1 Answer the following questions and briefly explain: (a) What assumptions are n
ID: 1231430 • Letter: 1
Question
1 Answer the following questions and briefly explain:(a) What assumptions are necessary for a market to be perfectly competitive? In light of what you have learned in this chapter, why is each of these assumptions important? (Hint: consider perfectly competitive firms’ demand curve, market power and long-run economic profits with these assumptions.)
(b) In what condition will a perfectly competitive firm that incurs economic losses choose to produce rather than shut down in the short run? Why will the firm do so?
(c) Should a firm produce at an output level at which long-run average cost is minimized? Explain. What is the economic profit that all firms earn in a perfectly competitive industry in the long run equilibrium?
Explanation / Answer
a) Unlimited buyers and sellers, no entry and exit barriers, Perfect factor mobility, Perfect information, no transaction costs, Profit maximization, Homogeneous products, and non-increasing returns to scale b) 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, then it should keep producing. c) A firm cannot continue to incur losses indefinitely. In the long run, the firm will have to earn sufficient revenue to cover all its expenses. The long-run decision is based on the relationship of the price and long-run average costs. If average cost is greater than profit, the firm will not survive. The firm will only make enough money is necessary to cover its economic costs