Perfect Competition Overheads Market Structure Market structure refers
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Perfect Competition Overheads
Market Structure Market structure refers to all characteristics of a market that influence the behavior of buyers and sellers, when they come together to trade Market structure refers to all features of a market that affect the behavior and performance of firms in that market
Key Factors Determining Market Structure Short run & long run objectives of buyers and sellers in the market Beliefs of buyers and sellers about the ability of themselves and others to set prices Degree of product differentiation Technologies employed by agents in the market Amount of information available to agents about the good and about each other Degree of coordination or noncooperation of agents Extent of entry and exit barriers
Definition of a competitive agent A buyer or seller (agent) is said to be competitive if the agent assumes or believes that the market price is given and that the agent's actions do not influence the market price We sometimes say that a competitive agent is a price taker
Common Market Structures Perfect (pure) competition Agents take prices as given Entry and exit barriers are minimal or nonexistent
Common Market Structures Monopoly (seller) or Monopsony (buyer) Firm sets price (faces market demand or supply curve) Entry and exit barriers result in the existence of one seller or one buyer
Common Market Structures Oligopoly Firm sets prices (faces residual demand) Entry and exit barriers result in the existence of few sellers or buyers
Common Market Structures Monopolistic competition Firm sets prices (faces residual demand) Entry and exit barriers are minimal
Perfect Competition 1. Buyers and sellers are competitive or price takers 2. All firms produce homogeneous (standardized) goods and consumers view them as identical 3. All buyers and sellers have perfect information regarding the price and quality of the product 4. Firms can enter and exit the industry freely 5. There are no transaction costs to participate in the market 6. Each firm bears the full cost of its production process 7. There is perfect divisibility of output
Competitive agents Large number of agents What really matters are beliefs
Homogeneous Goods Price and nothing else matters The demand for your product goes to zero if you raise price
Perfect Information Buyers and sellers know everything quality opportunities to buy and sell factors affecting the market in the future
Ease of Entry and Exit New firms enter when there are profits Existing firms leave when there are losses
No Transactions Costs Firms are not dissuaded by participation fees Buyers can take advantage of opportunities
No Externalities What is good for this market is good for society The market fully accounts for all costs
Divisible output Small price changes don’t lead to large quantity jumps Examples such as buildings and machinery
Demand facing the perfectly competitive firm The demand curve facing a perfectly competitive firm is horizontal at the market price If the firm were to raise its price, even a tiny bit, above this price, its sales would go to zero And no matter how much the firm produces, this price will not change
