Download Mechanics of Perfect Competition

Mechanics of Perfect Competition:
The Market for Garden Gnomes
Agenda:
I.
Equilibrium price & quantity, producer &
consumer surplus
II.
What about taxes?
III.
What about advances in technology?
PD = a - bQD
PS = c + dQS
Example: Garden Gnomes
Market demand: PD = 65 - (1/100)QD or QD= 6500 -100P
Market supply: PS = (1/1200)QS or QS= 1200P
FIRM total cost:
C(q) = 722 + q2/200
FRIM marginal cost:
MC(q) = 2q/200 = q/100
1. What is the equilibrium price and quantity for the MARKET?
PD = PS OR QD=QS
P = $5 and Q = 6,000
2. What is the amount supplied by the FIRM?
P = MR = MC(q)
Q (firm) = 500
3. If all firms have the same cost structure, how
many firms will be in this market? Q M Q F  6000 500  12
4. What is the profit (loss) for the FIRM? TR – TC = $528
5. What is the producer surplus for the FIRM?
P*Q – AVC*Q =$1,250
6. What is the consumer surplus for the MARKET? ½ (($65-$5)*6000)=$18,000
7. Would you want to go into the Garden Gnome industry? Yes! Why?
AVC
8. What is the lowest price you would sell your 500 Garden Gnomes for in = $2.50
the short run?
Garden Gnomes Continued…
What if the government imposes a tax of $1 per gnome?
Market demand: QD = 6500 -100P
Market supply: QS = 1200P
FIRM total cost:
C(q) = 722 + q2/200
FRIM marginal cost:
MC(q) = 2q/200 = q/100
What is the equilibrium price received by the supplier,
paid by the consumer and equilibrium quantity?
KEY: The price paid by the
6500 – 100(PS+$1) = 1200PS
consumer is NOT the same as the
PS = $4.92 PD = $5.92
price received by the supplier!
Q = 5,908
PD = PS + $1
4.92 = q/100
How much does each FIRM supply with the tax?
q = 492
What is the new producer surplus for the firm?
492($4.92 – 492/200) = $1,210.32
Garden Gnomes Continued…
What if the government imposes a tax of $1 per gnome?
Market demand: QD = 6500 -100P
Market supply: QS = 1200P
FIRM total cost:
C(q) = 722 + q2/400
FRIM marginal cost:
MC(q) = 2q/400 = q/200
What happens in the LONG RUN?
price
P3
P = MC + T
Long-run
supply
$5.92
P = MC
$5.00
Dead-weight loss
½($1*(6000-5908))= $46 (short run)
$4.92
Effective price to producers
Causes market exit!
5,908
6,000
Quantity
Garden Gnomes Continued…
What would be the effect on equilibrium supply and demand in
the short term if you develop a new manufacturing technology
that reduces your marginal costs? (Forget about the tax!)
FIRM total cost:
FRIM marginal cost:
C(q) = 722 + q2/400
MC(q) = 2q/400 = q/200
Test Yourself:
What is the new
producer surplus
and profit?
11 firms have the old cost structure, and 1, you, have the new cost structure.
What is the market supply?
QS = 1300P → P=(1/1300)Q
What is the new market equilibrium supply and demand Price and Quantity
Recall: Market demand: QD = 6500 -100P
P = $4.64 Q = 6,036
Garden Gnomes Continued…
What if you could NOT get a patent for your new
technology (assuming no new entry of firms)?
FIRM total cost:
FRIM marginal cost:
Market demand:
C(q) = 722 + q2/400
MC(q) = 2q/400 = q/200
QD = 6500 -100P
1. What is the new market supply?
P=Q/ 200
Q = (200P)*12 firms
Q= 2400P
2. What is the new market
equilibrium price and quantity?
2400P=6500-100P
P=$2.60 Q = 6,240
3. What is the producer surplus and profit for each firm?
Q = 6,240/12 = 520
AVC = 520/400 = $1.30
Profit: 520*$2.60-722-520*$1.30 =-$46
PS = 520*(2.6-1.3)= $676
4. What is likely to happen to this market in the long run?
Garden Gnomes Continued…
Would the market equilibrium price and quantity
change if you were to reduce your fixed costs to
$500?
Market demand: QD = 6500 -100P
Market supply: QS = 2400P
FIRM total cost:
C(q) = 500 + q2/400
FRIM marginal cost:
MC(q) = 2q/400 = q/200
Test yourself:
Will your producer surplus change?
Will your profit change?
What You Need to Know (AND PRACTICE!)
1. In a perfectly competitive market
Price = Marginal Revenue
2. In a perfectly competitive market equilibrium
Quantity Demanded = Quantity Supplied
OR
Price of Demand = Price of Supply
3. FIRM demand is where Price = Marginal Cost
4. Profit = Revenue – Total Expenses
Producer Surplus = Revenue – Variable Costs