Four Market Models Pure Competition: Characteristics & Occurrence ...
Microeconomics Notes: Chapter 2
Keely Henesey
Four Market Models
Imperfect Competition: o Pure Monopoly : one firm is the sole seller of product
Entry of additional firms are blocked Product differentiation isn’t an issue because they are producing a single unique product o Monopolistic Competition : relatively large number of sellers producing differentiated products Widespread nonprice competition (product is distinguished based on attributes like design/workmanship; NOT price) Entry/Exit is pretty easy o Oligopoly : only a few sellers of a standardized OR differentiated product; each firm is affected by the decisions of the other firms and must take them into account in determining its own price and output Pure Competition : large number of firms producing a standardized product o New firms can enter/exit easily
Pure Competition: Characteristics & Occurrence
Very Large Numbers large number of sellers; large market Standardized Product identical/homogeneous product o Buyers view products from firms B, C, D, & E as perfect substitutes for the product of firm A o If price is constant across all firms, buyers are indifferent to which firm the buy from Competitive Firms Are “Price Takers” cannot influence market price; can only adjust to it [ at the mercy of the market] o WHY? Each firm produces such a small fraction of total output that their own personal production decisions will not perceptibly influence total supply or, therefore, product price Free Entry & Exit it’s easy; no significant obstacles prohibit new firms from selling output in competitive market (legal/technological/financial)
Demand as Seen by a Purely Competitive Seller
Demand faced by entire competitive market is NOT perfectly elastic o By acting independently, but together, firms can increase or decrease price (through changes in output) o Individual Firm Can’t output is too small a fraction of total output Individual Firm: o Demand curve is perfectly elastic [straight, horizontal line] o Demand Curve = Average Revenue = Marginal Revenue
AR : revenue per unit
•
[ AR=Price] in purely competitive model (because demand curve is
perfectly elastic) MR : change in total revenue that results from selling one more MR=P in pure competition Total revenue increases by constant amount with each extra unit sold
o
TR ¿ P∙ Q S
∴ SLOPE IS CONSTANT
Profit Maximization in the Short Run: Two Approaches
Purely competitive firm attempts to maximize its economic profit (or minimize its economic loss) by adjusting its output
Microeconomics Notes: Chapter 2 o In Short Run adjustments can only be made through changes in amounts of variable
resources (materials, labor) Three Questions : o Should we produce this product? Yes if [Price ≥ Minimum AVC ] which is also when If so, in what amount?
o
[Losses ≤TFC ]
o
Where MR = MC [if perfect competition, MR = P] TR Exceeds TC by a Maximum Amount These are where profit is maximized/loss is minimized What economic profit (or loss) will we realize?
Economic Profit/Loss ¿ [ TR−TC ] =( Price− ATC ) × Q **PerUnit Profit = ( Price− ATC ) **
• • • MR, AVC, ATC… Losses/ Profits
Economic Profit positive
TR=TC ] Economic Loss negative [ only shutdown if MR> ATC ] Normal Profit zero [BreakEven Point:
Economic Profit
Normal Profit/ Break Even Point
Economic Loss
Shutdown/Stay Open (Indifferent)
MR> A T C
MR=AVC
AVC < MR< ATC
MR> A V C
MR< A V C
(Positive Economic Profit)
(Zero Economic Profit)
LossTFC
(Negativ e Economic Profit)
Shutdown
Marginal Cost & ShortRun Supply:
Each point where MR=MC represents a point on the supply curve o Note: QS would be zero at any price below the AVC o ∴ Portion of MC Curve Lying Above AVC Curve is the ShortRun Supply Curve Because of law of diminishing returns, MCs eventually rise as more units of output are produced o If MCs rise, prices must also rise to motivate a purely competitive firm to increase QS Changes in Supply : [shortrun] o Increase in Supply: technology improves; MC decreases; MC Curve shifts down as viewed from horizontal axis (rightward as viewed from vertical axis) o Decrease in Supply: wages increase; MC increases; MC Curve shifts up as viewed from horizontal axis (leftward as viewed from vertical axis) Determining the Equilibrium Price : o PE is where total quantity supplied equals total quantity demanded o Total Quantity Demanded
Assume a particular number of firms in the industry Assume all firms supply the same quantity at each price Total QD at any given price is: [quantity supplied by each firm] × [number of firms in the industry] Firm Vs. Industry : o Individual Competitive Firm Price is a Given Fact o All Competitive Firms of Industry Price is Determined by All of Their Supply Curves
