Week 9: Perfect Combination
Markets and the Nature of Competition
Competitive market
Individual suppliers don't have a lot of market power
Imperfect Markets
Individual suppliers have market powers
Many buyers and sellers
Similar (if not identical) goods
Free entry and exit
Firms are price takers
Decide price
Deciding how much to produce
Profit Maximizing Rule: A firm will expand output until marginal revenue (MR) is equal to marginal cost (MC)
MR = MC is the rule for stopping production
PMR as a price taker:
At point b MR = MC. In this point output would be 40 and price would be 10.
Point A is Average Total Cost when 40 units are produced. The green rectangle between point A and point B is profit
When MR is bigger than MC we should increase output until we reach the optimal quantity where MR = MC, in this case 40 or q
When MR is Lower than MC we should decrease output until it reaches q
Short Run Shutdown
Would you continue to operate incurring a loss?
Th firm should shut down if marginal revenue is not being able to cover AVC, ir if its located in the red area of the graph
this is because if the firm closes it firm shuts dont it will still need to pay fixed costs in full. therefore selling at a loss but still covering the AVC is better (ambar zone in graph)
In short run we will operate to minimize losses
Long Run Shutdown
In the long run we simply operate if we are profitable, if not we shutdown
Sunk Costs
Costs that have been incurred as a result of past decisions
Are unrecoverable
Sunk Cost Fallacy
Considering sunk costs when taking a new decision at the Margin
Can lead to using out of date facilities and incurring large opportunity costs
Is this gonna be beneficial in the future?
Entry and Exit
Profits are a signal for firms to enter or exit a market in the long run
Long Run Market Supply
Supply curve in a highly competitive market will be perfectly elastic in the long run
Thi is because as profit gets higher, more firms join market, with will create more demand, a need to lower prices and profits to fall
Likewise, If profits drop and market is not lucrative anymore firms leave market, leading to less competition and prices to higher
This creates a balance
Short and Long run Adjustment to Demand Increase
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