume the resort is not yet built, so that the potential owner can choose whether to pay these costs, including the fixed costs, by deciding to build the resort or not. If the resort will only do business in the summer, now what would summer revenues have to be for the resort to operate?

Hover here to see the hint for Question 9.17.
Click here to see the answer to Question 9.17.

Question 9.18 

Question 9.18

Why do some summer resort hotels stay open in the winter, even if they are not earning enough revenue to cover all of their costs in the winter? Why do some close?

Hover here to see the hint for Question 9.18.
Click here to see the answer to Question 9.18.

Question 9.19 

Question 9.19

Why is it profitable to operate a run-down hotel with a low cost of maintenance and probably low revenues? Would it not be better to improve the conditions in the hotel and attract more customers?

Hover here to see the hint for Question 9.19.
Click here to see the answer to Question 9.19.

Question 9.20

In the short run, how will an increase in fixed costs affect the output of a typical firm in a competitive market?

A

An increase in output

B

A decrease in output

C

No change in output

D

Cannot tell


Question 9.21

In the short run, how will an increase in demand affect the output of a typical firm in a competitive market?

A

An increase in output

B

A decrease in output

C

No change in output

D

Cannot tell


Question 9.22

In the case of an increase in fixed costs, what will happen to the economic profits of the typical competitive firm? Economic profits will ________.

A

Not change

B

Increase

C

Decrease

D

Cannot tell


Question 9.23

In the case of an increase in demand, what will happen to the economic profits of the typical competitive firm? Economic profits will ________.

A

Not change

B

Increase

C

Decrease

D

Cannot tell

Graphing Question 9.03

9.9 Supply in a Competitive Market

How can we derive the supply curve for an individual firm? We will see that in perfect competition, the supply curve for a single firm is actually the firm’s marginal cost curve above the shutdown point. The figure below helps derive this.

Figure 9.9: Deriving a supply curve for a perfectly competitive firm.​

In Figure 9.9 above, the firm’s short-run cost curves (MC, ATC, AVC) are given. Imagine various prices being given to the firm, starting with P5 and going down to P1. At each price, the firm will look for the quantity at the intersection of P = MC. Thus, at a price of P5, the firm will produce output level q5. This price-quantity combination is represented by the highest dot on the graph. Similarly, at price P4 the firm will produce output level q4, and so on. The exception is that at price P1 there is no q1, since P1 is below the shutdown price located at the minimum of the AVC function. Thus, at price P1, the firm would not produce output. Notice two important things about this analysis. First, the dots are all on the firm’s MC function. Second, the dots represent an upward-sloping relationship between price and quantity produced. This is a supply curve for an individual perfectly competitive firm. Thus, in perfect competition, the firm’s short-run supply curve is just the marginal cost function above the shutdown price.

9.9.1 From the Firm Supply to the Market Supply

If each firm is given a market price and then responds by producing that quantity where price equals its marginal cost, the total amount produced in the market will be each firm's quantity supplied added to every other firm's quantity supplied. The market supply curve then is the horizontal sum of all of the individual firm's supply curves. For example, see Figure 9.9. At a price of $15, each of the firms will produce 5,000. Thus, the quantity supplied in the market at a $15 price is equal to 15,000. At a price of $10, each firm will produce 3,000, and thus the market supply is a total of 9,000 produced. In essence, we are adding the individual supply curves together horizontally. In an actual competitive market, we would be adding many more firm supply curves together.

​​Figure 9.10: A higher demand leads to higher market prices, and individual firms will each produce more output at this higher price. ​

9.10 An Economist’s Look at Profits

Figure 9.11: Accountants and economists have different definitions of “profit.” [5]​

Firms maximize profits. Newspapers and corporations talk of profits as the difference between revenues from the sale of goods and services and costs, and they define costs as how much is paid for the raw materials, rent, labor, interest on loans, and all other payments made by the firm. Those costs are the explicit (or clearly defined) costs . We will label this very common and widely held view of profits as accounting profits.

You can think of explicit costs as occurring when the firm has to write a check and directly pay for something. However, economists always consider opportunity costs as well. For a firm, the opportunity cost includes what could be purchased with the payments for the factors of production in the accounting profit calculation. But it also includes the implicit cost, the profit the owners could earn in alternative businesses. By their involvement in this firm, the owners are giving up profit that could be earned elsewhere. That opportunity cost is a real cost to the owners.