Demand for Individual Firm Industry Supply-Demand Equilibrium $ $ S(p) p 0 D(p) Q 0 Output p 0 D(p) Output The demand curve for a perfectly competitive firm is horizontal If the firm were to raise its price above this price, sales would go to zero And no matter how much the firm produces, the price will not change
Behavior of a Single Competitive Firm The firm’s goal is to maximize profit
What is profit? Profit is revenue minus costs or
The firm’s goal is then to maximize returns from the technologies it controls, taking into account: The demand for final consumption goods Opportunities for buying and selling factors / products The actions of other firms in the market
The Firm Solves the Problem
Example Problem P = $184
y 0. 00 FC VC 200 0. 00 C AFC 200. 00 AVC ATC 1. 00 200 64. 00 200 130. 00 330. 00 100. 00 65. 00 3. 00 204. 00 404. 00 66. 67 68. 00 134. 67 MC Price TR 184 0 64. 00 264. 00 66. 00 165. 00 74. 00 184 184 -80. 00 184 368 38. 00 184 552 148. 00 184 736 244. 00 184 920 320. 00 184 1104 370. 00 184 1288 388. 00 184 1472 368. 00 184. 00 150. 22 184 88. 00 4. 00 292. 00 492. 00 50. 00 73. 00 123. 00 108. 00 5. 00 200 400. 00 600. 00 40. 00 80. 00 120. 00 134. 00 6. 00 200 534. 00 734. 00 33. 33 89. 00 122. 33 7. 00 200 8. 00 200 9. 00 200 1656 10. 00 200 166. 00 700. 00 900. 00 28. 57 100. 00 128. 57 204. 00 904. 00 1104. 00 25. 00 113. 00 138. 00 248. 00 1152. 00 1352. 00 22. 22 128. 00 304. 00 298. 00 1450. 00 1650. 00 20. 00 145. 00 165. 00 MR Profit -200. 00 184
Total Revenue and Cost Curves 4000 $ 3500 3000 2500 2000 1500 1000 500 0 TR C 0 2 4 6 8 10 12 14 16 18 Output Note that TR is linear with slope = 184
Price, Marginal Cost, and Average Cost Price = MR = Demand 400 $ 350 300 250 200 150 100 50 0 Price MC ATC 0 2 4 6 8 10 12 14 16 Output 18
Add average variable and average fixed costs AFC 400 $ 350 300 250 200 150 100 50 0 AVC ATC MC Price 0 2 4 6 8 10 12 14 16 Output 18
Maximizing profit Choose the level of output where the difference between TR and TC is the greatest
y 3 C 404 MC Price TR 184 552 88. 00 4 492 184 600 736 184 734 920 184 900 1104 184 1104 1288 1352 388 184. 00 184 1472 248. 00 9 370 184. 00 204. 00 8 320 184. 00 166. 00 7 244 184. 00 134. 00 6 Profit 148 184. 00 108. 00 5 MR 368 184. 00 184 1656 304
Profit Max Using MR and MC An increase in output will always increase profit if MR > MC An increase in output will always decrease profit if MR < MC
The rule is then Increase output whenever MR > MC Decrease output if MR < MC
y 4. 00 C 492. 00 MC Price 184 TR 736 108. 00 5. 00 600. 00 184 734. 00 920 184 900. 00 1104 184 1104. 00 1288 1352. 00 388. 00 184 1472 248. 00 9. 00 370. 00 184. 00 204. 00 8. 00 320. 00 184. 00 166. 00 7. 00 Profit 244. 00 184. 00 134. 00 6. 00 MR 368. 00 184 1656 Should we increase output from 5 to 6? Should we increase output from 6 to 7? Should we increase output from 7 to 8? 304. 00 Yes No !
Measuring Total Profit is always given by Graphically it is the distance between total revenue and total cost
Total Revenue and Cost Curves 4000 $ 3500 3000 2500 2000 1500 1000 500 0 TR C 0 2 4 6 8 10 12 14 16 18 Output
Profit, price, and average total cost Profit per unit is given by
Cost Curves and Profit ATC $ 350 MC 300 Price 250 ATC Opt 200 Q Opt 150 100 50 0 0 2 4 6 8 10 12 14 16 18 Output The distance between price and ATC at the optimum output level is profit per unit
