Download 5. THEORY OF COMPETITION Three features of MR=MC rule: 1

Prof. Teresa Kamińska
Microeconomics
5. THEORY OF COMPETITION
How to survive in the market?
Competition is the process in which enterprises – influenced by their environment
(rivals) – may set their quantity of supply and a price for a supplied commodity while
maximising their profits (neoclassical definition).
MARKET STRUCTURES (MODELS)
Market
structure
Perfect
competition
Monopolistic
competition
Quantity
of
producers
A great
deal
(infinite)
A lot of
Several
Oligopoly
Monopoly
Sort of
product
Decision
making
Homogenous - quantity
standardised of output
- quantity
of output
- a price
- quantity
homogenous
of output
or
- a price
differentiate
differentiate
One
Homogenous
standardised
- quantity
of output
- a price
Market
entry
Free
entrance in
a long run
Free in a
long run
Factors’
mobility
Economic
outcome in
the long run
complete
Normal profit
incomplete Normal profit
Bounded incomplete
or no entry
Economic
profit
Entry is
blockaded incomplete
by
definition
Economic
profit
No matter the market structure the firm’s goal is maximizing the economic profit
(short run) and maximizing the firm’s value (long run). If a firm is unable to
maximize the profit in the short run it should minimize its economic loss when
sources are available to finance the loss (implicit assumption). It is impossible to
support economic loss in the long run. The goal is achieved for an output level
when marginal revenue equals marginal cost, i.e. MR = MC, known as a golden
rule.
Three features of MR=MC rule:
1. Producing is preferable to shutting down
2. The rule is accurate to profit maximization for all firms regardless
the market structure
3. The rule can be restated as P=MC when applied to a purely
competition firm
Since a perfectly competitive firm is a price taker, it makes only a
decision of setting the level of sales (custom made production).
25
Prof. Teresa Kamińska
Quantity
Total
per day Revenue
(dry
(TR)
cleaned
clothes)
0
0
1
25
2
50
3
75
4
100
5
125
6
150
7
175
8
200
9
225
10
250
11
275
12
300
13
325
Microeconomics
Total
Costs
(TC)
Economic
Profit
(∏E = TR
– TC)
m.u.
TC
TR
350
300
22
45
66
85
100
114
126
141
160
183
210
245
300
360
-22
-20
-16
-10
0
11
24
34
40
42
40
30
0
-35
250
A
200
B
150
100
25
0 1 2 3 4 5 6 7 8 9 10 11 12 13 QC
m.u.
42
0
LE
4
9
12
QC
∏E
-22
26
Prof. Teresa Kamińska
Microeconomics
In the short run a firm’s the best economic position (its equilibrium point)
dependent on a market situation can be as followed:
- The firm attains economic profit, if TR>TC or P>ATC,
a market
an enterprise (a fixed plant)
PX
m.u.
MC
S
ATC
PE
PE
d=MR=AR
D
0
QX
0
qe
m.u.
qx
TC
TR
∏E
0
qe
When producing is preferable to shutting down, the competitive business that
wants to maximise profit or minimise its loss should produce at the point
where price equals marginal cost (P=MR
P=MC).
Only under perfect competition, because of P=MR=AR the MR=MC
rule may be substituted by P=MC.
27
Prof. Teresa Kamińska
Microeconomics
- A firm attains normal profit, if TR=TC or P=ATC,
market
PX
enterprise
jp.
MC
S
S1
PE
ATC
PE
d=MR=AR
D
0
QX 0
qE
jp.
qx
TC
TR
0
qe
28
Prof. Teresa Kamińska
Microeconomics
- Minimises an economic loss, when TVC<TR<TC or AVC<P<ATC or
Le<TFC;
Market
enterprise
PX
m.u.
MC
S
S1
PE
ATC
PE
d=MR=AR
AVC
D
D1
0
QX 0
qE
qx
m.u.
