Micro Economics

  • Useful Equations to Remember are
    TC=TFC+TVC; MC=    ? TC/ ?Q; AFC=TFC/Q; AVC=TVC/Q,and ATC = AFC+AVC

    Market Structure I: Perfect Competition
    Perfect competition is a market structure characterw.cd by a complete absence of' rivalry among individual runs. A perfectly competitive market model is constructed assuming that there are large number of buyers and sellers in the industry/market, so that no individual buyer or however large, can influence the price by changing the purchase or output; all firms the industry produce a homogenous product; entry and exit of firms is free for the industry. In perfect competition, an individual firm is a price taker. 

    Under perfect competition, the firm takes the market price as given and adjusts the level of' output to maximize the level of profit. The objective of the competitive firm is to maximize profits. In order to maximize profit, the firm adjusts its output level at which price equals the marginal cost or production, that is, P = MC. Diagrammatically, the firm reaches equilibrium, when the upward rising MC curve intercepts its horizontal demand curve. In perfect competition, the condition for the short run equilibrium of a firm is P MR = AR — MC.

    To determine a firm's shutdown point in the short run, variable costs must be taken into consideration. When market price equals minimum possible average variable cost, losses at the output for which price equals marginal cost are the same as fixed cost. If price falls below minimum possible average variable cost, the firm shuts down because operating losses would then exceed fixed cost. 

    In a perfect competition, no firm will earn abnormal profits. A firm in the long run operates at a point where its average cost is minimum. Average cost will be minimum when it is equal to marginal cost, MC = AC. Since in the long run no firm is earning abnormal profits, the revenue must be equal to its cost. In other words, Total Revenue = Total Cost (or) price is equal to cost. Thus, the long run zero-economic-profit condition requires price MC = Minimum long run AC. 

    The short run supply curve of the industry is obtained from the horizontal summation of the short run supply curves of the individual firms. The short run supply curve of the firm is again the upward rising portion of the marginal cost curve which lies above the AVC curve. However, in the long run, the MC curve is not the supply curve of the firm because in the long run, only one point of the MC curve can be the equilibrium point where the firm earns only normal profit. If the existing firms earn excess profits new firms enter into the industry and excess profit will soon be eliminated. 

    The supply curve of a firm in the long run depends on the cost curves. If the industry is a constant cost industry, the long run supply curve will be a horizontal straight line. If the industry is an increasing (decreasing) cost Industry, the long run supply curve will be upward rising(downward sloping). 

    Allocative efficiency, Pareto efficiency or simply efficiency is a condition achieved when resources are allocated in ways allowing the maximum possible net benefit from their use. All allocation is known as Pareto efficiency or allocative efficiency if the only way to make one individual better off is to make another worse off. Under ideal conditions, an economy attains allocative efficiency when all the firms operating in the industry are perfect competitors and there are no externalities.