Economic Profit Assignment Paper
TRUE or FALSE. If the statement is correct, write TRUE on your answer sheet. If the statement is incorrect, write FALSE. Explain why you answered TRUE or FALSE. 1. The demand curve for a competitive market is a horizontal line. 2. The marginal revenue in a competitive firm is . This means that is zero. This implies that the competitive firm has a significant share in the market. 3. The price level in a competitive market is determined when marginal revenue is equal to average variable cost. 4. If economic profit is positive in a competitive market for buko juice, firms will continue to enter this market; when the economic profit becomes zero no firm will exit the market. Economic Profit Assignment Paper
1. FALSE: The demand curve for a competitive market is not a horizontal line. Instead, it is downward sloping, indicating that as the price of a good decreases, the quantity demanded increases. In a perfectly competitive market, all firms face the same demand curve, which is the market demand curve.
2. TRUE: The marginal revenue in a competitive firm is MR=P because the firm is a price taker and must sell its output at the prevailing market price. The firm’s output is a small fraction of the total market output and has a negligible impact on the market price. Therefore, the firm can increase its revenue only by selling more output, which means that its marginal revenue is equal to the market price. The derivative of Q with respect to P is zero because the firm cannot influence the market price by changing its own output level. Economic Profit Assignment Paper
* However, the fact that a competitive firm has zero influence on the market price does not imply that it has a significant share in the market. In fact, the opposite is true. A competitive firm has a negligible market share, and its output level is so small that it has no impact on the market price. Therefore, the firm must accept the market price as given and adjust its output level accordingly.
* FALSE: The price level in a competitive market is not determined when marginal revenue is equal to average variable cost. Instead, it is determined when marginal cost equals marginal revenue. At the profit-maximizing level of output, a competitive firm produces where marginal cost equals marginal revenue, which is also the market price. This is because a competitive firm cannot charge a higher price than the market price, nor can it charge a lower price because it would not be able to cover its variable costs. Therefore, the market price serves as a constraint on the firm’s pricing decision. Economic Profit Assignment Paper
* However, the average variable cost plays an important role in determining whether a competitive firm will stay in business in the short run. If the market price is below the average variable cost, the firm will not be able to cover its variable costs and will shut down in the short run. If the market price is above the average variable cost but below the average total cost, the firm will continue to produce in the short run but will incur losses.
* FALSE: If economic profit is positive in a competitive market for buko juice, firms will not continue to enter this market indefinitely. Instead, the market supply will increase, causing the market price to fall until economic profit becomes zero. At this point, the market is in long-run equilibrium, and no firm has an incentive to enter or exit the market.
* Similarly, if economic profit becomes zero, it does not mean that no firm will exit the market. In a competitive market, firms are free to enter and exit, and they will do so if they cannot earn a positive economic profit. If the market price falls below the average total cost, some firms will incur losses and may exit the market. This will reduce the market supply and cause the market price to rise, restoring the economic profit to zero. Economic Profit Assignment Paper
* In conclusion, a competitive market is characterized by a downward-sloping demand curve, zero market power for individual firms, and a price level determined by the intersection of marginal cost and marginal revenue. In the short run, a competitive firm will produce where the market price is above the average variable cost and shut down if the market price falls below it. In the long run, firms will enter or exit the market depending on the profitability of the market, and the market will reach equilibrium when economic profit is zero Economic Profit Assignment Paper