Thus, a better definition of profit is what is called economic profit , meaning revenues minus costs of the factors of production and other inputs and minus the accounting profit that could be earned in another business. The accounting profit that could be earned elsewhere is often simply described as “normal profit.” See Table 9.3. Normal profits are the opportunity cost of capital and other inputs supplied by the owners of a business.

To an economist, if a firm is earning accounting profits just equal to what the average firm earns, it is not actually earning a profit. That is a zero economic profit. Zero economic profit doesn’t mean the firm is in trouble or going bankrupt. It just means that they are earning the same accounting profit in the current business as they could earn elsewhere. They are not doing any better here compared to the next best alternative. To earn positive economic profits, the firm must be earning accounting profits that are greater than what could be earned elsewhere. Normal profits are a good proxy for that opportunity cost. As a quick example, suppose you are earning $50,000 accounting profit in your current laundromat business. If you could also earn $50,000 accounting profit running a yogurt shop, your economic profit in the laundromat is zero. However, if your laundromat accounting profit is $60,000 and your potential yogurt shop accounting profit is $45,000, then your economic profit in the laundromat is $15,000. Running the yogurt shop means you have an economic loss of $15,000 since you could be doing better elsewhere.


Question 9.24

Question 9.24

A campus charity is raising funds for a local homeless shelter. One of the members of the board comes up with an idea to sell bagels on the terrace outside the student center. Would this effort be profitable?

Hover here to see the hint for Question 9.24.
Click here to see the answer to Question 9.24.

Table 9.3: Calculating economic profits.​
Table 9.4: Numerical example showing accounting vs. economic profits.​

Question 9.25 

Question 9.25

Using your own words, explain why economic profit is much more relevant to decision-making in a business than accounting profit. (This is a key understanding. Make sure you can do it.)

Hover here to see the hint for Question 9.25.
Click here to see the answer to Question 9.25.

Question 9.26

Accounting profits at a firm's economic profit break-even point are ________.

A

Positive

B

Negative

C

Zero

D

Equal to the firm’s total revenue


Question 9.27

What are economic profits at a firm’s break-even point?

A

Positive and equal to fixed costs

B

Positive and equal to opportunity costs

C

Negative

D

Zero


Question 9.28

If accounting profits equal $10 million for a firm and the owners could likely earn $7 million in a similar business, the firm’s economic profit is ________.

A

$3 million

B

$7 million

C

$10 million

D

$13 million


Question 9.29

Accountants tell a franchise owner that she earned $30,000 in profits last year. The owner knows that most of her business acquaintances earned at least $70,000 in profits in comparable franchises. Which of the following is true? Her firm earned an economic __________.

A

Profit of $30,000

B

Profit of $100,000

C

Loss of $100,000

D

Loss of $40,000


Question 9.30

Given the following data, calculate profit as an accountant would measure it (give your answer in millions of dollars).

question description


Question 9.31

Given the following data, calculate profit as an economist would measure it $___.

question description


Question 9.32

Select all explicit costs from the list below.

A

Wages

B

Raw materials

C

Revenues

D

Rent

E

Profit earned in similar businesses


Question 9.33

Select all implicit costs from the list below.

A

Wages

B

Raw materials

C

Revenues

D

Rent

E

Profit earned in similar businesses


Question 9.34

Economic profits are ______________ than accounting profits.

A

Always less

B

Always more

C

Sometimes more

D

Sometimes less

Question 9.35

Question 9.35

What are economic losses? Can a firm earn accounting profits and economic losses at the same time? Explain.

Hover here to see the hint for Question 9.35.
Click here to see the answer to Question 9.35.

Question 9.36

Question 9.36

Using your own words and the concepts of accounting and economic profits, explain how you might make a career choice.

Hover here to see the hint for Question 9.36.
Click here to see the answer to Question 9.36.

9.11 Equilibrium in a Competitive Market In the Long Run


Figure 9.12: More people will become Uber or Lyft drivers if it becomes more profitable as a business. [6]​

If firms in an industry are earning economic profits, other firms will enter the industry.

Question 9.37

Question 9.37

Why do new firms enter?

Click here to see the answer to Question 9.37.
Click here to see the answer to Question 9.37.

