Post on 11-Jan-2016
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Perfect Competition
Overheads
Market Structure
Market structure refers to all characteristics of a marketthat influence the behavior of buyers and sellers,when they come together to trade
Market structure refers to all features of a market that affectthe 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 themselvesand others to set prices
Degree of product differentiation
Technologies employed by agents in the market
Amount of information available to agents about the goodand 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 competitivecompetitive if theagent assumes or believes that the market price is givenand 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 ofone seller or one buyer
Common Market Structures
Oligopoly
Firm sets prices (faces residual demand)
Entry and exit barriers result in the existence offew sellers or buyers
Common Market Structures
Monopolistic competition
Firm sets prices (faces residual demand)
Entry and exit barriers are minimal
Perfect Competition1. Buyers and sellers are competitive or price takers
2. All firms produce homogeneous (standardized) goodsand consumers view them as identical
3. All buyers and sellers have perfect informationregarding 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 productgoes 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 firmis 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
Industry Supply-Demand Equilibrium
$
Output
S(p)
p0
Q0
D(p)
Demand for Individual Firm
$
Output
p0 D(p)
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
π Revenue Costs
R C
The firm’s goal is then to maximize returns fromthe 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
π(p, w1 , w2 , ) maxx, y
p y Σn
i 1wixi such that x ε P(x)
π(p , w1 , w2 , ) maxy
py C(y , w1 , w2 , )
π(p, w1, w2 , ) maxx
pf (x1 , x2 , , xn) Σn
i 1wixi
Example Problem
P = $184
Cost(y) 200 65y 2y 2 y 3
y FC VC C AFC AVC ATC MC Price TR MR Profit0.00 200 0.00 200.00 184 0 -200.00
64.00 184.001.00 200 64.00 264.00 200.00 64.00 264.00 184
184 -80.0066.00 184.00
2.00 200 130.00 330.00 100.00 65.00 165.00 184 368 38.00
74.00 184.00
3.00 200 204.00 404.00 66.67 68.00 134.67 184552 148.00
88.00 184.00
4.00 200 292.00 492.00 50.00 73.00 123.00 184736 244.00
108.00 184.00
5.00 200 400.00 600.00 40.00 80.00 120.00 184920 320.00
134.00 184.006.00 200 534.00 734.00 33.33 89.00 122.33 184
1104 370.00166.00 184.00
7.00 200 700.00 900.00 28.57 100.00 128.57 1841288 388.00
204.00 184.008.00 200 904.00 1104.00 25.00 113.00 138.00 184
1472 368.00 248.00 184.00
9.00 200 1152.00 1352.00 22.22 128.00 150.22 1841656 304.00
298.00 184.0010.00 200 1450.00 1650.00 20.00 145.00 165.00
184 1840 190.00
Note that TR is linear with slope = 184
Total Revenue and Cost Curves
0500
1000150020002500300035004000
0 2 4 6 8 10 12 14 16 18Output
$
TR
C
Price
Price = MR = Demand
Price, Marginal Cost, and Average Cost
0
50
100
150200
250
300
350400
0 2 4 6 8 10 12 14 16 18Output
$
ATC
MC
Price
MC
AVC
ATC
AFC
Add average variable and average fixed costs
0
50
100
150200
250
300
350
400
0 2 4 6 8 10 12 14 16 18Output
$
Maximizing profit
Choose the level of output wherethe difference between TR and TCis the greatest
y C MC Price TR MR Profit3 404 184 552 148
88.00 184.004 492 184 736 244
108.00 184.005 600 184 920 320
134.00 184.006 734 184 1104 370
166.00 184.007 900 184 1288 388
204.00 184.008 1104 184 1472 368
248.00 184.00 9 1352 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
Should we increase output from 5 to 6?
Should we increase output from 6 to 7?
Should we increase output from 7 to 8?
Yes
Yes
No !