TC
TVC
TR
LE
0
qe
29
Prof. Teresa Kamińska
Microeconomics
TVC=TR or AVC=P or Le=TFC denotes a shut – down point,
market
PX
enterprise
m.u.
MC
S
S1
ATC
AVC
D
PE
D1 PE
d=MR=AR
D2
0
QX 0
qE
qx
m.u.
TC
TVC
TR
LE
0
qe
qx
30
Prof. Teresa Kamińska
Microeconomics
- for P <AVC or TR <TVC or Le>TFC the firm will supply zero.
market
enterprise
PX
m.u.
S
MC
S1
S2
ATC
D
PE
D1
AVC
PE
d=MR=AR
D2
0
QX
0
qE
qx
m.u.
TC
TVC
LE
TR
0
qe
qx
In the short run it pays to shut down (cease production) whenever the price falls below
the minimum of average variable cost (AVC).
Firms in all market structures will expand output if the gain in marginal revenue
exceeds the increase in marginal costs, and will contract output if the loss in revenue is
smaller than the reduction in costs.
31
Prof. Teresa Kamińska
Microeconomics
P
MC
ATC
P4
P3
s
AVC
P2
P1
0
q1 q2
q3 q4
qx
Firm in perfect competition
Break-even points
m.u.
Pareto optimal
allocative optimum
MC
ATC
d=MR=AR
AVC
productive optimum (technical efficiency)
0
shut-down point
Considering below data that concern a firm operating in a perfectly competitive market
indicate the lowest possible price, which justifies
production in the short run.
qX
MC
0
-
1
50
2
10
3
6
4
14
5
30
32
Prof. Teresa Kamińska
Microeconomics
PURE MONOPOLY
Five factors that may lead to this market structure:
exclusive control over key inputs
economies of scale
patents
network economies
government licenses or franchises.
P1
∆P
P2
monopoly sacrifices TR = ∆P Q1
monopoly gains
TR = ∆Q P2
I
MR =
∆Q ⋅ P2 − ∆P ⋅ Q1
∆Q
II
D=d
0
Q1 ∆ Q Q2
Q
Once ∆P approaches zero, the expression for marginal revenue approaches
∆P
MR = P −
Q
∆Q .
∆P
Solving equation of price elasticity of demand for ∆Q and substitute an outcome into
1
the above equation, we get MR = P (1 − E ) .
dp
33
Microeconomics
Prof. Teresa Kamińska
TOTAL REVENUE AND TOTAL COST FUNCTIONS
- a monopoly attains an economic profit if TR>TC or P>ATC
m.u.
36
m.u.
TR
TC
12
TR
0
qE
output (sales)
D=d
MR
0 1 2 3 4 5 6 7 8 9 10 11 12
MC
PE
ATC
MR
D=d=AR
P = 12-QX
0
P
12
11
10
9
8
7
6
5
4
3
2
1
0
Q
0
1
2
3
4
5
6
7
8
9
10
11
12
TR
0
11
20
27
32
35
36
35
32
27
20
11
0
qE
MR
11
9
7
5
3
1
-1
-3
-5
-7
-9
-11
34
Microeconomics
Prof. Teresa Kamińska
In monopoly there is no supply curve, since a price is endogenous, what means,
that the sales value does not respond to the price level directly; it is possible to sell
various amount of output at the same price or the same amount of output at
various prices.
Find the marginal revenue curves that correspond to the demand curves:
• P = 12 – 3Q
• P = 100 – 2Q
Monopoly power is equal to L =
P − MC
1
=
P
E dp ,
which could be interpreted as the profit – maximizing mark – up. For example, if
the price elasticity of demand facing a monopoly were equal to - 2, the profit –
maximizing mark – up would be ½, which implies that the profit – maximizing
price is twice marginal cost. The profit – maximizing mark – up grows smaller as
demand grows more elastic.
