Download Competition

Perfect Competition
Overheads
Market Structure
Market structure refers to all characteristics of a market
that influence the behavior of buyers and sellers,
when they come together to trade
Market structure refers to all features of a market that affect
the 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 themselves
and others to set prices
Degree of product differentiation
Technologies employed by agents in the market
Amount of information available to agents about the good
and 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 competitive if the
agent assumes or believes that the market price is given
and 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 of
one seller or one buyer
Common Market Structures
Oligopoly
Firm sets prices (faces residual demand)
Entry and exit barriers result in the existence of
few sellers or buyers
Common Market Structures
Monopolistic competition
Firm sets prices (faces residual demand)
Entry and exit barriers are minimal
Perfect Competition
1. Buyers and sellers are competitive or price takers
2.
All firms produce homogeneous (standardized) goods
and consumers view them as identical
3.
All buyers and sellers have perfect information
regarding 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 product
goes 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 firm
is 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
$
$
S(p
)
p0
D(p)
Q0
Demand for Individual Firm
Output
p0
D(p)
Output
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 from
the 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
n
π(p, w1 , w2 , )  max p y Σ wi xi such that x ε P(x)
x, y
i 1
n
π(p, w1 , w2 , )  max pf (x1 , x2 , , xn) Σ wi xi
x
i 1
π(p, w1 , w2 , )  max py C(y , w1 , w2 ,  )
y
Example Problem
P = $184
Cost(y)  200 65y 2y 2 y 3
y
0.00
FC VC
200 0.00
C
AFC
200.00
AVC
ATC
1.00
200 64.00
264.00 200.00
64.00
2.00
200 130.00 330.00 100.00
65.00
3.00
200 204.00 404.00 66.67 68.00 134.67
MC
Price TR
184 0
64.00
264.00
66.00
165.00
74.00
184.00
184 184
-80.00
184.00
184 368
38.00
184.00
184 552
148.00
184.00
184 736
244.00
184.00
184 920
320.00
184.00
184 1104
370.00
184.00
184 1288
388.00
184.00
184 1472
368.00
184.00
150.22
184
88.00
4.00
200 292.00 492.00 50.00 73.00 123.00
108.00
5.00
200 400.00 600.00 40.00 80.00 120.00
134.00
6.00
200 534.00 734.00 33.33 89.00 122.33
7.00
200
8.00
200
9.00
200
1656
10.00 200
166.00
700.00 900.00 28.57 100.00
128.57
204.00
904.00 1104.00
25.00 113.00 138.00
248.00
1152.00
1352.00
22.22 128.00
304.00
298.00
1450.00
1650.00
20.00 145.00 165.00
MR
Profit
-200.00
184.00
184
Total Revenue and Cost Curves
4000
$ 3500
3000
2500
2000
1500
1000
500
0
TR
C
0
2
4
6
8
10 12 14 16 18
Output
Note that TR is linear with slope = 184
Price, Marginal Cost, and Average Cost
Price = MR = Demand
400
$
350
300
250
200
150
100
50
0
Price
MC
ATC
0
2
4
6
8
10
12
14 16
Output
18
Add average variable and average fixed costs
AFC
400
$ 350
300
250
200
150
100
50
0
AVC
ATC
MC
Price
0
2
4
6
8
10 12
14 16
Output
18
Maximizing profit
Choose the level of output where
the difference between TR and TC
is the greatest
y
3
C
404
MC
Price TR
184 552
88.00
4
492
184
600
736
184
734
920
184
900
1104
184
1104
1288
1352
388
184.00
184
1472
248.00
9
370
184.00
204.00
8
320
184.00
166.00
7
244
184.00
134.00
6
Profit
148
184.00
108.00
5
MR
368
184.00
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
y
4.00
C
492.00
MC
Price
184
TR
736
108.00
5.00
600.00
184
734.00
920
184
900.00
1104
184
1104.00
1288
1352.00
388.00
184.00
184
1472
248.00
9.00
370.00
184.00
204.00
8.00
320.00
184.00
166.00
7.00
Profit
244.00
184.00
134.00
6.00
MR
368.00
184.00
184
1656
Should we increase output from 5 to 6?
Should we increase output from 6 to 7?
Should we increase output from 7 to 8?
304.00
Yes
Yes
No !