y C MC Price TR MR Profit4.00 492.00 184 736 244.00
108.00 184.005.00 600.00 184 920 320.00
134.00 184.006.00 734.00 184 1104 370.00
166.00 184.007.00 900.00 184 1288 388.00
204.00 184.008.00 1104.00 184 1472 368.00
248.00 184.00 9.00 1352.00 184 1656 304.00
Measuring Total Profit
Profit π Total revenue Total cost
py C (y , w1 , w2 , )
Profit is always given by
Graphically it is the distance betweentotal revenue and total cost
Total Revenue and Cost Curves
0500
1000150020002500300035004000
0 2 4 6 8 10 12 14 16 18Output
$
TR
C
Profit, price, and average total cost
Profit per unit is given by
Profit per unit πy
py C(y , w1 , w2 , )
y
pyy
TCy
p ATC
MC
The distance between price and ATC at the optimumoutput level is profit per unit
Cost Curves and Profit
0
50
100
150
200
250
300
350
0 2 4 6 8 10 12 14 16 18Output
$ ATC
Price
ATC Opt
Q Opt
Total profit is given by the area of the boxbounded by
price,
the optimum quantity,
average total cost at the optimum quantity,
and the price axis
MC
Cost Curves and Profit
0
50
100
150
200
250
300
350
0 2 4 6 8 10 12 14 16 18Output
$ ATC
Price
ATC Opt
Q Opt
The firm earns a profit wheneverp > ATC
y C AVC ATC MC Price TR Profit5.00 600.00 80.00 120.00 184 920 320.00
134.00 6.00 734.00 89.00 122.33 184 1104 370.00
166.00 7.00 900.00 100.00 128.57 184 1288 388.00
204.00 8.00 1104.00 113.00 138.00 184 1472 368.00
(184 - 128.5714) = 55.4286
(55.4286) (7) = $388
A firm suffers a loss whenever p < ATCat the optimum level of output
Let p = $97
We can show that theoptimum quantity is 4 units
y C AVC ATC MC Price TRProfit0.00 200.00 97 0 -200.00
64.00 1.00 264.00 64.00 264.00 97 97 -167.00
66.00 2.00 330.00 65.00 165.00 97 194 -136.00
74.00 3.00 404.00 68.00 134.67 97 291 -113.00
88.00 4.00 492.00 73.00 123.00 97 388 -104.00
108.005.00 600.00 80.00 120.00 97 485 -115.00
134.006.00 734.00 89.00 122.33 97 582 -152.00
166.007.00 900.00 100.00 128.57 97 679 -221.00
Cost Curves and Profit
0
50
100
150
200
250
300
350
400
0 2 4 6 8 10 12 14 16 18Output
$
ATC
MC
Price
ATC OptQ Opt
Loss
y FC VC C AFC AVC ATC MC Price TR MR Profit0.00 200 0.00 200.00 97 0 -200.00
64.00 97.001.00 200 64.00 264.00 200.00 64.00 264.00 97 97
-167.0066.00 97.00
2.00 200 130.00 330.00 100.00 65.00 165.00 97 194 -136.00
74.00 97.003.00 200 204.00 404.00 66.67 68.00 134.67 97291 -113.00
88.00 97.004.00 200 292.00 492.00 50.00 73.00 123.00 97388 -104.00
108.00 97.005.00 200 400.00 600.00 40.00 80.00 120.00 97485 -115.00
134.00 97.006.00 200 534.00 734.00 33.33 89.00 122.33 97582 -152.00
166.00 97.007.00 200 700.00 900.00 28.57 100.00 128.57 97
679 -221.00204.00 97.00
8.00 200 904.00 1104.00 25.00 113.00 138.00 97776 -328.00
248.00 97.009.00 200 1152.00 1352.00 22.22 128.00 150.22 97
873 -479.00298.00 97.00
10.00 200 1450.00 1650.00 20.00 145.00 165.00 97 970 -680.00
Another example problem
P = $120
Cost(y) 200 100y 14y 2 y 3
MC(y) 100 28y 3y 2
y Price TR MR FC VC C AFC AVC ATC MCProfit
0.00 120 0 1202000.00 200.00 -200.000.25 120 30 12020024.14 224.14 800.00 96.56 896.56 93.19 -194.140.50 120 60 12020046.63 246.63 400.00 93.25 493.25 86.75 -186.631.00 120 120 12020087.00 287.00 200.00 87.00 287.00 75.00 -167.002.00 120 240 120200152.00 352.00 100.00 76.00
176.00 56.00 -112.003.00 120 360 120200201.00 401.00 66.67 67.00
133.67 43.00 -41.004.00 120 480 120200240.00 440.00 50.00 60.00
110.00 36.00 40.005.00 120 600 120200275.00 475.00 40.00 55.00
95.00 35.00 125.006.00 120 720 120200312.00 512.00 33.33 52.00
85.33 40.00 208.007.00 120 840 120200357.00 557.00 28.57 51.00
79.57 51.00 283.008.00 120 960 120200416.00 616.00 25.00 52.00
77.00 68.00 344.009.00 120 1080 120200 495.00 695.00 22.22 55.00 77.22 91.00 385.0010.00 120 1200 120 200 600.00 800.00 20.00
60.00 80.00 120.00 400.0011.00 120 1320 120 200 737.00 937.00 18.18
67.00 85.18 155.00 383.0012.00 120 1440 120 200 912.00 1112.00 16.67
76.00 92.67 196.00 328.0014.00 120 1680 120 200 1400.00 1600.00 14.29
100.00 114.29 296.00 80.0016.00 120 1920 120 200 2112.00 2312.00 12.50
132.00 144.50 420.00 -392.00
For a given price we can find optimal output
HOW?