Characteristics of the long run:

  • No fixed costs
  • All costs are variable
  • Firms can leave or enter

New firms enter in response to economic profits because, by definition, they can earn more in that industry than they can elsewhere. As a new firm enters, one more firm’s supply curve will be added to the market supply. (See Figure 9.13.) The market supply increases by the quantities supplied by each new firm at each possible price. In this case, the new firm adds a quantity of 5 at a price of $15 and a quantity of 3 at a price of $10.

Figure 9.13: Market supply increases (shifts right) when new firms enter the industry. ​

The increases in quantities supplied at the old equilibrium price means that there will be a surplus. Prices will come down to a new equilibrium. As prices begin to fall, each firm will reduce production. This is because, at the old firm production level, price is less than the marginal cost. If economic profits are still earned, even more firms will enter, pushing the price down further. The long-run result will be a price that is equal to the minimum average cost and where there is no economic profit. (See Figure 9.14). Prices will not go below the minimum average cost, because the driving force was a new firm entering the market to earn the economic profits. Once the price equals the minimum average cost, there will be no economic profits and thus no incentive for entry or exit. 

Figure 9.14: Firms entering as a result of positive economic profits. The rightward supply shift pushes prices downward until profits are zero. At that time, firms stop entering the industry.​


Table 9.5: The process to long-run equilibrium.​

Having shown the process to equilibrium, we can examine some scenarios in which product demand or firm costs could change. We will show the short run and long run effects on market production, economic profits, marginal costs, and market prices.

First, let’s consider an increase in demand.

Figure 9.15: Short-run and long-run effects of an increase in demand.​

With an increase in demand, the market price increases from P1 to P2, and firms expand production as economic profits are higher. The market reacts to the increase in demand by producing more. Eventually (in the long run), new firms enter. This is shown by the rightward shift in supply. As new firms enter, prices begin to come back down and we end up with an increased number of firms (an increased market supply) each producing the same amount as the original production. That is, the individual firms go back to producing output q1, but the market output has increased to Q3.

Table 9.6: Short-run and long-run adjustments that occur as a result of a demand increase.​

The changes listed for the long run indicate changes from the short-run levels. For example, firm production increases initially. In the long run, it decreases back to the original amount.

We can now consider how a typical firm (and the market) would react to production cost changes. Let’s first examine a change in fixed costs (assuming marginal costs remain the same).

Figure 9.16: An increase in fixed costs will reduce market supply as firms exit the industry in the long run.​

Higher fixed costs increase average costs, but not marginal costs. Nothing happens in the short run in the market. However, economic profits are reduced, and the typical firm is now earning economic losses. Eventually, some firms will leave, and the market supply is reduced. The price begins to increase, and the economic losses become smaller. That process continues until there are no longer economic losses being earned. The process stops with no economic losses, higher prices, fewer firms, and less being produced in the market. The summary table shows a fall in economic profits in the short run. In the long run, economic profits increase, going from losses back to zero economic profits.

Table 9.7: The market adjustments as a result of an increase in fixed costs.​

Briefly, we can also examine a case in which variable costs change. Suppose marginal and variable costs rise. Firms reduce production. Prices begin to increase as firm and market supply are reduced. With the higher costs, firms are earning economic losses, and eventually begin to exit. The market supply is reduced further. Prices continue to rise and the losses get smaller until there are no economic losses.

Table 9.8: The market adjustments as a result of an increase in variable costs.​

In sum, you can think of it this way. Any change to demand or costs in the short run will allow existing firms to adjust output. In the long run, firm entry and exit will cause the price to adjust back to the long-run equilibrium where economic profits are zero.

Question 9.38

Question 9.38

Explain the process of adjustment in the short and long runs of a fall in demand.

Hover here to see the hint for Question 9.38.
Click here to see the answer to Question 9.38.

Question 9.39

In the short run, how will a decrease in variable costs affect the output of a typical firm in a competitive market?

A

An increase in output

B

A decrease in output

C

No change in output

D

Cannot tell


Question 9.40

The addition of a single firm in a competitive market will cause the market ______________ to ______________.

A

Demand; increase

B

Demand; decrease

C

Supply; increase

D

Supply; decrease

E

Supply and demand; not change

9.12 The Market in the Long Run

9.12.1 The Long-Run Price

Our discussion so far assumes that the cost functions of a firm do not change as the industry expands and contracts. That is, the cost relationships of a firm are not affected by the size of the industry. An industry in which firm costs are not affected in the long run by expansion is labeled a constant cost industry.