Measuring Total Profit
Profit is always given by
Profit  π  Total revenue Total cost
 py C (y, w1 , w2 ,)
Graphically it is the distance between
total revenue and total cost
Total Revenue and Cost Curves
4000
$ 3500
3000
2500
2000
1500
1000
500
0
TR
C
0
2
4
6
8
10 12 14 16 18
Output
Profit, price, and average total cost
Profit per unit is given by
py C(y, w1 , w2 , )
π
Profit per unit 

y
y
p
y
TC


y
y
 p ATC
Cost Curves and Profit
ATC
$ 350
MC
300
Price
250
ATC Opt
200
Q Opt
150
100
50
0
0
2
4
6
8
10
12
14
16
18
Output
The distance between price and ATC at the optimum
output level is profit per unit
Total profit is given by the area of the box
bounded by
price,
the optimum quantity,
average total cost at the optimum quantity
and the price axis
Cost Curves and Profit
ATC
$ 350
MC
300
Price
250
ATC Opt
200
Q Opt
150
100
50
0
0
2
4
6
8
10
12
14
16
18
Output
y
5.00
6.00
7.00
8.00
C
600.00
AVC ATC
MC
80.00 120.00
134.00
734.00 89.00 122.33
166.00
900.00 100.00 128.57
204.00
1104.00 113.00 138.00
Price TR
184 920
184
Profit
320.00
1104 370.00
184 1288 388
184
1472 368.00
(184 - 128.5714) = 55.4286
(55.4286) (7) = $388
The firm earns a profit whenever
p > ATC
A firm suffers a loss whenever p < ATC
at the optimum level of output
Let p = $97
We can show that the
optimum quantity is 4 units
y
C
AVC
Profit
0.00 200.00
ATC
MC
Price
TR
97
0
-200.00
97
97
-167.00
97
194
-136.00
97
291
-113.00
97
388
-104.00
97
485
-115.00
97
582
-152.00
64.00
1.00 264.00 64.00
264.00
66.00
2.00 330.00 65.00
165.00
74.00
3.00 404.00 68.00
134.67
88.00
4.00 492.00 73.00
123.00
108.00
5.00 600.00 80.00
120.00
134.00
6.00 734.00 89.00
122.33
166.00
Cost Curves and Profit
400
$ 350
300
250
200
150
100
50
0
ATC
MC
Price
ATC Opt
Q Opt
Loss
0
2
4
6
8
10 12 14 16 18
Output
y
FC VC
0.00 200 0.00
200.00
1.00
2.00
200 64.00
-167.00
C
AFC
200.00
AVC
264.00 200.00
200 130.00 330.00 100.00
-136.00
ATC
MC
Price TR
97
0
97.00
97
97
66.00
65.00 165.00
97.00
97
194
200 204.00 404.00 66.67 68.00 134.67
97.00
97
291
88.00
4.00 200 292.00 492.00 50.00 73.00 123.00
104.00
-113.00
97.00
97
388
-
108.00
5.00
200 400.00 600.00 40.00 80.00 120.00
97
485
97
582
97.00
-115.00
97.00
-
134.00
6.00 200 534.00 734.00 33.33 89.00 122.33
152.00
7.00
8.00
200 700.00 900.00 28.57 100.00
-221.00
200 904.00 1104.00
Profit
-
64.00
64.00 264.00
74.00
3.00
MR
166.00
128.57
204.00
25.00 113.00 138.00
97
97.00
679
97
97.00
776
Another example problem
P = $120
Cost(y)  200  100y 14y 2  y 3
MC(y )  100 28y  3 y 2
y
PriceTR MR FC VC
0.00 120 0
120 200
200.00
0.25 120 30 120 200
93.19
-194.14
0.50 120 60 120 200
86.75
-186.63
1.00 120 120 120 200
75.00
-167.00
2.00 120 240 120 200
56.00
-112.00
3.00 120 360 120 200
-41.00
4.00 120 480 120 200
40.00
5.00 120 600 120 200
6.00 120 720 120 200
7.00 120 840 120 200
8.00 120 960 120 200
9.00 120 1080120 200
C
AFC
AVC
ATC
MC
0.00
200.00
24.14
224.14 800.00
96.56 896.56
46.63
246.63 400.00
93.25 493.25
87.00
287.00 200.00
87.00 287.00
152.00 352.00 100.00
76.00 176.00
Profit
-
201.00 401.00 66.67 67.00 133.67
43.00
240.00 440.00 50.00 60.00 110.00
36.00
275.00
312.00
357.00
416.00
495.00
475.00
512.00
557.00
616.00
695.00
40.00
33.33
28.57
25.00
22.22
55.00
52.00
51.00
52.00
55.00
95.00
85.33
79.57
77.00
77.22
35.00
40.00
51.00
68.00
91.00
125.00
208.00
283.00
344.00
385.00
For a given price we can find optimal output
HOW?
