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Ten Principles of Economics - Part 31

Ten Principles of Economics - Part 31. Economics is the study of how society manages its scarce resources. In most societies, resources are allocated not by a single central planner but through the combined actions of millions of households and firms. Economists therefore study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. Economists also study how people interact with one another. | CHAPTER 14 FIRMS IN COMPETITIVE MARKETS 311 Thus for these two reasons the long-run supply curve in a market may be upward sloping rather than horizontal indicating that a higher price is necessary to induce a larger quantity supplied. Nonetheless the basic lesson about entry and exit remains true. Because firms can enter and exit more easily in the long run than in the short run the long-run supply curve is typically more elastic than the short-run supply curve. I QUICK QUIZ In the long run with free entry and exit is the price in a market equal to marginal cost average total cost both or neither Explain with a diagram. CONCLUSION BEHIND THE SUPPLY CURVE We have been discussing the behavior of competitive profit-maximizing firms. You may recall from Chapter 1 that one of the Ten Principles of Economics is that rational people think at the margin. This chapter has applied this idea to the competitive firm. Marginal analysis has given us a theory of the supply curve in a competitive market and as a result a deeper understanding of market outcomes. We have learned that when you buy a good from a firm in a competitive market you can be assured that the price you pay is close to the cost of producing that good. In particular if firms are competitive and profit-maximizing the price of a good equals the marginal cost of making that good. In addition if firms can freely enter and exit the market the price also equals the lowest possible average total cost of production. Although we have assumed throughout this chapter that firms are price takers many of the tools developed here are also useful for studying firms in less competitive markets. In the next three chapters we will examine the behavior of firms with market power. Marginal analysis will again be useful in analyzing these firms but it will have quite different implications. Summary Because a competitive firm is a price taker its revenue is proportional to the amount of output it produces. The price of the good .