Perfect Competition Chapter 11

Profit Maximization Economic profit is total revenue less total costs which consist of implicit and explicit costs. Economic profit differs from accounting profit in that accounting profit does not consider implicit costs.

Normal profit is the opportunity cost of the resources owned by the firm

Assumption of profit maximization

What is a perfectly competitive firm? A firm with the following attributes: Standardized product A price taker Factors of production are mobile in the long-run The firm and consumers have perfect information

2 assumptions about short-run production Number of firms is fixed Each firm has some fixed inputs

Profit maximization in the short-run We ask the question: How does a firm choose a level of output in the short-run with the objective of maximizing profit?

Compare total revenue and total cost Compare marginal revenue and marginal cost

Where is the short-run supply curve? It is represented by the upward sloping section of the marginal cost curve beginning where AVC = MC.

Short-run industry supply The horizontal aggregate of individual firm supply curves.

The short-run competitive equilibrium How is price determined in the short-run?

Is the short-run competitive equilibrium efficient? A competitive equilibrium is allocatively efficient when there is no room for further mutually beneficial exchange.

Producer Surplus A measure of “how much better off a firm is as a result of having supplied its profit maximizing level of output”.

Perfect Competition in the long-run Firms may enter and leave the industry. Firms may change their scale of production by changing all inputs. Firms earning a loss will shut down.

Adjustment process from short-run to long-run How long will it take? Depends on Degree that firms are identical in technology, cost structure, and efficiency. How long does it take to adjust capital stock? How long does it take for new firms to enter?

Socially desirable properties of the long-run outcome P=MC in short-run and long-run Allocative efficiency Mutual gains to buyers and sellers are maximized. All firms earn an economic profit of zero Buyers do not pay more than what it costs the firms to produce.

There is no such thing as a free market The market is not costless

The long-run market supply curve Varies depending on cost conditions 3 cases All firms have identical LAC curves All firms have horizontal LAC curves Changing input prices

Price elasticity of supply A measure of responsiveness of quantity supplied to changes in prices