Total profit is given by the area of the box bounded by price, the optimum quantity, average total cost at the optimum quantity and the price axis
Cost Curves and Profit ATC $ 350 MC 300 Price 250 ATC Opt 200 Q Opt 150 100 50 0 0 2 4 6 8 10 12 14 16 18 Output
y 5. 00 6. 00 7. 00 8. 00 C 600. 00 AVC ATC MC 80. 00 120. 00 134. 00 734. 00 89. 00 122. 33 166. 00 900. 00 128. 57 204. 00 113. 00 138. 00 Price TR 184 920 184 Profit 320. 00 1104 370. 00 184 1288 388 184 1472 368. 00 (184 - 128. 5714) = 55. 4286 (55. 4286) (7) = $388 The firm earns a profit whenever p > ATC
A firm suffers a loss whenever p < ATC at the optimum level of output Let p = $97 We can show that the optimum quantity is 4 units
y C AVC Profit 0. 00 200. 00 ATC MC Price TR 97 0 -200. 00 97 97 -167. 00 97 194 -136. 00 97 291 -113. 00 97 388 -104. 00 97 485 -115. 00 97 582 -152. 00 64. 00 1. 00 264. 00 66. 00 2. 00 330. 00 65. 00 165. 00 74. 00 3. 00 404. 00 68. 00 134. 67 88. 00 492. 00 73. 00 123. 00 108. 00 5. 00 600. 00 80. 00 120. 00 134. 00 6. 00 734. 00 89. 00 122. 33 166. 00
Cost Curves and Profit 400 $ 350 300 250 200 150 100 50 0 ATC MC Price ATC Opt Q Opt Loss 0 2 4 6 8 10 12 14 16 18 Output
y 0. 00 1. 00 2. 00 FC VC 200 0. 00 200 64. 00 -167. 00 C AFC 200. 00 AVC 264. 00 200 130. 00 330. 00 100. 00 -136. 00 ATC MC Price TR 97 0 97. 00 97 97 66. 00 65. 00 165. 00 97 194 200 204. 00 404. 00 66. 67 68. 00 134. 67 97. 00 97 291 88. 00 4. 00 292. 00 492. 00 50. 00 73. 00 123. 00 -113. 00 97 388 97 485 97 582 97 -104. 00 97. 00 -115. 00 97. 00 -152. 00 97. 00 679 97 97. 00 776 108. 00 5. 00 200 400. 00 600. 00 40. 00 80. 00 120. 00 134. 00 6. 00 7. 00 8. 00 9. 00 200 534. 00 734. 00 33. 33 89. 00 122. 33 200 700. 00 900. 00 28. 57 100. 00 -221. 00 200 904. 00 1104. 00 -328. 00 200 1152. 00 166. 00 128. 57 204. 00 25. 00 113. 00 138. 00 1352. 00 Profit -200. 00 64. 00 264. 00 74. 00 3. 00 MR 248. 00 22. 22 128. 00 150. 22 97. 00 97 873
Another example problem P = $120
y Price. TR MR FC VC 0. 00 120 200 200. 00 0. 25 120 30 120 200 93. 19 -194. 14 0. 50 120 60 120 200 86. 75 -186. 63 1. 00 120 120 200 75. 00 -167. 00 2. 00 120 240 120 200 56. 00 -112. 00 3. 00 120 360 120 200 -41. 00 4. 00 120 480 120 200 40. 00 5. 00 120 600 120 200 6. 00 120 720 120 200 7. 00 120 840 120 200 8. 00 120 960 120 200 9. 00 120 1080120 200 C AFC AVC ATC MC 0. 00 200. 00 24. 14 224. 14 800. 00 96. 56 896. 56 46. 63 246. 63 400. 00 93. 25 493. 25 87. 00 200. 00 87. 00 287. 00 152. 00 352. 00 100. 00 76. 00 176. 00 Profit - 201. 00 401. 00 66. 67 67. 00 133. 67 43. 00 240. 00 440. 00 50. 00 60. 00 110. 00 36. 00 275. 00 312. 00 357. 00 416. 00 495. 00 475. 00 512. 00 557. 00 616. 00 695. 00 40. 00 33. 33 28. 57 25. 00 22. 22 55. 00 52. 00 51. 00 52. 00 55. 00 95. 00 85. 33 79. 57 77. 00 77. 22 35. 00 40. 00 51. 00 68. 00 91. 00 125. 00 208. 00 283. 00 344. 00 385. 00
For a given price we can find optimal output HOW? Choose output level where MC = MR = P
AVC Short Run Equilibrium ATC 300 $ MC 250 Q Opt 200 Profit 150 100 P = 120 50 0 0 2 4 6 8 10 12 P = MC y* = 10 = $400 14 16 Output 18
y 7. 00 8. 00 9. 00 10. 00 11. 00 12. 00 Price 120 120 120 TR 840 960 1080 1200 1320 1440 MR 120 120 120 Cost 557. 00 616. 00 695. 00 800. 00 937. 00 1112. 00 MC 51. 00 68. 00 91. 00 120. 00 155. 00 196. 00 = $400 The firm is happy!! And R - VC (ROVC) = $600 Profit 283. 00 344. 00 385. 00 400. 00 383. 00 328. 00
