MicroL16 Essay Example | Topics and Well Written Essays - 1250 words

MicroL16 - Essay Example Still, it seems likely to be a reasonable assumption to help understand market behavior. Industries in which there are many producers and in which it is difficult to differentiate between goods from individual producers, baking potatoes for example, it is likely that assuming the market is perfectly competitive can yield a reasonably accurate understanding of the way the market works. For markets, however, in which there are a limited number of producers and in which the costs to enter the market are high, or where the government restricts entry, it does not seem a reasonable assumption. Electric power, for instance, is often only available within a community from a single commercial producer. While there may be some alternatives available to consumers, such as buying their own generators or banks of solar cells, for all but the most committed, the price of these alternatives is so high as to make them non-viable. Clearly, for a market like this, assuming competitive behavior is not reasonable. 2. Profits. In a competitive market in long term equilibrium, no firm can make an â€Å"economic profit†Ã¢â‚¬â€that is, have revenues in excess of costs, including â€Å"normal profit.† This is because economic profit will provide an incentive to other firms to enter the marketplace, shifting the industry supply curve and driving down the price until there is no longer an economic profit. In the short term, a firm may enjoy economic profits in the following three ways. The first way is when a firm might innovate in a way that drives down its costs of production. While other firms work to catch up, the innovative firm can enjoy economic profit. The second way is when a firm might innovate in a way that favorably differentiates its product from others, again allowing it to earn economic profit while other firms worked to match it. The third way is when an external event occurs, such as perhaps the introduction of a new complementary good, which might shift t he demand curve for the good in question, allowing the entire industry to experience short term economic profits until more firms were able to enter the market and increase supply. 3. Shutdown point for a firm. In the short run, a firm should keep operating as long as its average variable costs are less than the price of its product. This is because total revenue will cover the variable costs. Since, in the short run, fixed costs are not avoidable they should not be considered. In the long run, the firm cannot continue to operate at a loss. This means that a firm should shut down and leave the industry if, over the long run, average total costs will exceed price. 4. Long-Run Cost Curve, Economies of Scale and Firm Size. A firm is enjoying economies of scale when long-run (i.e., all inputs variable) average costs decrease as the number of units produced by the firm increases. As demand for the product increases, a firm in this position is likely to be able to meet the additional dema nd at a lower cost than a new firm entering the market, providing the existing firm with a competitive advantage. To the degree the firms in an industry experience economies of scale, there will likely be fewer firms (i.e., increased concentration) then there would in an industry where firms were experiencing decreased returns to scale Taken to the extreme, an existing firm with a continuously declining long-run cost curve would be in a