1 . A firm that is a pure competitor has P > ATC and P > MC on the output (Q) it
ID: 1095975 • Letter: 1
Question
1. A firm that is a pure competitor has P > ATC and P > MC on the output (Q) it is presently producing and selling. Is this firm maximizing its profits? If not, which direction should it change its output if it wants to maximize its total profit? Explain your reasoning fully.
2. Is a pure competitor in short-run or long -run equilibrium if it has P=MC=ATC? Explain.
3. There is free entry in the model of pure competition. Assuming that P > ATC for a vast number of firms producing a standardized product for a given market, what will happen to market supply as the consequence? What will happen to the market price (P) of the product these firms are producing?
4. Firms in pure competition have horizontal demand functions. (The market determines product price, so firms in this competitive market are price takers.) Do firms in this model have to lower price if they want to sell more output? Why or why not?
Explanation / Answer
1) If a firm is producing at level P>AVC and P>MC,then the firm is not maximzingprofits. If it charges price higher than MC, then more firms will enter and sweep away the market share by offeringlower price. Therefore, the profit maximizng point in perfect competition is P=MR=MC.
2) The long run equilibrium point of perfect competition is when P=MC=MR=AVC. If P>AVC then there exist economic profits,more firms will enter the market. If P<AVC firms will exit the market due to losses. P=AVC is the perfect condition and long run equilibrium point.
3) If P>AVC then there exist economic profits,more firms will enter the market and increase supply. The price will fall since suplly is greater than demand. This will continue till P=AVC. If P<AVC firms will exit the market due to losses and suplly will fall till P=AVC.
4) SInce the demand is horizontal line, this means the demand will not exist for any other price except P from where the line originates. Whatever the price be lower or higher, the demand will be zero for any other price. Therefore there is no point in lowering the price. The total output of the market can only be shared by number of firms. There cannot be change in price.
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