Choose output level where MC = MR = P
AVC
MC
ATC
P = 120
Short Run Equilibrium
0
50
100
150
200
250
300
0 2 4 6 8 10 12 14 16 18Output
$
P = MC y* = 10
Q Opt
= $400
Profit
y Price TR MR Cost MC Profit7.00 120 840 120 557.00 51.00 283.008.00 120 960 120 616.00 68.00 344.009.00 120 1080 120 695.00 91.00 385.0010.00 120 1200 120 800.00 120.00 400.0011.00 120 1320 120 937.00 155.00 383.0012.00 120 1440 120 1112.00 196.00 328.00
= $400
The firm is happy!!
And R - VC (ROVC) = $600
AVC
MC
ATC
P = 120
Short Run Equilibrium
0
50
100
150
200
250
300
0 2 4 6 8 10 12 14 16 18Output
$
P = MC y* = 10
Q Opt
ROVC = $600
ROVC
y Price TR MR VC C MC Profit6 91 546 91 312 512 40 347 91 637 91 357 557 51 808 91 728 91 416 616 68 1129 91 819 91 495 695 91 12410 91 910 91 600 800 120 11011 91 1001 91 737 937 155 6412 91 1092 91 912 1112 196 -20
Now let p = $91
y* = 9, = $124
The firm is still happy!!
And R - VC (ROVC) = $324
AVC
MC
ATC
P = 120
Short Run Equilibrium
0
50
100
150
200
250
300
0 2 4 6 8 10 12 14 16 18Output
$
P = 91
AVC
MC
ATCShort Run Equilibrium
0
50
100
150
200
250
300
0 2 4 6 8 10 12 14 16 18Output
$
P = 91
P = MC y* = 9
= $ 124 ROVC = $324
Q Opt
ProfitROVC
y Price TR MR VC C MC Profit6 68 408 68 312 512 40 -1047 68 476 68 357 557 51 -818 68 544 68 416 616 68 -729 68 612 68 495 695 91 -8310 68 680 68 600 800 120 -12011 68 748 68 737 937 155 -18912 68 816 68 912 1112 196 -296
Now let p = $68
y* = 8, = $-72
The firm is not so happy!!
But R - VC (ROVC) = $128
AVC
MC
ATC
P = 120
P = 68
Short Run Equilibrium
0
50
100
150
200
250
300
0 2 4 6 8 10 12 14 16 18Output
$
P = 91
AVC
MC
ATC
P = 68
Short Run Equilibrium
0
50
100
150
200
250
300
0 2 4 6 8 10 12 14 16 18Output
$
P = MC y* = 8
= $-72 ROVC = $128
ROVC
Q OptLoss
y Price TR MR VC C MC Profit6 51 306 51 312 512 40 -2067 51 357 51 357 557 51 -2008 51 408 51 416 616 68 -2089 51 459 51 495 695 91 -23610 51 510 51 600 800 120 -29011 51 561 51 737 937 155 -37612 51 612 51 912 1112 196 -500
Now let p = $51
y* = 7, = $ -200
The firm may as well shut down
AVC
P = 51
MC
ATC
P = 120
P = 68
Short Run Equilibrium
0
50
100
150
200
250
300
0 2 4 6 8 10 12 14 16 18Output
$
P = 91
AVC
P = 51
MC
ATCShort Run Equilibrium
0
50
100
150
200
250
300
0 2 4 6 8 10 12 14 16 18Output
$
P = MC y* = 7
= $-200 ROVC = $0
ROVC
Q OptLoss
y Price TR MR C MC Profit5 40 200 40 475 35 -2756 40 240 40 512 40 -2727 40 280 40 557 51 -2778 40 320 40 616 68 -2969 40 360 40 695 91 -33510 40 400 40 800 120 -40011 40 440 40 937 155 -497
Now let p = $40
y* = 6, = $ -272
The firm should get out in a hurry!
AVC
P = 51
MC
ATC
P = 120
P = 68
Short Run Equilibrium
0
50
100
150
200
250
300
0 2 4 6 8 10 12 14 16 18Output
$
P = 40
P = 91
AVC
P = 51
MC
ATC
P = 120
P = 68
Short Run Equilibrium
0
50
100
150
200
250
300
0 2 4 6 8 10 12 14 16 18Output
$
P = 40
P = 91
P = MC y* = 6
= $- 272 ROVC = $-72
Loss
ROVC
AVC
P = 51
MC
ATC
P = 196
P = 120
P = 68
Short Run Equilibrium
0
50
100
150
200
250
300
0 2 4 6 8 10 12 14 16 18Output
$
P = 40
P = 91
Short run supply
At different prices we know how muchthe firm will choose to supply
By plotting these points we can obtainthe short run supply curve
Short-run supply curveAVC
P = 51
MC
P = 196
P = 120
P = 68
0
50
100
150
200
250
300
0 2 4 6 8 10 12 14 16 18Output
$
P = 40
P = 91
MC
AVC
ATC
Short Run Supply Curve
0
50
100
150
200
250
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14Output
$
Supply
0 2 4 6 8 10 12 14 16 18Output
Short Run Equilibrium
050
100150200250300
$
We can connect the dots?
