Download Pure Competition

Energy Economics and Policy
Spring 2012
Instructors: Chu Xiaodong , Zhang Wen
Email：[email protected],
[email protected]
Office Tel.: 81696127
09
Pure Competition in the Short Run
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Four Market Models
• Pure competition
• Pure monopoly
• Monopolistic competition
• Oligopoly
Pure
Competition
Monopolistic
Competition
Oligopoly
Pure
Monopoly
Market Structure Continuum
LO1
8-3
Four Market Models
Characteristics of the Four Basic Market Models
Pure
Characteristic Competition
Monopolistic
Competition
Oligopoly
Monopoly
Number of firms
A very large
number
Many
Few
One
Type of product
Standardized
Differentiated
Standardized or
differentiated
Unique; no
close subs.
Control over
price
None
Some, but within rather
narrow limits
Limited by mutual
inter-dependence;
considerable with
collusion
Considerable
Conditions of
entry
Very easy, no
obstacles
Relatively easy
Significant
obstacles
Blocked
Nonprice
Competition
None
Considerable emphasis
on advertising, brand
names, trademarks
Typically a great
deal, particularly
with product
differentiation
Mostly public
relation
advertising
Examples
Agriculture
Retail trade, dresses,
shoes
Steel, auto, farm
implements
Local utilities
LO1
8-4
Pure Competition: Characteristics
• Very large numbers of sellers
• Standardized product
• “Price takers”
• Easy entry and exit
• Perfectly elastic demand
• Firm produces as much or little as they
want at the price
• Demand graphs as horizontal line
LO2
8-5
Average, Total, and Marginal Revenue
• Average Revenue
• Revenue per unit
• AR = TR/Q = P
• Total Revenue
• TR = P X Q
• Marginal Revenue
• Extra revenue from 1 more unit
• MR = ΔTR/ΔQ
LO3
8-6
Average, Total, and Marginal Revenue
Firm’s
Demand
Schedule
(Average
Revenue)
QD
P
Firm’s
Revenue
Data
TR
MR
0 $131
$0
] $131
1 131 131
] 131
2 131 262
] 131
3 131 393
] 131
4 131 524
] 131
5 131 655
] 131
6 131 786
] 131
7 131 917
] 131
8 131 1048
] 131
9 131 1179
131
10 131 1310 ]
LO3
TR
P = MR = AR
8-7
Profit Maximization: TR–TC Approach
• Three questions:
• Should the firm produce?
• If so, what amount?
• What economic profit (loss) will be
realized?
LO3
8-8
Profit Maximization: TR–TC Approach
The Profit-Maximizing Output for a Purely Competitive Firm: Total Revenue –
Total Cost Approach (Price = $131)
(1)
Total Product
(Output) (Q)
(2)
Total Fixed Cost
(TFC)
(3)
Total Variable
Costs (TVC)
(4)
Total Cost
(TC)
(5)
Total Revenue
(TR)
(6)
Profit (+)
or Loss (-)
0
$100
$0
$100
$0
$-100
1
100
90
190
131
-59
2
100
170
270
262
-8
3
100
240
340
393
+53
4
100
300
400
524
+124
5
100
370
470
655
+185
6
100
450
550
786
+236
7
100
540
640
917
+277
8
100
650
750
1048
+298
9
100
780
880
1179
+299
10
100
930
1030
1310
+280
LO3
8-9
Profit Maximization: TR–TC Approach
Total Economic
Profit
Total Revenue and Total Cost
$1800
1700
1600
1500
1400
1300
1200
1100
1000
900
800
700
600
500
400
300
200
100
LO3
Break-Even Point
(Normal Profit)
Total Revenue, (TR)
Maximum
Economic
Profit
$299
Total Cost,
(TC)
P=$131
Break-Even Point
(Normal Profit)
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Quantity Demanded (Sold)
$500
400
300
200
100
Total Economic
Profit
$299
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Quantity Demanded (Sold)
8-10
Profit Maximization: MR-MC Approach
The Profit-Maximizing Output for a Purely Competitive Firm: Marginal
Revenue – Marginal Cost Approach (Price = $131)
(1)
Total
Product
(Output)
(2)
Average
Fixed Cost
(AFC)
(3)
Average
Variable
Costs (AVC)
(4)
Average
Total Cost
(ATC)
(5)
Marginal
Cost
(MC)
(5)
Price =
Marginal
Revenue
(MR)
0
LO3
(6)
Total
Economic
Profit (+)
or Loss (-)
$-100
1
$100.00
$90.00
$190
$90
$131
-59
2
50.00
85.00
135
80
131
-8
3
33.33
80.00
113.33
70
131
+53
4
25.00
75.00
100.00
60
131
+124
5
20.00
74.00
94.00
70
131
+185
6
16.67
75.00
91.67
80
131
+236
7
14.29
77.14
91.43
90
131
+277
8
12.50
81.25
93.75
110
131
+298
9
11.11
86.67
97.78
130
131
+299
10
10.00
93.00
103.00
150
131
+280
8-11
Profit Maximization: MR-MC Approach
Cost and Revenue
$200
MR = MC
150
MC
P=$131
MR = P
ATC
Economic Profit
100
AVC
A=$97.78
50
0
1
2
3
4
5
6
7
8
9
10
Output
LO3
8-12
Loss-Minimizing Case
• Loss minimization
• Still produce because P > minAVC
• Losses at a minimum where MR=MC
LO3
8-13
Loss-Minimizing Case
Cost and Revenue
$200
MC
150
Loss
A=$91.67
ATC
AVC
100
P=$81
50
0
MR = P
V = $75
1
2
3
4
5
6
7
8
9
10
Output
LO3
8-14
Shutdown Case
Cost and Revenue
$200
MC
150
ATC
V = $74
100
AVC
MR = P
P=$71
Short-Run Shut Down Point
P < Minimum AVC
$71 < $74
50
0
1
2
3
4
5
6
7
8
9
10
Output
LO3
8-15
Three Production Questions
Output Determination in Pure Competition in the Short Run
LO3
Question
Answer
Should this firm produce?