However, it actually may be that costs fall or increase as the industry supply expands. For example, as a software industry expands in response to increased demand, two events may happen. The cost of software writers might increase. The increasing demand for inputs causes their prices to increase, which in turn raises costs for software firms. In that case, the costs end up higher (and therefore the price will be higher) compared to before the increase in demand for software. This type of market is described as an increasing cost industry.

The opposite possibility is that as the software industry expands, there may be savings because existing code may be reused and more efficient hardware is designed. Costs might fall, and the long-run result will be lower prices after all of the firm and market adjustments. In this case, the industry is a decreasing cost industry.

Long-run market supply, or the series of combinations of prices and quantities supplied after all the market and firm adjustments, may be upward sloping, horizontal, or even downward sloping – depending upon the nature of costs.

In the short run, demand increases, creating a shortage. Buyers offer higher prices. Businesses increase output in order to increase profits. (Prices are above marginal costs.) Businesses may also increase prices due to higher costs as they expand. And as prices rise, some consumers reduce the amounts they are willing to purchase. This process continues until the quantity demanded equals the quantities supplied in the market – that is, there is no upward pressure on prices and until firms are producing levels of output that are maximizing profits in the short run.

Prices will be above average costs, and thus firms will be earning economic profits. Given this incentive, new firms will enter the market in the long run. As the market supply increases, downward pressure is placed on prices and firms cut back production. The process continues until there are no longer economic profits being earned. There is more produced in the market due to the new firms, but the price has returned to the original minimum average cost.

In the second case, the same process occurs. However, in the long run, costs increase as the industry begins to expand. What this means is that as firms enter the industry, prices fall and costs rise. The long-run equilibrium occurs at a price that is higher than the original minimum average cost.

In both cases, the markets return to long-run equilibriums. The long-run supply curves for the markets are the combinations of prices and quantities supplied. In the case of the constant cost industry, prices return to the original minimum average cost, and thus the long-run supply curve is a horizontal, perfectly elastic supply.

These graphs can get quite complicated. See below for the case of an increasing cost industry.

Figure 9.17: In increasing cost industries, individual firm costs will increase as market supply increases thus bringing the price higher than the original equilibrium.​

When market demand increases, price increases as well. When more firms enter, the market supply begins to shift to the right. However, when this happens in an increasing cost industry, costs of each existing firm start to increase, and the cost curves shift upward. Thus, when new firms enter the market in the long run, the market supply curve doesn’t shift far right enough to bring the price back to the original equilibrium. The new final price is higher. We can draw the long run supply curve (LRS in the graph) for the industry by connecting to the two long-run equilibrium points. With increasing costs, this function is upward sloping. Constant cost, increasing cost, and decreasing cost market graphs are shown below without adding the detail of the individual firm.

Figure 9.18: Constant cost, increasing cost, and decreasing cost industries in the long-run as a result of a demand increase.​

You should be able to work through the steps for a decreasing cost industry and arrive at the correct result.

In the decreasing cost industry, the short-run process is the same. In the long run, as firms enter, output increases, and prices fall. However, what is new is that costs begin to fall due to the economies that accompany the industry expansion. The end result is that because costs fall the industry expansion lasts longer. Prices come down to a level below the original level, and industry output is greater than it would otherwise be as more firms enter.

Question 9.41

Assume that competitive firms and a competitive market are in long-run equilibrium. In the short run, what will be the effects of an increase in fixed costs on the output of a typical firm in a competitive market?

A

An increase in output

B

A decrease in output

C

No change in output

D

Cannot tell


Question 9.42

Assume that competitive firms and a competitive market are in long-run equilibrium. What will happen in the long run if fixed costs increase? Firms will ______________ because economic profits have ______________.

A

Enter; decreased

B

Enter; increased

C

Exit; decreased

D

Exit; increased


Question 9.43

Assume that competitive firms and a competitive market are in long-run equilibrium. Assume a constant cost industry. In the short-run, an increase in demand will cause firm output to ______________ and the market price to ______________.

A

Increase; increase

B

Remain the same; increase

C

Remain the same; remain the same

D

Increase; remain the same


Question 9.44

Assume that competitive firms and a competitive market are in long-run equilibrium. What will happen in the long run in that same constant cost industry? Prices will ______________ and the market output will ______________ when compared to the levels prior to the increase in demand.

