Economics: Important Questions

Topics: Economics, Perfect competition, Monopoly Pages: 7 (2128 words) Published: April 11, 2013

-What is a market? Definition.
A market is a reconciliation of quantity decisions of buyers and sellers through price adjustments.

-Define supply and demand.
Supply is the quantity of a good sellers wish to sell at each possible price. Demand is the quantity that buyers wish to purchase at each conceivable price.

-Equilibrium price is the price at which the quantity supplied equals the quantity demanded.

-Excess supply exists when the quantity supplied exceeds the quantity demanded at the ruling price.

-Excess demand exists the quantity demanded exceeds the quantity supplied at the ruling price.

-Demand curve shows the relation between price and quantity demanded, other things equal.

-Supply curve shows the relation between price and quantity supplied, other thing equal.

In a perfectly competitive market, both buyers and sellers believe their own actions have no effect on the market price. In contrast, a monopolist, the only seller or potential seller in the industry, sets the price.

-Perfect competition
Each firm in a perfectly competitive industry faces a horizontal demand curve. However much the firm sells, it gets the market price. If it charges a price above the curve it won’t sell any output: buyers will go to other firms whose product is just as good. Since the firm can sell as much as it wants at P0, it won’t charge less than P0. A horizontal demand curve, along which the price is fixed, is the key feature of a perfectly competitive firm. To be a plausible description of the demand curve facing the firm, the firm must have four attributes. First, there must be many firms, each trivial relative to the entire industry. Second the product must be standardised. Each producer ceases to be trivial relative to the relevant market and cannot acts as a price-taker. In a perfectly competitive industry, all firms must be making the same product, for which they all charge the same price. Even if all firms in an industry made homogeneous or identical goods, each firm may have some discretion over the price it charges if buyers have imperfect information about the quality or characteristics of products. To rule this out in a competitive industry, we must assume that buyers have almost perfect information about the products being sold. They know the products of different firms in a competitive industry really are identical. The fourth crucial characteristic of a perfectly competitive industry is free entry and exit. Even if existing firms could organise themselves to restrict total supply and drive up the market price, the consequent rise in revenues and profits could simply attract new firms into the industry, thereby increasing total supply again and driving the price back down. Conversely, as we shall shortly see, when firms in a competitive industry are losing money, some firms will close down and, by reducing the number of firms remaining in the industry, reduce the total supply and drive the place up, thereby allowing the remaining firms to survive. To sum up, each firm in a competitive industry faces a horizontal demand curve at the going market price. To be a plausible description of the demand conditions facing a firm, the industry must have: -many firms, each trivial relative to the industry;

-a homogeneous product, so that buyers would switch between firms if their prices differed; -perfect customer information about product quality, so that buyers know that the products of different firms really are the same; -free entry and exit, to remove any incentive for existing firms to collude.

A perfectly competitive firm’s supply decision
The firm uses the marginal condition (MC=MR) to find the best output. Then it uses the average condition to check if the price for which this output is sold covers average costs. This general theory must hold for the special case of perfectly competitive firms. The special feature of perfect competition is the...
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