In A Perfectly Competitive Market

Front 1

Marginal Cost (MC)

Back 1

The marginal cost of an additional unit of output is the cost of the additional inputs needed to produce that output. More formally, the marginal cost is the derivative of total production costs with respect to the level of output.

Front 2

Marginal Cost vs. Average Cost

Back 2

the marginal cost is negative for the case on the left. The cost of producing the extra unit is far more than offset by the decrease in the average cost of the first 100 units. The case on the right illustrates the opposite possibility. Producing one more unit increases the cost for the first 100 units so that the extra unit has a marginal cost of 111. In both cases, producing the marginal unit must have some effect on the efficiency of producing the first 100 units.

If the average cost does not change because the AC curve is flat, then MC = AC. This is why the MC curve passes through the minimum of the AC curve.

Front 3

Calculus for Marginal Cost

Back 3

MC = dTC / dQ = d(Q · AC) / dQ

Front 4

Deadweight Loss

Back 4

economics terms

Deadweight Loss

Deadweight loss is the inefficiency caused by, for example, a tax or monopoly pricing. The diagram below shows a deadweight loss (labeled "gone") caused by a sales tax. By causing a difference between the pre-tax price received by producers and the after-tax price paid by consumers, the government secures the area labeled Government Revenue. This revenue comes at the expense of the consumer surplus and producer surplus that would have existed in the no tax equilibrium. The "gone" triangle of deadweight loss goes to no one because those transactions are prevented by the sales tax.

Front 5

Consumer Surplus

Back 5

Only the marginal consumer is willing to pay just the market price in a typical supply and demand equilibrium. The consumers would be willing to pay more than the market price are what makes the demand curve slope downward. The amount that these consumers would be willing to pay, but do not have to pay is known as the consumer surplus.

Front 6

Producer Surplus

Back 6

The supply curve slopes upward because, given a market price, there are producers who can produce profitably at a price below that market price. The revenues to producers that exceed the minimum amount that they would have to receive is known as the producer surplus.

Front 7

Demand Curve

Back 7

The demand curve shows the amount that consumers are willing to buy given a particular market price

Front 8

Elasticity

Back 8

economics terms

Elasticity

The elasticity of y with respect to x is the percentage change in y caused by a one percent change in x. Formally, this is

e = dy/dx · (x/y).

An intuitive version of this formula replaces the derivative with changes

e = ∆y/∆x · (x/y).

Reorganizing this yields

e = (∆y/y) / (∆x/x).

The form highlights the ratio of percentage changes.

A common functional form is

log(y) = a + b · log(x).

or y = exp(a+b·log(x)). Differentiating using the chain rule yields

dy/dx = (b/x)·exp(a+b·log(x)) = (b/x)·y = b·(y/x).

The elasticity of y with respect to x is then b, which is constant.

Front 9

Average Cost (AC)

Back 9

The average cost is the total cost divided by the number of units produced.

It is important to understand that firms maximize profits by considering the marginal cost, not the average cost. The difference between the average cost and the sales price does determine the profits per unit once the profit maximizing quantity is determined, but the profit maximizing quantity generally does not maximize profits per unit.

Front 10

Solving for equilibrium price

Back 10

To solve for the equilibrium price, one must either plot the supply and demand curves, or solve for their equations being equal.

Front 11

Supply and demand

Back 11

If demand increases and supply remains unchanged, then it leads to higher equilibrium price and quantity.
If demand decreases and supply remains unchanged, then it leads to lower equilibrium price and quantity.
If supply increases and demand remains unchanged, then it leads to lower equilibrium price and higher quantity.
If supply decreases and demand remains unchanged, then it leads to higher price and lower quantity.

Front 12

Perfect_competition

Back 12

Infinite buyers and sellers – Infinite consumers with the willingness and ability to buy the product at a certain price, and infinite producers with the willingness and ability to supply the product at a certain price.
Zero entry and exit barriers – It is relatively easy for a business to enter or exit in a perfectly competitive market.
Perfect factor mobility - In the long run factors of production are perfectly mobile allowing free long term adjustments to changing market conditions.
Perfect information - Prices and quality of products are assumed to be known to all consumers and producers.[1]
Zero transaction costs - Buyers and sellers incur no costs in making an exchange (perfect mobility).[1]
Profit maximization - Firms aim to sell where marginal costs meet marginal revenue, where they generate the most profit.
Homogeneous products – The characteristics of any given market good or service do not vary across suppliers.
Non-increasing returns to scale - Non-increasing returns to scale ensure that there are sufficient firms in the industry.[2]

Front 13

The shutdown point

Back 13

Restated, the rule is that for a firm to continue producing in the short run it must earn sufficient revenue to cover its variable costs.[16] The rationale for the rule is straightforward. By shutting down a firm avoids all variable costs.[17] However, the firm must still pay fixed costs.[18] Because fixed cost must be paid regardless of whether a firm operates they should not be considered in deciding whether to produce or shutdown. Thus in determining whether to shut down a firm should compare total revenue to total variable costs (VC) rather than total costs (FC + VC). If the revenue the firm is receiving is greater than its total variable cost (R > VC) then the firm is covering all variable cost plus there is additional revenue (“contribution”), which can be applied to fixed costs. (The size of the fixed costs is irrelevant as it is a sunk cost. The same consideration is used whether fixed costs are one dollar or one million dollars.) On the other hand if VC > R then the firm is not even covering its production costs and it should immediately shut down. The rule is conventionally stated in terms of price (average revenue) and average variable costs.

Front 14

Short-run supply curve in a competitive market

Back 14

The short run supply curve for a perfectly competitive firm is the marginal cost (MC) curve at and above the shutdown point. Portions of the marginal cost curve below the shut down point are not part of the SR supply curve because the firm is not producing in that range. Technically the SR supply curve is a discontinuous function composed of the segment of the MC curve at and above minimum of the average variable cost curve and a segment that runs with the vertical axis from the origin to but not including a point "parallel" to minimum average variable costs.[27]