A

Have increased; have increased

B

Remain the same; remain the same

C

Have increased; remain the same

D

Remain the same; have increased


Question 9.45

Assume that competitive firms and a competitive market are in long-run equilibrium. In the short run, what will be the effects of an increase in variable costs on the output of a typical firm in a competitive market?

A

An increase in output

B

A decrease in output

C

No change in output

D

Cannot tell


Question 9.46

Assume that competitive firms and a competitive market are in long-run equilibrium. What will happen in the long run as a result of that increase in variable costs in the previous question? Firms will ______________ because profits have ______________.

A

Enter; decreased

B

Enter; increased

C

Exit; decreased

D

Exit; increased

9.12.2 Economic Efficiency 

Figure 9.19: Producers of products in a supermarket are in constant competition with one another to try and get consumers to purchase their products. [7]​

Perfectly competitive firms will, in the long run, be producing at levels of output where average costs are a minimum. The reasoning is that entry and exit change market prices, which in turn change the levels of output of the firms, eventually to output levels where average cost is as low as possible. The market price will also be pushed toward the minimum of the average cost, which forces each individual firm to minimize their costs.

If one firm does not identify the lowest possible costs, its average cost will be above the price. The firm will eventually be earning economic losses and leave the industry. In the long run, only the most efficient and lowest cost firms survive, and the perfectly competitive market will create a technically efficient and allocatively efficient outcome.

In thinking through allocative efficiency, there are several steps. First, if consumers are maximizing satisfaction, they are consuming amounts where the marginal utility per dollar spent on each good and service is equal to that of every other good and service.

Second, perfectly competitive firms are producing levels of output where marginal costs are equal to price. Profit incentives are the encouragement to do so.

Third, from society’s viewpoint, this outcome guarantees an allocatively efficient level of output. We cannot produce any other amount of output that will make us better off. The reason? Given that the marginal cost equals the price of a good, the marginal utility per dollar of resources used to produce a good is equal to its opportunity cost – the marginal utility per dollar of resources used to produce other goods or services.

Intuitively, allocative efficiency means there is “just the right amount” of the good being produced and traded when considering societal costs and benefits. In terms of our supply and demand framework, it means we efficiently get to the price in which quantity supplied equals quantity demanded in a competitive equilibrium, and gains from trade are maximized. This implies that any deviation from this price and quantity will result in lower economic welfare in the market.

Question 9.47

Question 9.47

You should by now be able to explain why an equality of marginal utility per dollar of marginal cost is allocatively efficient. Use our marginal analysis approach to do it.

Click here to see the answer to Question 9.47.
Click here to see the answer to Question 9.47.

9.13 Summary

  • Perfectly competitive firms will attempt to maximize profits.
  • In so doing, the firms will respond to changes in costs and prices in the market.
  • Individual firms in a perfectly competitive market will produce where marginal cost equals price and may or may not earn economic profits in the short run.
  • A short-run closure may happen if prices fall below average variable cost.
  • In the long run, the entry and exit of firms guarantees that economic profits will go toward zero.
  •  Perfectly competitive markets respond with increased production to increases in demand and decreased production when demand falls.
  • When costs of production increase, market prices increase. When costs fall, market prices fall.
  • In the long run, changes in demand can result in increases, decreases, or no change in market prices. 
  • Perfectly competitive markets will tend to result in allocatively and technically efficient prices and quantities. 

9.14 Key Concepts

Characteristics of perfect competition
  Large numbers of buyers and sellers
  Homogeneous products
  Perfect knowledge
  Easy exit and entry

Market and firm demand
Economic profits
Profit maximization
Price = marginal cost
Market and firm supply
Market equilibrium
Zero economic profits in the long run
Shutdown point
Constant, increasing, decreasing industry costs
Shapes of supply curves.
Economic efficiency.
  Technical Efficiency
          Allocative Efficiency
Marginal cost equals marginal benefit.
Prices allocate resources and answer questions of what, how, and for whom.

9.15 Glossary

Accounting profit: Total revenue minus explicit costs. Accounting profit that could be earned elsewhere is not counted as a cost.

Average revenue: Total revenue divided by the quantity sold.

Economic profits: Accounting profits minus normal profits.

Entry Barriers: Any impediment that makes entry into a market difficult or impossible for new firms.

Firm supply: A firm's quantity supplied at each price level.

Long-run market supply: The quantity supplied at each price, after firms are given time to vary all inputs and to enter and exit the industry.

