Question

1.Using the concepts of producer theory in which firms maximize profit as discussed in the course materials, explain how perfectly competitive firms maximize profit in the short run versus in the long run.

2.Explain how the level of competition and anti-trust regulation affect firm decision making and markets?

Answer 1

1. In order to maximize profits in a perfect competition, the prefectly competitive firms set Marginal Revenue (MR) equal to Marginal cost (MC), MR = MC.

Marginal Revenue is the slope of the revenue curve which is equal to demand and price. In the short run it is possible for economic profits to be positive, zero or negative. When price(p) is greater than the ATC ( Average Total Cost), the firm earns profits and when ATC is greater than the price (p) , the firm incurs loss.

In the long run, if the firm is earning positive economics profits, this will lead to more firms entering the market, which can shift the supply curve to the right. When the supply curve shifts towards the right, the equilibrium prices will fo down and hence economic profits will decrease until they become zero.

When price (p) is less than ATC in the long run the firms are making a loss. If a firm is earning negative economic profits, more firms will leave the markets, which will shift the supply curve to the left. Which in turn will increase the prices and economic profits will increase until they become zero.

In the long run firms that are engaged in a perfectly competitive market earn zero economic profits.