Not really
Short Run Supply Curve
0
50
100
150
200
250
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14Output
$
Supply
We connect, but with a discontinuity
Short Run Supply Curve
0
50
100
150
200
250
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14Output
$
Supply
The competitive firm's supply curve has two parts
To summarize
For all prices above the minimum pointon the firm’s average variable cost (AVC) curve,the supply curve coincides with themarginal cost curve (MC)
For prices below the minimum pointon the average variable cost curve (AVC),the firm will shut down,
so its supply curve is a vertical line at zero units of output
MC
AVC
Short Run Supply
0
50
100
150
200
250
300
0 2 4 6 8 10 12 14 16 18Output
$
AVC
MC
Short Run Supply
0
50
100
150
200
250
300
0 2 4 6 8 10 12 14 16 18Output
$
AVC
ATC
Short Run Supply
0
50
100
150
200
250
300
0 2 4 6 8 10 12 14 16 18Output
$
MC
yi yi (p , w1 , w2 , , wn , z)
We write the individual supply curve as
p - price of output
w1, w2, w3, … - 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
It is constructed by summing the quantitiessupplied by the individual firms
Shows the quantity supplied by the industryat each price when the plant size of each firmand the number of firms remain constant
Q S ΣL
i 1yi (p , w1 ,w2 , , z)
The market or industry supply curve, QS, is the horizontal summation of the individual firm supply curves
We account for the fact that yi yi(p , w1 , w2 , , wn , z )
will be zero at some price levels
yi yi (p , w1 , w2 , , wn , z)
The market supply curve is then a curve indicatingthe quantity of output that all sellers in a marketwill produce at different prices.
Q S L y(p , w1 ,w2 , , z)
If there are L identical firms, each with supply,
yi y (p, w1 , w2 , , wn , z) 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
0
50
100
150
200
250
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14Output
$
Supply
P = 51, y = 7
P = 68, y = 8
P = 120, y = 10
Short Run Market Supply Curve
0
50
100
150
200
250
0 100 200 300 400 500 600 700Output
$
Supply
P = 51, y = 350
P = 68, y = 400
P = 120, y = 500
Short Run Market (Industry) Equilibrium
Market Demand Curve
050
100150200250
0 100 200 300 400 500 600 700Output
$
D
Q D 1250 6.25P
P 200 0.16Q D
Short Run Market Supply & Demand Curves
Finding the market equilibrium
P = $120, Q = 500
0
50
100
150
200
250
0 100 200 300 400 500 600 700Output
$ SupplyDemand
P
Q*
D1
Increase the demand toQ D 1825 6.25P P 292 0.16Q D
P = $196, Q = 600
Short Run Market Supply & Demand Curves
0
50
100
150
200
250
300
0 100 200 300 400 500 600 700 800Output
$
Supply
DemandPQ*
P1Q1*
D1
Decrease the demand toQ D 825 6.25P P 132 0.16Q D
P = $68, Q = 400
Short Run Market Supply & Demand Curves
0
50
100
150
200
250
300
0 100 200 300 400 500 600 700 800Output
$
Supply
DemandPQ*
Q1*
D2P2Q2*
P1
AVC
MC
Going back to the individual firmQ D 1250 6.25P P 200 0.16Q D
P 120, Q S 500
yi = 10
Life is good ATC
P = 120
0
50
100
150
200
250
300
0 2 4 6 8 10 12 14 16 18Output
$
i = 400
What about the equilibrium price of $68.00?
Not what the managers had in mind!
AVC
MC
ATC
P = 68
0
50
100
150
200
250
300
0 2 4 6 8 10 12 14 16 18Output
$
With short run losses, the firm will onlystay in the industry in the short run
In the long run, a firm with losses willexit the industry
At the same time, short run profits willencourage firms to enter the industry
And so we must consider the long run!
The End
AVC
P = 91
MC
P = 51
ATC
P = 196
P = 120
P = 68
Short Run Equilibrium
0
50
100
150
200
250
300
0 2 4 6 8 10 12 14 16 18Output
$
P = 40
P = MC y* = 10
= $400
P1
Increase the demand toQ D 1825 6.25P P 292 0.16Q D
P = $196, Q = 600
Short Run Market Supply & Demand Curves
0
50
100
150
200
250
300
0 100 200 300 400 500 600 700 800Output
$
Supply
DemandPQ*D1
Q1*
D2P2Q2*