Marginal revenue: The change in total revenue resulting from the sale of one more unit.

Market supply: The sum of all of the individual firms' quantities supplied at each price.

Perfectly competitive markets: A market with many buyers and sellers, with each seller offering the same good or service. Consumers and producers are aware of quality of inputs and goods and prices. Firms can easily enter and exit the industry.

Price-taker: A firm "takes" the price that is given it by the market supply and demand conditions. The firm can do nothing to change that price.

Total revenue: The number of goods sold multiplied by the price at which they are sold.





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Answer Keys:

Answer to Question 9.01

Some possible answers could include farming commodities, stock markets, or fishing boats all catching and selling the same fish at a market.

Click here to return to Question 9.01.













Answer to Question 9.06

The firm experiences diminishing marginal product in the short run. With lower marginal product comes higher marginal costs.

Click here to return to Question 9.06.














Answer to Question 9.08

At production of 1000: 

Average revenue = $20,000 / 1000 = $20

At production of 1001:


Thus ($20 x 1001) – ($20 x 1000) = $20,020 - $20,000 = $20.

For a perfectly competitive firm, average revenue = marginal revenue = price. This results from the fact that the firm can sell however much it desires at the going market price. Thus, on average, it receives the market price for its product. And if it produces one more unit, it will receive the market price for the extra unit as well.

Click here to return to Question 9.08.





Answer to Question 9.09

If the income from producing a good is greater than the additional cost of producing when compared with not producing, the firm is better off producing. But if the firm adds to losses by producing when the extra revenue from each unit is less than the additional cost from that unit, the firm should not produce at all. Let's look at some examples.

Click here to return to Question 9.09.













Answer to Question 9.13

Firm 1 should not produce; it is better off by stopping production and only losing $10 rather than $15.

Click here to return to Question 9.13.














Answer to Question 9.16

Firm 2 should produce. The conclusion that should be reached is that if the price is greater than average variable cost, losses will be less when the firm produces; more when it does not.

Click here to return to Question 9.16.














Answer to Question 9.17

The firm would have to earn revenues of at least $50,000 per month in the summer. If it earns $60,000, it makes sense to stay open. If it closes, the resort will lose $1 million per month. If it opens during the summer, it will lose $990,000 during those summer months. It is better to stay open.

In the winter, it must earn revenues at least $4 million per month in order for it to make sense to stay open.

If the resort were to open only in the summer and, assuming the same total costs, the resort would have to have revenues over the summer of at least $12 million to cover the former fixed costs, plus additional revenue of $50,000 per month.

Click here to return to Question 9.17.










Answer to Question 9.18

The point is made above. As long as variable costs can be covered, the owners will earn something to help reduce the fixed costs from the rest of the year.

Click here to return to Question 9.18.














Answer to Question 9.19

To fix up the hotel will cost something. A comparison of that improvement cost with the increase in revenues from the higher room rates will give the answer. If the room rates do not increase sufficiently to cover the repair and improvement costs, then it makes no sense to improve the run-down hotel.

Click here to return to Question 9.19.













Answer to Question 9.24

In answering the question, costs of the bagels and any other inputs should be considered and subtracted from the revenues. That provides a measure of accounting profits. However, the real question that needs to be asked next is, what could the students have done with their time? If they could have earned even more for the charity by holding a fundraising drive, then that amount really needs to be subtracted from the accounting profits to get a measure of the true profits – that is, the economic profits.

Click here to return to Question 9.24.














Answer to Question 9.25

A possible answer: A business that earns an accounting profit has revenues that are greater than the costs than it must explicitly pay now or in the future. However, that does not mean that it is earning an actual profit. It may be able to earn even larger accounting profits in another similar business. If it can, then those larger accounting profits that it could earn elsewhere are actual costs. Thus, it is giving up its explicit costs plus a large implicit cost (the profits it could earn elsewhere), which together are greater than its revenues. It is losing in very real terms. If the business used the concept of economic profits, then it should decide to leave its current business.

Click here to return to Question 9.25.











Answer to Question 9.35

Earning economic losses means that a firm is earning less than normal profits. Thus, if most firms earn a profit of 15 percent of sales and this particular firm is earning 5 percent, it is earning an accounting profit of 5 percent and an economic loss of 10 percent. That is, it is earning 10 percent less than it could earn if it were a typical business.

