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What four conditions characterize a competitve market? What are economic profits?

1. What four basic conditions characterize a competitve market?

2. The short-run marginal cost of the Ohio Bag Company is 2Q. Price is $100. The company operates in a competitve industry. Currently, the company is producing 40 units per period. What is the optimal short-run output? Calculate the profits that Ohio Bag is losing through suboptimal output.

3. Should a company ever produce an output if the mangers know it will lose money over the period? Explain.

4. What are economic profits? Does a firm in a competitive industtry earn long-run economic profits? Explain.

5. The Johnson Oil Company has just hired the best manager in the industry. Shoud the owners of the company anticipate economic profits? Explain.

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Question (1)

Actually I'd say there are 5 characteristics for competitive market:

1. Atomicity -- there are a large number of small producers and consumers on a given market, each so small that its actions have no significant impact on others. Firms are price takers, meaning that the market sets the price that they must choose.
2. Homogeneity -- that goods and services are perfect substitutes (there is no product differentiation).
3. Perfect and complete information -- all firms and consumers know the prices set by all firms.
4. Equal access -- all firms have access to production technologies, and resources (including information) are perfectly mobile.
5. Free entry -- any firm may enter or exit the market as it wishes (see Barriers to entry).

Remember, the most important two factors are that there are many firms that sell the same product; and each firm is small relative to the size of the market.


Question (2)

Output determination in short-run:

The optimal level of output must satisfy the two following conditions:
(i) MC must be rising at the level of output where p = MC
(ii) Profits with p = SRMC producing something must exceed that producing nothing.

Thus, p equals/larger than AVC.

Thus, rule for optimal output level in short-run:
- produce where p = SRMC, as long as p equal/larger than AVC
- if p smaller than AVC, shut down (produce zero)

Notice AVC not AC - fixed (sunk) costs don't matter. The rule defines the short-run supply curve of the firm, indicating the output the firm is wiling to supply at different prices.

So as long as Ohio Bag's SRMC = p i.e. $100, that's the optimal production point for the company. i.e. 2Q = $100, Q = 50.

For the last ...

Solution Summary

In a 1250 word response, the solution carefully explains each question in a very understandable manner.