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Topic V: Perfect Competition
Microeconomics 202
49
Economics
Undergraduate 2
04/01/2013

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Term
Market Structure characteristics
Definition
-special emphasis placed on firms' level of competition present in that market
Term
Level of competition relates to:
Definition
-# of firms
-similarity/difference of firms' products
-ease of market entry/exit
Term
Market Structure model
Definition
-perfect competition (most competitive)
-monopolistic competition
-oligopoly
-monopoly (least competitive)
Term
Characteristics of Perfect Competition
Definition
-very large # of independent sellers
-homogeneous product
-easy market entry/exit
Term
an example of perfect competition
Definition
Corn farmers all sell the same product (buyers don't really prefer a certain brand over the other)
Term
Characteristics of Monopolistic Competition
Definition
-large # of independent sellers
-differentiated product
-relatively easy market entry/exit
Term
an example of monopolistic competition
Definition
gas retailers, clothing brands, etc.
Term
Characteristics of an Oligopoly
Definition
-few firms (may be independent or interdependent)
-homogeneous or differentiated product
-difficult market entry/exit
Term
an example of oligopoly
Definition
homogeneous product: aluminum/steel
differentiated product: car dealerships
Term
Characteristics of a Monopoly
Definition
-one seller
-unique product (no close substitutes)
-absolute barrier to entry (no new firms may enter market)
Term
an example of a monopoly
Definition
-landline telephone service/water service in a town
Term
How does perfect competition arise?
Definition
-minimum efficient scale at a low output level
-homogeneous product (buyers don't care about the brand)
Term
Price Taker
Definition
a firm that cannot influence the price of the good/service it produces
Term
how are perfectly competitive firms price takers?
Definition
the individual perf. comp. firm is so small relative to the market and the product is identical to every other firm's product (this makes it a price taker)
Term
Implication of Price-Taking in the Perf. Comp. Market
Definition
-individual sellers have no control over product price (price is set by market)
-arbitrage forces price to/near equality in all market segments
-For individual sellers, price is constant for all output levels, so demand is perceived as perfectly elastic to the perf. comp. seller
Term
Marginal Revenue
Definition
the increase in total revenue generated by the production and sale of an additional unit of output
Term
Marginal Revenue (MR) formula
Definition
MR= (change in Total Revenues)/ (change in quantity)

or MR= P*Q
Term
Pricing Policy of the Perfectly Competitive Firm
Definition
-must sell (or choose not to sell) its output at the market price
-price is constant for all levels

MR=P for perf. comp. seller
Term
Arbitrage:
Definition
buying a good in a market where the product is low and reselling it in a market where its price is higher
Term
The firm's output decision
Definition
(in the short run) the firm operates at an output level where profits are maximized or losses are minimized

Profits= TR - TC
or Profits= TR - (FC+VC)

if the firm shuts down, losses= FC
Term
The firm will shut down (set output level to 0) when...
Definition
at all nonzero output levels, TR falls short of VC

TR
Term
The firm will increase profits by increasing output as long as...
Definition
MR>MC
Term
The firm will stop increasing output when...
Definition
MR=MC
(it will only move into the output range where MR
Term
The firm maximizes profits/minimizes losses at...
Definition
MR=MC

or P=MC (since P=MR for perf. comp. firm)
Term
The firm will continue to operate in the short run when...
Definition
TR>TC
Term
Revenue per unit of output equals...
Definition
TR/Q = P
Term
Variable cost per unit of output equals...
Definition
VC/Q =AVC
Term
The perf. comp. firm will continue to operate in the short run as long as...
Definition
P>AVC (the firm will shut down inf P
Term
the perf. comp. firm will max profits/min losses at the output level where...
Definition
P=MC (as long as P>AVC)
Term
How does a perf. comp. firm earn profit at points of the graph?
Definition
when P>ATC (when P
Term
When will a firm shut down in a perf. comp. market?
Definition
when P
Term
The Perf. Comp. Firm's Short-run Supply Curve
Definition
-produces at output level where P=MC, as long as P>AVC so that its supply curve = its MC curve for prices >AVC

(the MC curve slopes upward because of the law of diminishing returns)
Term
Why does the perf. comp. market supply curve slope upward?
Definition
because of the law of decreasing returns

-the supply curve is obtained by adding the MC curves of all the firms in that market
Term
Conditions for short-run equilibrium
Definition
-no tendency for market price to change, so quantity demanded=quantity supplied
-the firm should have no reason to change its output level, so the firm operates at the output level where P=MC when P>AVC
Term
Conditions for Long-run Equilibrium
Definition
-quantity demanded=quantity supplied at the market price
-the firm operates at the output level where P=MC (and P>AVC)
-the # of firms in the market should be stable (no tendency for firms to enter/exit market) so the typical firm earns zero economic profits (P=ATC)
Term
Constant Cost Industry:
Definition
an industry in which production costs remain constant as output expands in the long-run
Term
Adjustments to an Increase in Market Demand in the short run
Definition
-market price increases
-the typical firm's output level increases
-the typical firm's profit level increases
Term
Adjustment to an increase in market demand in the long run
Definition
-economic profits attract additional firms into the market
-market supply increases
-price declines to the point where economic profits are eliminated
Term
Long Run Supply Curve
Definition
a curve that connects points of long-run equilibrium in a perfectly competitive market
Term
The LRS curve for a constant cost industry
Definition
perfectly elastic (horizontal)
Term
Increasing cost industry
Definition
industry in which costs increase as output expands in the long run
Term
Adjustment to an increase in market demand (Increasing Cost Industry) in the short run
Definition
-market price increases
-the firm's output level and profits increase
Term
Adjustment to an increase in market demand (Increasing Cost Industry) in the long run
Definition
-economic profits attract new firms into the market
-market supply increases
-price declines and ATC rises to the point where economic profits are eliminated
-the long run equilibrium price lies above the original equilibrium price
Term
LRS curve for increasing cost industry
Definition
slopes upward
Term
Decreasing cost industry
Definition
an industry in which production costs decrease as output increases in the long run
Term
Adjustment to an increase in market demand (Decreasing Cost Industry) in the short run
Definition
-market price increases
-the firm's output level and the profit level increases
Term
Adjustment to an increase in market demand (Decreasing Cost Industry) in the short run
Definition
-economic profits attract new firms in the market
-market supply increases
-price declines and ATC falls to the point where economic profits are eliminated
-the new long-run equilibrium price lies below the original equilibrium price
Term
LRS curve- decreasing cost industry
Definition
curve slopes downward
Term
The things that make perfect competition "perfect"
Definition
-production efficiency: the perfectly competitive firm operates at the minimum point on its ATC curve at long-run equilibrium
-Allocative efficiency: the perfectly competitive firm maximizes profits/minimizes losses by producing at the output level where P=MC
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