Glossary
Average Variable Cost (AVC)
The total variable cost divided by the quantity of output produced, representing the variable cost per unit.
Example:
If producing 100 t-shirts incurs 5 per t-shirt.
Entering
The act of a new firm beginning to produce and sell goods or services in a market, typically when economic profits are available.
Example:
Seeing the success of local food trucks, a new chef decided on entering the mobile culinary market with her unique taco recipes.
Exiting
The act of a firm ceasing production and leaving a market, often due to sustained economic losses.
Example:
After several months of low sales, the small boutique coffee shop decided on exiting the competitive downtown market.
Fixed Costs
Costs that do not vary with the level of production in the short run, such as rent or insurance premiums.
Example:
The monthly rent for a factory building is a fixed cost because it must be paid regardless of how many units are produced.
Long-Run Entry and Exit
The process by which firms enter or leave an industry in the long run in response to economic profits or losses, leading to market adjustments.
Example:
The rise and fall of Blockbuster and Netflix illustrate Long-Run Entry and Exit, as new streaming services entered while traditional video rental stores exited.
Long-Run Equilibrium
A state in a perfectly competitive market where there is no incentive for firms to enter or exit, as all firms are earning zero economic profit.
Example:
After years of intense competition, the market for generic pain relievers reached a Long-Run Equilibrium where prices stabilized, and no new companies were entering or existing ones leaving.
Losses (Long-Run)
When a firm's total revenue is less than its total costs, leading to negative economic profit, which incentivizes firms to exit the industry in the long run.
Example:
If a solar panel installation company consistently experiences losses because of falling panel prices and rising labor costs, it will eventually exit the market.
Low Barriers to Entry/Exit
The ease with which new firms can enter an industry or existing firms can leave, meaning there are minimal obstacles like high startup costs or complex regulations.
Example:
Starting a lemonade stand has low barriers to entry/exit because it requires minimal capital and can be easily closed down if unprofitable.
Many Sellers
A characteristic of perfectly competitive markets where a large number of independent firms compete, ensuring no single firm has significant market power.
Example:
In the online retail space for generic phone cases, there are many sellers, making it difficult for any one seller to stand out or charge a premium.
Perfectly Competitive Markets
A market structure characterized by many sellers, identical products, low barriers to entry and exit, and firms acting as price takers.
Example:
Imagine a bustling farmers' market where hundreds of vendors sell identical apples; no single farmer can influence the market price, and new farmers can easily join or leave the market.
Price (P)
The amount of money consumers pay for a single unit of a good or service in the market.
Example:
The price of a movie ticket might be $12, which is what a consumer pays to see one film.
Price Takers
Firms in a perfectly competitive market that must accept the prevailing market price for their goods, as they are too small to influence it.
Example:
A single wheat farmer is a price taker because they must sell their crop at the market price determined by global supply and demand, not by their individual output.
Producer Surplus (PS)
The difference between the total revenue a producer receives and the total variable cost of production.
Example:
If a custom furniture maker sells a table for 400, their Producer Surplus for that table is $600.
Profits (Long-Run)
When a firm's total revenue exceeds its total costs, leading to positive economic profit, which incentivizes new firms to enter the industry in the long run.
Example:
The booming demand for electric vehicles led to significant profits for early manufacturers, attracting many new companies to enter the EV market.
Shutdown Rule
A short-run decision rule stating that a firm should cease production if the market price falls below its average variable cost (P < AVC).
Example:
A struggling restaurant facing high utility bills and low customer turnout might apply the Shutdown Rule and close temporarily if its daily revenue can't even cover the cost of ingredients and hourly wages.
Total Revenue (TR)
The total amount of money a firm receives from selling its output, calculated as price multiplied by quantity sold.
Example:
If a bakery sells 100 loaves of bread at 400.
Total Variable Cost (TVC)
Costs that change with the level of output, such as raw materials and labor wages.
Example:
The cost of flour, sugar, and eggs used to bake cakes is a Total Variable Cost because it increases as more cakes are produced.
Zero Economic Profit
A condition where a firm's total revenue equals its total costs, including both explicit and implicit costs, meaning the firm is earning just enough to cover its opportunity costs.
Example:
Even though a small bakery might be making accounting profit, if the owner could earn more by working elsewhere, they are making zero economic profit.