Chapter14+JDEM

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=Introduction...= ==== //In Microeconomics, markets are categorized in to 4 divisions. Monopoly, Monopolistic Competition, Perfectly Competitive, and Oligapoly. Using theoretical graph models, economists are able to predict the future behaviors of each firms in different markets. This chapter is about one of the 4 markets, Perfectly Competitive market. We will look deeply in to behaviors of firms in short run and long run.// ====

=// Perfectly Competitive Market //=

There are few characteristics of a perfectly competitive market. 1. Each seller and buyer has no control over price. 2. Perfect Knowledge. 3. Homogeneous Products. 4. Firms freely enter and freely exit the market.

The first characteristic simply means that, in a competitive market, the market and the firms are all price takers according to the supply and demand curves. One person, or one firm does not have any power over price control. They are both "Price takers". The second characteristic means that in a theoretical model of the competitive market, economists assume perfect knowledge. Perfect knowledge means that all producers and consumers are familiar with what is happening in the market. (Example: which super market sells chocolate pies for lowest price) Based on this assumption, economists can consider the supply and demand curve of the idealistic model to be right. The third characteristic means that the in the same market, many different firms compete with homogeneous products. The meaning of this characteristic is quite straight forward. Fourth characteristic is very important as this strongly alters the firms in the long run in a perfectly competitive market. It means that firms are free to come in or exit the market. (Example: If some firm is making profit off of certain product, other firms will enter the market of same product to earn profit.)

=// Profit Maximization //= There is only one thing that you have to memorize for profit maximization. MR=MC. Any firm would try to make the most profit, therefore will sell at the point where the marginal cost and marginal revenue meets. MR=MC (For firms in competitive market, Price is average revenue and also marginal revenue. The price does not change accordingly to the quantity produced.)

This same rule applies to other markets as well, so memorize this.

- If MC is greater than MR, the firm should decrease the production of its product**
 * - If MR is greater than MC, the firm should increase the production of its product

Considering this, the firms will make decisions to maximize their profit. (As we learned in the past, we assume that all firms try their best to get the highest profit. This is according to Adam Smith's invisible hand. "Everyone in the market works their best for their personal interests and goals, therefore market works efficiently."

=// Firms Shut down in Short Run //= Sometimes, it is more beneficial for the firm to shut down and pay the fixed cost than to keep the business in to place. Firms Shut down when: TR < VC TR/Q < VC/Q P<AVC

These three equations are the same, just written differently. The firms should shut down when they are put in to situations such as those three equations.

=// Firms exit in the long run //= The situations are same for the firms in the long run. There is only one difference. In the short run, they consider the fixed cost and states shut down if P<AVC. However, in the long run, the time span is so long that fixed costs are negligible. The equations change for when firms should exit in the long run. Firms exit when: TR<TC TR/Q<TC/Q P<ATC

The equations are same except that AVC turned in to ATC. After fixed cost becoming negligible, Average Variable Cost includes the fixed costs turning in to Average Total Cost.

=// Why do firms in a competitive market end up with zero profit in the long run? //=

As stated earlier, this has to do with perfect knowledge and many firm's freedom to enter and exit the market.

Here is an example of PC firm in a competitive market (short run, which means at this point, this firm is making profits)



At this point (short run), the firm is still making profits. However, as we assume perfect knowledge, producers from other market hears about the profit making in PC market. Eventually, other firms will enter the PC market shifting the supply curve to the right side. As a result, the price is moved down. The price will be moved down till it hits the average total cost in the long run. At that exact point, other firms stop entering the market knowing that it is not profitable to join the market at that point. (Remember that in long run, people exit the market when P < ATC)



The firms are left with no profit in the market. Zero profit equilibrium is reached.

=Profit= Profit can always be calculated by the ultimate equation of:

Profit = (Price - Average Total Cost) x Quantity

=// Sunk Cost //=

Sunk costs are simply costs that are already committed and it is hard to be recovered.



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=// Glossary //= Perfect Knowledge: Assumption that every buyer and seller in the market knows what is going on in the market. Price takers: Ones taking the price of the product without having any control over the price. Competitive market: a market with many buyers and sellers trading identical products so that each buyer and seller is a price taker. Average Revenue: total revenue divided by the quantity sold. Marginal Revenue: the change in total revenue from an additional unit sold. Sunk Cost: A cost that has already been committed and can't be recovered.

=**Conclusion!**= As we learned about the perfectly competitive market, the students will get the hang of how firms behave accordingly to certain characteristics explained above. After knowing why firms enter and exit the market of certain product, it may sound logical now. Try not to memorize the rules, but understand the concepts and these theoretical models and assumptions will seem very logical and reasonable to you. After all, economics is based on many big assumptions.

1. When do firms shut down? a. TR < VC b. TR/Q > VC/Q c. P < ATC d. TR = MR

2. What is not a characteristic of a competitive market? a. Each seller and buyer has no control over price. b. Perfect Knowledge. c. Heterogeneous Products. d. Firms freely enter and freely exit the market.

3. When do firms exit? a. TR<TC b. TR/Q = TC/Q c. P< AVC d. AR = P

4. What is a sunk cost? a. A Cost that is forgotten by the market. b. A cost that has already been committed and can't be recovered. c. A cost that can re recovered by increasing supply. d. A cost that has been committed but can be recovered

5. Which statement is true a. If MR is greater than MC, the firm should increase the production of its product b. If MC is less than MR, the firm should increase the production of its product c. If MR is less than MC, the firm should increase the production of its product d. If ATV is greater than MR, the firm should decrease the production of its product

http://www.s-cool.co.uk/alevel/economics/market-structure-1/short-run-and-long-run-equilibrium.html

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