Yes, if price is equal to, or greater than,
minimum average variable cost. This
means that the firm is profitable or that
its losses are less than its fixed cost.
What quantity should this firm produce?
Produce where MR (=P) = MC; there,
profit is maximized (TR exceeds TC by
a maximum amount) or loss is
minimized.
Will production result in economic
profit?
Yes, if price exceeds average total cost
(TR will exceed TC). No, if average
total cost exceeds price (TC will exceed
TR).
8-16
Firm and Industry: Equilibrium
Firm and Market Supply and the Market Demand
LO4
(1)
Quantity
Supplied,
Single
Firm
(2)
Total
Quantity
Supplied,
1000 Firms
(3)
Product
Price
(4)
Total
Quantity
Demanded
10
10,000
$151
4,000
9
9,000
131
6,000
8
8,000
111
8,000
7
7,000
91
9,000
6
6,000
81
11,000
0
0
71
13,000
0
0
61
16,000
8-17
Firm and Industry: Equilibrium
S = ∑ MC’s
s = MC
Economic
Profit
ATC
d
$111
$111
AVC
D
8
LO4
8000
8-18
09
Pure Competition in the Long Run
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
The Long Run in Pure Competition
• In the long run
• Firms can expand or contract capacity
• Firms enter and exit the industry
LO1
9-20
Profit Maximization in the Long Run
• Easy entry and exit
• The only long-run adjustment we consider
• Identical costs
• All firms in the industry have identical
•
LO2
costs
Constant-cost industry
• Entry and exit do not affect resource
prices
9-21
Long-Run Equilibrium
• Entry eliminates profits
• Firms enter
• Supply increases
• Price falls
• Exit eliminates losses
• Firms exit
• Supply decreases
• Price rises
LO3
9-22
Entry Eliminates Economic Profits
P
P
S1
MC
ATC
$60
50
MR
40
S2
$60
50
D2
40
D1
0
100
(a)
Single Firm
LO3
q
0
80,000 90,000 100,000
Q
(b)
Industry
9-23
Exit Eliminates Losses
P
P
S3
MC
ATC
$60
S1
$60
50
50
MR
D1
40
40
D3
0
100
(a)
Single Firm
LO3
q
0
80,000
90,000
100,000 Q
(b)
Industry
9-24
•
•
•
LO4
Long Run Supply
Constant cost industry
• Entry/exit does not affect LR ATC
• Constant resource price
• Special case
Increasing cost industry
• Most industries
• LR ATC increases with expansion
• Specialized resources
Decreasing cost industry
9-25
LR Supply: Constant-Cost Industry
P
P1
P2 $50
Z3
Z1
Z2
S
P3
D1
D3
0
LO4
Q3
90,000
Q1
100,000
D2
Q2
110,000
Q
9-26
LR Supply: Increasing-Cost Industry
P
S
P2 $55
Y2
P1 $50
Y1
P3 $40
Y3
D2
D1
D3
0
LO4
Q3
90,000
Q1
100,000
Q2
110,000
Q
9-27
LR Supply: Decreasing-Cost Industry
P
P3 $55
X3
X1
P1 $50
X2
P2 $40
D3
S
D2
D1
0
LO4
Q3
90,000
Q1
100,000
Q2
110,000
Q
9-28
Pure Competition and Efficiency
• In the long run, efficiency is achieved
• Productive efficiency
• Producing where P = min. ATC
• Allocative efficiency
• Producing where P = MC
LO5
9-29
Pure Competition and Efficiency
Single Firm
Market
P=MC=Minimum
ATC (Normal Profit) MC
Consumer
Surplus
S
Price
Price
ATC
P
MR P
Producer
Surplus
D
0
LO5
Qf
Quantity
0
Qe
Quantity
9-30
Dynamic Adjustments
• Purely competitive markets will
•
LO6
automatically adjust to
• Changes in consumer tastes
• Resource supplies
• Technology
Recall the “Invisible Hand”
9-31
Technological Advance: Competition
• Entrepreneurs would like to increase
profits beyond just a normal profit
• Decrease costs by innovation
• New product development
LO6
9-32
Creative Destruction
• Competition and innovation may lead to
“creative destruction”
• Creation of new products and methods
destroys the old products and methods
LO6
9-33
Efficiency Gains from Entry
• Patent protected prescription drugs earn
•
substantial economic profits for the
pharmaceutical company
Generic drugs become available as the
patent expires on the existing drug
• Results in a 30-40% reduction price
• Greater consumer surplus and efficiency
9-34
Efficiency Gains from Entry
a
S
P1
b
c
d
f
P2
D
Q1
Q2
9-35
Next Lecture
• We will move to the other two market
models: pure monopoly and oligopoly
• Please read in advance chapters 10 and 11 of
[McConnell, Brue, and Flynn, 2012]