Because monopolies often earn economic profits, they have incentives to acquire
monopoly power. Activities aimed at creating or preserving monopoly power are
called rent – seeking activities. Expenditures on that sort of performance can
represent an important social costs of monopoly. The monopoly profit represents
the maximum a firm would be willing to spend on rent – seeking activities to
protect its monopoly.
35
Microeconomics
Prof. Teresa Kamińska
Normal profit, when TR=TC or P=ATC
m.u.
MC
ATC
PE
D=d=AR
MR
0
qE
production (sale)
TC
TR
0
qE
production (sale)
36
Microeconomics
Prof. Teresa Kamińska
A monopoly minimises an economic loss if TVC<TR<TC or AVC<P<ATC
or Le<TFC
m.u.
MC
ATC
AVC
MR
0
qE
D=d=AR
TC
m.u.
TVC
TR
qE
Qx
37
Microeconomics
Prof. Teresa Kamińska
- TVC=TR or AVC=P or Le=TFC means a shut down point
m.u.
MC
ATC
AVC
MR
0
D=d=AR
qE
m.u.
TC
TVC
TR
0
qE
Qx
38
Microeconomics
Prof. Teresa Kamińska
Gives up (ceases) a production if TVC>TR or AVC>P or Le>TFC
m.u.
MC
MR
0
D=d=AR
qE
m.u.
ATC
AVC
Qx
TC
TVC
TR
0
qE
Qx
Basing on below data complete the table and illustrate both situations graphically
Firm’s position
1.
MR=P>ATC=MC>AVC
2.
MR<AVC<P=MC<ATC
Market
structure
Edp in
optimum
Economic
outcome
Necessary
changes
qx: ↑ ↓ no
Px: ↑ ↓ no
qx: ↑ ↓ no
Px: ↑ ↓ no
.
39
Microeconomics
Prof. Teresa Kamińska
natural monopoly
m.u.
PE
profit maximizing pricing rule
AC pricing rule
MC pricing rule
Pmax
LAC
PO
LMC
0
qE
qmax qO
Price discrimination is a practice of charging different prices to different customers for
similar commodities because of differences in buyers’ willingness to pay (not because of
costs of production) . The key idea is to convert consumer surplus into economic profit.
Monopoly is able to discriminate the prices when the firm:
1. has got a market power (a diminishing demand function)
2. has got an information about various prices that customers are willing to pay for
the commodity
3. is able to prevent from its product resale for higher price (it is impossible or
impractical for buyers to trade among themselves).
Therefore monopoly is capable to discriminate prices in three ways:
first - degree price discrimination – the firm tries to price each unit at the
consumer’s reservation price (i.e. the consumer’s maximum willingness to pay)
for that unit
under second – degree price discrimination, the firm offers consumers a quantity
discount (the amount the consumer pays depends on the number of units he/she
purchases)
with third – degree price discrimination, the firm identifies different receiver
groups or segments in the market because of various price elasticity of demand.
The profit – maximizing firm sets a price for each segment of the market by
setting marginal revenue equal to marginal cost.
40
Microeconomics
Prof. Teresa Kamińska
First – degree price discrimination
m.u.
P1
P2
P3
P4
P5
P6
P7
P8
P9
P10
PE
MC
E
AR
D=d=MR
0 1 2 3 4 5 6 7 8 9 10 qE
Qx
Optimum when P = MC
Second – degree price discrimination
m.u.
P1=MR1
P1
P2=MR2
P2
MC
P3
P3 = MR3
D
0
q1
q2
q3
Q
Optimum when MC = MRn =Pn
41
Microeconomics
Prof. Teresa Kamińska
Subscription and a unit charge
P
pr =0.29
MC
d
0
33 h
If consumer’s surplus were bigger than subscription the consumer would be
willing to purchase the subscription.
Third – degree price discrimination
m.u.
segment I
segment II
Pcl
Pcn
MC
DI
coal
MRI
MRII
qcl
qcn
DII
corn
optimum when ∑MR = MC= MRI = MRII
42