Principles of economics openstax chapter8

CHARACTERISTICS OF PERFECT COMPETITIONA large number of firms in the market such that no one can influence the price The firm sells a good identical to those sold by other firms Firms ha

COLLEGE PHYSICS

Chapter # Chapter Title

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PRINCIPLES OF ECONOMICS

Chapter 8 Perfect Competition

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FAMILY FARMING

Depending upon the competition and prices offered,

a wheat farmer may choose to grow a different crop

CHARACTERISTICS OF PERFECT COMPETITION

A large number of firms in the market such

that no one can influence the price

The firm sells a good identical to those sold

by other firms

Firms have reliable sales and cost forecasts There is no legal or economic barrier to enter into or exit from the market

FIRM’S OBJECTIVE

Profit maximization – To make the largest amount of profit possible

Total Revenue = Price*Quantity

Total Cost = Average Cost*Quantity

Total Profit = TR - TC

FIRM’S OBJECTIVE

Total revenue for a perfectly competitive firm is

a straight line sloping up The slope is equal to the price of the good

Total cost also slopes up, but with some

curvature At higher levels of output, total cost begins to slope upward more steeply because

of diminishing marginal returns

The maximum profit will occur at the quantity

where the gap of total revenue over total cost is largest

PROFIT MAXIMIZATION

MARGINAL REVENUE-MARGINAL COST

RULE

MR is a horizontal straight line because it is

equal to the price of the good, which is

determined by the market

MC is U-shaped: division of labor causing MC to fall, but diminishing return forcing MC to rise

Profit maximization requires MR = MC

Since P = MR, then P = MC

FIGURE 8.3

MARKET EQUILIBRIUM

The equilibrium price of raspberries is determined through the interaction of market supply and market demand at

$4.00.

FIRM’S PROFITABILITY

In panel (a), P = MC, but P > AC Thus TR > TC and firm makes profit

In panel (b), P = MC, and P = AC Thus TR = TC and firm breaks even

In panel (c), P = MC, but P < AC Thus TR < TC and firm operates with a loss

FIRM’S PROFITABILITY

FIRM’S OPERATION DECISION

In panel (a), P = MC, but AVC < P < AC Firm

operates with a loss < TFC It continues to

operate, expecting price to rise

In panel (b), P = MC, but P < AVC Firm operates with a loss > TFC It must shut-down

FIRM’S OPERATION DECISION

FIRM’S OPERATION DECISION

Break-even point:

P = MC and P = AC Firm operates with zero

profit since TR = TC

Shut-down point:

P = MC, but P = AVC Firm operates with a loss

= TFC It stays open if expects price to rise

FIRM’S OPERATION DECISION

CHANGING MARKET CONDITIONS

In panel (a), Increase in demand = Increase in supply: quantity increases, but price stays the same

In panel (b), Increase in demand > Increase in supply: quantity increases and price rises

In panel (c), Increase in demand < Increase in supply: quantity increases, but price falls

CHANGING MARKET CONDITIONS