AVC Short Run Equilibrium ATC 300 $ MC 250 Q Opt 200 ROVC 150 100 P = 120 50 0 0 2 4 6 8 10 12 P = MC y* = 10 ROVC = $600 14 16 Output 18
Now let p = $91 y 6 7 8 9 10 11 12 Price 91 91 TR 546 637 728 819 910 1001 1092 MR 91 91 VC 312 357 416 495 600 737 912 C 512 557 616 695 800 937 1112 MC 40 51 68 91 120 155 196 y* = 9, = $124 The firm is still happy!! And R - VC (ROVC) = $324 Profit 34 80 112 124 110 64 -20
AVC Short Run Equilibrium ATC 300 $ MC 250 200 150 P = 91 100 P = 120 50 0 0 2 4 6 8 10 12 14 16 Output 18
AVC Short Run Equilibrium ATC 300 $ MC 250 Q Opt 200 ROVC Profit 150 P = 91 100 50 0 0 2 4 6 8 10 12 P = MC y* = 9 = $ 124 ROVC = $324 14 16 Output 18
Now let p = $68 y 6 7 8 9 10 11 12 Price 68 68 TR 408 476 544 612 680 748 816 MR 68 68 VC 312 357 416 495 600 737 912 C 512 557 616 695 800 937 1112 MC 40 51 68 91 120 155 196 y* = 8, = $-72 The firm is not so happy!! But R - VC (ROVC) = $128 Profit -104 -81 -72 -83 -120 -189 -296
AVC Short Run Equilibrium ATC 300 $ MC 250 200 P = 68 150 P = 91 100 P = 120 50 0 0 2 4 6 8 10 12 14 16 Output 18
AVC Short Run Equilibrium ATC 300 $ MC 250 Q Opt Loss ROVC 200 150 P = 68 100 50 0 0 2 4 6 8 10 12 P = MC y* = 8 = $-72 14 16 Output ROVC = $128 18
Now let p = $51 y 6 7 8 9 10 11 12 Price 51 51 TR 306 357 408 459 510 561 612 MR 51 51 VC 312 357 416 495 600 737 912 C 512 557 616 695 800 937 1112 MC 40 51 68 91 120 155 196 Profit -206 -200 -208 -236 -290 -376 -500 y* = 7, = $ -200 The firm may as well shut down
AVC Short Run Equilibrium ATC 300 $ MC 250 200 P = 51 150 P = 68 P = 91 100 P = 120 50 0 0 2 4 6 8 10 12 14 16 Output 18
AVC Short Run Equilibrium ATC 300 $ MC 250 Q Opt P = 51 Loss ROVC 200 150 100 50 0 0 2 4 6 8 10 12 14 16 Output P = MC y* = 7 = $-200 ROVC = $0 18
Now let p = $40 y 5 6 7 8 9 10 11 Price 40 40 TR 200 240 280 320 360 400 440 MR 40 40 C 475 512 557 616 695 800 937 MC 35 40 51 68 91 120 155 Profit -275 -272 -277 -296 -335 -400 -497 y* = 6, = $ -272 The firm should get out in a hurry!
AVC Short Run Equilibrium ATC 300 $ MC 250 P = 40 200 P = 51 150 P = 68 P = 91 100 P = 120 50 0 0 2 4 6 8 10 12 14 16 Output 18
AVC Short Run Equilibrium ATC 300 $ MC 250 P = 40 Loss 200 P = 51 ROVC 150 P = 68 P = 91 100 P = 120 50 0 0 2 4 6 8 10 P = MC y* = 6 = $- 272 12 14 16 Output ROVC = $-72 18
AVC Short Run Equilibrium ATC 300 $ MC 250 P = 40 200 P = 51 150 P = 68 P = 91 100 P = 120 50 P = 196 0 0 2 4 6 8 10 12 14 16 Output 18
Short run supply At different prices we know how much the firm will choose to supply By plotting these points we can obtain the short run supply curve
Short-run supply curve AVC 300 $ MC 250 P = 40 200 P = 51 150 P = 68 P = 91 100 P = 120 50 P = 196 0 0 2 4 6 8 10 12 14 16 Output 18
Short Run Equilibrium 300 $ 250 200 150 100 50 0 ATC AVC MC 0 $ 2 4 6 8 10 12 14 16 Output 18 Short Run Supply Curve 250 200 150 Supply 100 50 0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Output
We can connect the dots? Short Run Supply Curve 250 $ 200 150 Supply 100 50 0 0 1 2 3 4 5 6 7 Not really 8 9 10 11 12 13 14 Output
We connect, but with a discontinuity Short Run Supply Curve 250 $ 200 150 Supply 100 50 0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Output
