perfect competition michael j. murray · perfect competition ... •final equilibrium in the long...
TRANSCRIPT
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Perfect
Competition
• Michael J. Murray
Slides and Images, © Worth Publishers Inc.
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Market Structure Analysis
By observing a few industry characteristics,
we can predict pricing and output behavior
of the firm.
These factors are important:
• Number of firms
• Nature of product
• Barriers to entry
• Extent of control over price
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Primary Market Structures
1. Competition
2. Monopolistic Competition
3. Oligopoly
4. Monopoly
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Competitive Markets
Characteristics of Competitive
Markets:
• Many buyers and sellers
• Homogeneous (standardized)
products
• No barriers to market entry or exit
• No long-run economic profits
• No control over price
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Monopolistic Competition
Characteristics of Monopolistic
Competition:
• Many buyers and sellers
• Differentiated products
• No barriers to market entry or exit
• No long-run economic profits
• Some control over price
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Oligopoly
• Characteristics of Oligopoly:
• Fewer firms
• Mutually interdependent decisions
• Substantial barriers to entry
• Potential for long-run economic
profits
• Shared market power and
considerable control over price
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Monopoly
• Characteristics of Monopoly:
• One firm
• No close substitutes for product
• Nearly insuperable barriers to entry
• Potential for long-run economic
profits
• Substantial market power and
control over price
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Competitive Markets
In a competitive market, each firm
is a price taker.
• Price taker: Individual firms in
competitive markets get their prices from
the market since they are so small they
cannot influence market price.
Each firm’s total revenue will be
equal to
price x quantity sold = (PxQ)
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Marginal Revenue
Marginal revenue: change in total
revenue that results from the sale
of one added unit of a product.
• Reminder: Total revenue = P x Q
• MR = DTR/DQ
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A Firm in a Competitive Market
D
S
Industry Output Firm’s Output
Pri
ce (
$)
Pri
ce (
$)
Panel A
(Industry)
Panel B
(Firm)
200 200
Qe
d=MR=P=$200
q1 q2
The individual firm takes the market price as given.
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The Short Run and the Long Run
Reminder: in the short run, plant
size is fixed…
We focus here on short-run profit
maximization (at a given plant size)
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The Profit-Maximizing Rule
• A firm maximizes profit by producing
at the point where marginal revenue
equals marginal cost (MR = MC) • If a firm is earning zero economic profits at this
point, it means that it is earning a normal rate of
accounting profit.
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Economic Profits
MC
ATC
AVC
d=MR=P=$200 200
180
Co
sts
($)
Output 84
Profit
Profit = (P – ATC) x Quantity
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The Short Run and the Long Run
In the short run, one factor of
production is fixed, usually the plant
size. • Firms cannot enter or leave the industry.
• In the long run, all factors are variable. • Firms will enter the industry in response to
profits.
• Firms will leave the industry in response to
losses.
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Normal Profits
MC
ATC
AVC PL
Co
sts
($)
Output
d=MR=P=$177.60
200
180
75
The firm earns zero economic profit. This is a normal rate of return.
Normal profits: equal to zero economic profits, where P = ATC
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Loss Minimization
If price falls below average total cost,
the firm will incur a loss.
The firm can minimize the loss by
following this rule: • Continue to produce (in the short run) as long
as price covers average variable cost.
• Shut down in the short run if price falls below
average variable cost.
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Loss Minimization
MC
ATC
AVC
d=MR=P=$170
$177.85
$170
Co
sts
($)
Output 65
Loss
Loss = Negative Profit = (P – ATC) x Quantity= -$510.25
If price falls to $170…
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Shutdown rule: when the price falls below minimum AVC,
firm should shut down immediately.
When to Shut Down?
MC
ATC
AVC
d=MR=P=$162.50 $162.50
Co
sts
($)
Output 65
Loss
Losses begin to exceed fixed costs. The firm will do better
to close down and limit losses to fixed costs.
If price falls below $162.50
(minimum AVC)…
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Short-Run Supply Curve The firm’s short-run supply curve is its
marginal cost curve above the
minimum point on the average variable
cost curve.
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Long Run Adjustments
• If firms in the industry are earning short run
economic profits, new firms can be
expected to enter the industry in the long
run, or existing firms may increase the
scale of their operations.
• Losses will lead to the exit of some firms.
• Final equilibrium in the long run is the point
at which industry price is just tangent to the
minimum point on the ATC curve.
• P = MR = MC = LRATCmin
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Profit
Economic profits attract more
supply…
D
S0
Industry Output
Pri
ce (
$)
Panel A
(Industry)
P0
Q0
S1
P1
QL
MC
ATC
AVC
P1
Co
sts
($
)
Firm’s Output
P0
Panel B
(Firm)
As long as there are above-normal profits, industry supply
increases and market price falls. Profits decline toward zero
economic profits.
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Losses cause firms to exit
Supply decreases, price rises and profits must rise
(or losses must decrease).
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Competition and the Public
Interest
The long-run outcome in
competitive markets will have:
• Productive Efficiency: Goods are
supplied at the lowest possible
opportunity cost.
• Allocative Efficiency: The mix of goods
and services produced are just what
society desires. The price that consumers
pay is equal to marginal cost and is also
equal to the least average total cost.
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Long Run Industry Supply
Long run industry supply:
•How much does the expansion of an
industry influence resource prices?
•When an industry expands, this new
demand for raw materials and labor
may push up the price of some inputs.
•Increasing cost industry: an industry that
faces higher prices and costs as industry
output expands.
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Constant Cost Industries
• Constant cost industries: expand in
the long run without significant
changes in average cost.
• Some fast food restaurants re-create
their operations from market to market
without a noticeable rise in costs.
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Increasing Cost Industries
• Increasing cost industry: An
industry that experiences higher
costs as it expands.
• Examples?
• Oil industry
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Increasing, Constant, and
Decreasing Cost Industries