M Economics Ch8

Chapter 8 Questions and Problems targeting the exam. Questions: 1, 4 Problems: 1

Q1: What are main characteristics of perfectly competitive

market that cause buyers and sellers to be price taker? Explain

The atomistic size and limited financial resources of the competitive firm militate against its acquisition of any special managerial or technical expertise; firms are unable successfully to differentiate their products, and no firm can attain any position of market dominance. Beside that the common knowledge of changing market conditions, all participants in the market become aware of such changes simultaneously, and all ad ust at approximately the same rates. !o, a common price likely emerges in the market, and no market participant finds incentive to try to charge any price higher or lower than the market price.

Explain !hy the demand curve facin" a perfectly competitive firm is assumed to be perfectly elastic? (i.e., horizontal at the going market price
Q :

"emand curve is the graphical representation for the relationship between the #rice and demanded $uantity. %n perfect competition markets there are unlimited number of firms, each firm has no market power, therefore it is a price taker, and this price is determined according to market supply and demand.
P P %

!emand Cur"e o# the per#ectl$ competiti"e P1 #irm

P1

! Q Q

Therefore, any producer &or any consumer' can sell &or buy' any quantity of the product at the same price; so the price is constant and equal to marginal revenue and average revenue.

#roblem1:

$ollo!in" is the "raphical representation of short%run situation faced by a perfectly competitive firm& 's this a "ood market for this firm to be in? Explain& What do you expect !ill happen in the lon" run? Explain&

(C *&C P & ! &C &'C P

! *Q

Short Run Analysis:

%n perfect competition market each firms is a price taker, and this price is determined according to market supply and demand. (rom the graph above we notice that) The firm studies the quantity of its production to continue in this market. This quantity is determined when)
o *arginal +ost , *arginal -evenue, and o *arginal +ost is increasing

%n this point the resulted profit. loss is determined by comparing #rice &/verage -evenue' with average cost &/+'. (rom the graph we notice that /verage +ost &/+' is more than /verage -evenue &#rice'; therefore the result is losses for the firm.

This loss is equal to the area &/+0 " / #'

(rom the previous analysis we find that this is a bad market for this firm at the short1run.

2owever, the firm may continue to produce in this market at the short1run because /verage -evenue is more than /verage 3ariable +ost &/3+', which means that the firm will cover part of fixed cost. 4n the other hand, in case the firm preferred to stop production at short1 run, it will pay for all fixed costs.

Long Run Analysis:

The firm may be able to produce in such market at short1run, and bear losses hoping that it will recover in long run.

2owever, in perfectly competitive market, in which the firm is price taker and the price is constant, the firm will not be able to face the market with its current cost pattern.

Therefore, unless the firm will be able to ad ust its cost function to achieve profit margin, it is better for the firm to leave market in long run.