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Perfect Competition and Optimization Rule

## Conditions for Perfectly Competitive Markets

Read Openstax text Ch 8: Perfect Competition and Review the Perfect Competition

Tutorial.

1. A perfectly competitive market price is determined by the forces of supply and demand. The “demand curve” facing the firm is horizontal which means that it is a price taker and cannot influence market price but can sell as much as it wants at that marketprice. It also means that the market price is equal to the average revenue the firm receives for each unit it sells and it also means that the price is equal to the marginal revenue the firm receives for each additional unit sold (one more). P=MR=AR

The optimization rule for the firm is to produce that quantity of output where MR=MC.

In that way the firm will maximize its profits (or minimize its losses).

Given the following cost table of the firm:

a) what is the profit maximizing level of output IF the market price is \$20?

b) Is the firm earning economic profits or losses?

c) What is the value of its profits or losses?

d) Suppose demand shifts left in the market and the market price falls to \$12 a bushel. What is the profit maximizing level of output now?

e) Is the firm earning economic profits or losses now and what is the value of these profits or losses?

f) What would the market price have to fall to for the firm to be indifferent between staying open and shutting down?

2. Below is a picture of a firm in a market that has achieved a Long Run (LR) equilibrium price and quantity. The equilibrium Price = _____ and the equilibrium Quantity is __________. The ATC at this quantity is \$_____. Economic Profits are \$______.

Below is a picture of a firm in a market that has NOT achieved a LR equilibrium price and quantity. The equilibrium Price = _____ and the equilibrium Quantity is __________. The ATC at this quantity is \$_____. Economic Profits are \$______.

Explain why the first graph is a Long Run market condition and the second graph is not.

3. List the necessary conditions for a perfectly competitive market. Explain why all firms are price takers.

4. Suppose that rocking-chair manufacturing is a perfectly competitive industry in which there are 1000 identical firms. Each firm’s total cost is related to output per day as follows:

a. Fill in the table above.

b. Plot the ATC, AVC and MC for the firm.

5. For the firm in question 4 the firm’s supply curve is the MC curve above the minimum point on the AVC curve. If the price is \$300, the optimal quantity=4; if \$400, q=5; if p=\$500, q=6; and if p=\$600, q=7. a. With 1000 identical firms in the market, simply multiply firm supply by 1000. What is the equilibrium price _______ and equilibrium quantity _______ of chairs per day in this market?

b. Based on the costs in question 4, and equilibrium P & Q above, What is the firm’s TR?_____ TC?_______ What is the firm’s profit or loss at the equilibrium price?__