Keely Henesey
Four Market Models
Imperfect Competition: o Pure Monopoly : one firm is the sole seller of product
Entry of additional firms are blocked Product differentiation isn’t an issue because they are producing a single unique product o Monopolistic Competition : relatively large number of sellers producing differentiated products Widespread nonprice competition (product is distinguished based on attributes like design/workmanship; NOT price) Entry/Exit is pretty easy o Oligopoly : only a few sellers of a standardized OR differentiated product; each firm is affected by the decisions of the other firms and must take them into account in determining its own price and output Pure Competition : large number of firms producing a standardized product o New firms can enter/exit easily
Pure Competition: Characteristics & Occurrence
Very Large Numbers large number of sellers; large market Standardized Product identical/homogeneous product o Buyers view products from firms B, C, D, & E as perfect substitutes for the product of firm A o If price is constant across all firms, buyers are indifferent to which firm the buy from Competitive Firms Are “Price Takers” cannot influence market price; can only adjust to it [ at the mercy of the market] o WHY? Each firm produces such a small fraction of total output that their own personal production decisions will not perceptibly influence total supply or, therefore, product price Free Entry & Exit it’s easy; no significant obstacles prohibit new firms from selling output in competitive market (legal/technological/financial)
Demand as Seen by a Purely Competitive Seller
Demand faced by entire competitive market is NOT perfectly elastic o By acting independently, but together, firms can increase or decrease price (through changes in output) o Individual Firm Can’t output is too small a fraction of total output Individual Firm: o Demand curve is perfectly elastic [straight, horizontal line] o Demand Curve = Average Revenue = Marginal Revenue
AR : revenue per unit
•
[ AR=Price] in purely competitive model (because demand curve is
perfectly elastic) MR : change in total revenue that results from selling one more MR=P in pure competition Total revenue increases by constant amount with each extra unit sold
o
TR ¿ P∙ Q S
∴ SLOPE IS CONSTANT
Profit Maximization in the Short Run: Two Approaches
Purely competitive firm attempts to maximize its economic profit (or minimize its economic loss) by adjusting its output
Microeconomics Notes: Chapter 2 o In Short Run adjustments can only be made through changes in amounts of variable
resources (materials, labor) Three Questions : o Should we produce this product? Yes if [Price ≥ Minimum AVC ] which is also when If so, in what amount?
o
[Losses ≤TFC ]
o
Where MR = MC [if perfect competition, MR = P] TR Exceeds TC by a Maximum Amount These are where profit is maximized/loss is minimized What economic profit (or loss) will we realize?
Economic Profit/Loss ¿ [ TR−TC ] =( Price− ATC ) × Q **PerUnit Profit = ( Price− ATC ) **
• • • MR, AVC, ATC… Losses/ Profits
Economic Profit positive
TR=TC ] Economic Loss negative [ only shutdown if MR> ATC ] Normal Profit zero [BreakEven Point:
Economic Profit
Normal Profit/ Break Even Point
Economic Loss
Shutdown/Stay Open (Indifferent)
MR> A T C
MR=AVC
AVC < MR< ATC
MR> A V C
MR< A V C
(Positive Economic Profit)
(Zero Economic Profit)
LossTFC
(Negativ e Economic Profit)
Shutdown
Marginal Cost & ShortRun Supply:
Each point where MR=MC represents a point on the supply curve o Note: QS would be zero at any price below the AVC o ∴ Portion of MC Curve Lying Above AVC Curve is the ShortRun Supply Curve Because of law of diminishing returns, MCs eventually rise as more units of output are produced o If MCs rise, prices must also rise to motivate a purely competitive firm to increase QS Changes in Supply : [shortrun] o Increase in Supply: technology improves; MC decreases; MC Curve shifts down as viewed from horizontal axis (rightward as viewed from vertical axis) o Decrease in Supply: wages increase; MC increases; MC Curve shifts up as viewed from horizontal axis (leftward as viewed from vertical axis) Determining the Equilibrium Price : o PE is where total quantity supplied equals total quantity demanded o Total Quantity Demanded
Assume a particular number of firms in the industry Assume all firms supply the same quantity at each price Total QD at any given price is: [quantity supplied by each firm] × [number of firms in the industry] Firm Vs. Industry : o Individual Competitive Firm Price is a Given Fact o All Competitive Firms of Industry Price is Determined by All of Their Supply Curves