To summarize The competitive firm's supply curve has two parts For all prices above the minimum point on the firm’s average variable cost (AVC) curve, the supply curve coincides with the marginal cost curve (MC) For prices below the minimum point on the average variable cost curve (AVC), the firm will shut down, so its supply curve is a vertical line at zero units of output
Short Run Supply 300 $ 250 200 MC AVC 150 100 50 0 0 2 4 6 8 10 12 14 16 Output 18
Short Run Supply 300 $ 250 200 MC AVC 150 100 50 0 0 2 4 6 8 10 12 14 16 Output 18
Short Run Supply 300 $ 250 200 150 MC ATC 100 AVC 50 0 0 2 4 6 8 10 12 14 16 Output 18
We write the individual supply curve as p - price of output w 1, w 2, w 3, … - prices of inputs z - fixed inputs
Assumptions about the industry in the short-run The number of firms is fixed The firm is operating on a short-run cost curve Some inputs are fixed
Short run industry or market supply Shows the quantity supplied by the industry at each price when the plant size of each firm and the number of firms remain constant It is constructed by summing the quantities supplied by the individual firms
The market or industry supply curve, QS, is the horizontal summation of the individual firm supply curves We account for the fact that will be zero at some price levels
The market supply curve is then a curve indicating the quantity of output that all sellers in a market will produce at different prices. If there are L identical firms, each with supply, then
Example L = 50 P = $120 yi = 10 QS = (50)(10) = 500
Example L = 50 P = $196 yi = 12 QS = (50)(12) = 600
Individual Short Run Supply Curve $ 250 P = 51, y = 7 200 P = 68, y = 8 150 P = 120, y = 10 Supply 100 50 0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Output
Short Run Market Supply Curve 250 $ P = 51, y = 350 200 P = 68, y = 400 150 P = 120, y = 500 100 Supply 50 0 0 100 200 300 400 500 600 700 Output
Short Run Market (Industry) Equilibrium Market Demand Curve 250 $ 200 150 100 50 0 D 0 100 200 300 400 500 600 Output 700
Finding the market equilibrium Short Run Market Supply & Demand Curves 250 $ Supply Demand P Q* 200 150 100 50 0 0 100 200 300 400 P = $120, Q = 500 600 700 Output
Increase the demand to Short Run Market Supply & Demand Curves Demand P Q* D 1 300 $ Supply 250 200 150 P 1 Q 1* 100 50 0 0 100 200 300 400 500 P = $196, Q = 600 700 Output 800
Decrease the demand to Short Run Market Supply & Demand Curves Demand P Q* D 1 300 $ Supply 250 200 150 P 1 Q 1* 100 D 2 50 P 2 Q 2* 0 0 100 200 300 400 500 P = $68, Q = 400 600 700 Output 800
Going back to the individual firm AVC 300 $ Life is good ATC 250 MC 200 P = 120 150 yi = 10 100 i = 400 50 0 0 2 4 6 8 10 12 14 16 Output 18
What about the equilibrium price of $68. 00? 300 $ 250 AVC 200 ATC 150 MC 100 P = 68 50 0 0 2 4 6 8 10 12 14 16 Output 18 Not what the managers had in mind!
With short run losses, the firm will only stay in the industry in the short run In the long run, a firm with losses will exit the industry At the same time, short run profits will encourage firms to enter the industry
And so we must consider the long run!
The End
AVC Short Run Equilibrium ATC 300 $ MC 250 P = 40 200 P = 51 150 P = 68 P = 91 100 P = 120 50 P = 196 0 0 2 4 6 8 10 12 P = MC y* = 10 = $400 14 16 Output 18
Increase the demand to Short Run Market Supply & Demand Curves Demand P Q* D 1 300 $ Supply 250 200 150 P 1 Q 1* 100 D 2 50 P 2 Q 2* 0 0 100 200 300 400 500 P = $196, Q = 600 700 Output 800
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