Click here to return to Question 9.35.













Answer to Question 9.36

Using the concept of economic profit is, in essence, just considering opportunity cost. An analogy would be that a first job (that pays $25,000) may seem to be a good opportunity. But, if the alternative is a position you would enjoy just as much but would pay $30,000, you would be losing income by choosing the job with the lesser pay. You would be earning an “economic loss” of $5,000 and an "accounting profit" of $25,000.

Click here to return to Question 9.36.












Answer to Question 9.37

New firms will enter if there are profit opportunities. More specifically, if the industry is earning positive economic profits, new firms will enter.

Click here to return to Question 9.37.














Answer to Question 9.38

If demand decreases, the market price will fall and the marginal cost at each level of output will be greater than the price. The average cost at each output level will also be greater than the price. The firm will begin to cut back. Market price and quantity will be less than the original price and quantity. Because economic losses are being earned, firms in the long run will begin to leave. Market supply decreases. Prices begin to increase. The process continues until the market price is equal to the original price, assuming a constant cost industry. No economic losses will be earned. But the quantity in the market will be less, as there are fewer firms in the market.

Click here to return to Question 9.38.











Answer to Question 9.47

The equality is necessary if the economy is producing goods and services that will make us as well off as possible. If this were not true, one dollar’s worth of resources could be removed from the production of the good with the lowest marginal utility per dollar of marginal cost. If that dollar’s worth of resources is used to produce that other good, an increase in total satisfaction will occur. Thus, a reallocation would make us better off. (The actual switching also changes the marginal utilities and likely the marginal costs and brings the ratios into equality.)

Click here to return to Question 9.47.












Image Credits

[1] Image courtesy of Max Pixel under CC0 Public Domain.

[2] Image courtesy of skeeze under CC0 Public Domain

[3] Image courtesy of Neolux in the Public Domain.

[4] Image courtesy of Degrootelulu under CC BY-SA 4.0.

[5] Image courtesy of Meditations under CC0 Public Domain

[6] Image courtesy of Alexander Torrenegra under CC BY 2.0.

[7] Image courtesy of Iyzadanger under CC BY-SA 2.0.

Barriers to Entry. Any impediment that makes it difficult or impossible for a new firm to enter and compete in a market.
A perfectly competitive market has many buyers and sellers all producing the same product. Consumers and producers are aware of quality and prices. Firms can easily enter and exit the industry.
Think of all the assumed characteristics of competitive markets.
Profit maximization. We assume that competitive firms have the maximization of profits as their only goal, or at least that they act as that is their only goal.
A firm "takes" the price that is given by the market supply and demand conditions. The firm can do nothing to change that price.
The cost curve shape is related to productivity of inputs.
The number of goods sold times the price at which they are sold
The change in total revenue resulting from the sale of one more unit
Total revenue divided by the quantity sold
Use your TR equation.
Think about equations used to find profits.
You must consider revenues and costs at the chosen output level for the firm.
You must consider revenues and costs at the chosen output level for the firm.
Remember that fixed costs are there no matter if the resort is open or closed. The decision to stay open depends on if the firm can cover variable expenses.
This is similar to the above question. What expenses can the firm cover in the off season?
Think about added expenses and added revenues associated with fixing up the building.
The cost that a business pays by writing a check or paying cash.
Total revenues minus explicit costs.
The cost that a business bears by being in its business and not in another business. It is the profit that could be earned elsewhere. It is the opportunity cost.
Total revenues minus all costs, including explicit and implicit costs. Economic profit equals accounting profit minus normal profit (the accounting profit foregone).
Think about profits.
We want to consider other alternatives for investment!
How are profits and losses calculated?
Think of yourself as wanting to maximize economic profits among alternative careers.
Think about the incentives and goals of a firm.
In the short run, existing firms can change their levels of output. In the long run, firm entry and exit is allowed.
As the industry expands, prices of inputs do not change
As the industry expands, prices of inputs increase
As the industry expands, prices of inputs decrease
Technical Efficiency
Average costs, at every possible level of output, are at minimums. That is the firm would minimize average cost for its current level of output. The second part of technical efficiency is that the firm is producing a level of output that results in the minimum of all of those possible average costs.
Allocative Efficiency
The levels of production of goods and services are such that a change in those levels will make consumers worse off, not better off.
Think about opportunity costs of production and consumer valuation of goods.