Choose output level where MC = MR = P
AVC
Short Run Equilibrium
ATC
300
$
MC
250
Q Opt
200
Profit
150
100
P = 120
50
0
0
2
4
6
8
10
12
P = MC  y* = 10
 = $400
14
16
Output
18
y
7.00
8.00
9.00
10.00
11.00
12.00
Price
120
120
120
120
120
120
TR
840
960
1080
1200
1320
1440
MR
120
120
120
120
120
120
Cost
557.00
616.00
695.00
800.00
937.00
1112.00
MC
51.00
68.00
91.00
120.00
155.00
196.00
 = $400
The firm is happy!!
And R - VC (ROVC) = $600
Profit
283.00
344.00
385.00
400.00
383.00
328.00
AVC
Short Run Equilibrium
ATC
300
$
MC
250
Q Opt
200
ROVC
150
100
P = 120
50
0
0
2
4
6
8
10
12
P = MC  y* = 10
ROVC = $600
14
16
Output
18
Now let p = $91
y
6
7
8
9
10
11
12
Price
91
91
91
91
91
91
91
TR
546
637
728
819
910
1001
1092
MR
91
91
91
91
91
91
91
VC
312
357
416
495
600
737
912
C
512
557
616
695
800
937
1112
MC
40
51
68
91
120
155
196
y* = 9,  = $124
The firm is still happy!!
And R - VC (ROVC) = $324
Profit
34
80
112
124
110
64
-20
AVC
Short Run Equilibrium
ATC
300
$
MC
250
200
150
P = 91
100
P = 120
50
0
0
2
4
6
8
10
12
14
16
Output
18
AVC
Short Run Equilibrium
ATC
300
$
MC
250
Q Opt
200
ROVC
Profit
150
P = 91
100
50
0
0
2
4
6
8
10
12
P = MC  y* = 9
 = $ 124
ROVC = $324
14
16
Output
18
Now let p = $68
y
6
7
8
9
10
11
12
Price
68
68
68
68
68
68
68
TR
408
476
544
612
680
748
816
MR
68
68
68
68
68
68
68
VC
312
357
416
495
600
737
912
C
512
557
616
695
800
937
1112
MC
40
51
68
91
120
155
196
y* = 8,  = $-72
The firm is not so happy!!
But R - VC (ROVC) = $128
Profit
-104
-81
-72
-83
-120
-189
-296
AVC
Short Run Equilibrium
ATC
300
$
MC
250
200
150
P = 68
100
P = 91
P = 120
50
0
0
2
4
6
8
10
12
14
16
Output
18
AVC
Short Run Equilibrium
ATC
300
$
MC
250
Q Opt
Loss
ROVC
200
150
P = 68
100
50
0
0
2
4
6
8
10
12
P = MC  y* = 8
 = $-72
14
16
Output
ROVC = $128
18
Now let p = $51
y
6
7
8
9
10
11
12
Price
51
51
51
51
51
51
51
TR
306
357
408
459
510
561
612
MR
51
51
51
51
51
51
51
VC
312
357
416
495
600
737
912
C
512
557
616
695
800
937
1112
MC
40
51
68
91
120
155
196
Profit
-206
-200
-208
-236
-290
-376
-500
y* = 7,  = $ -200
The firm may as well shut down 

AVC
Short Run Equilibrium
ATC
300
$
MC
250
200
P = 51
150
P = 68
100
P = 91
P = 120
50
0
0
2
4
6
8
10
12
14
16
Output
18
AVC
Short Run Equilibrium
ATC
300
$
MC
250
Q Opt
P = 51
Loss
ROVC
200
150
100
50
0
0
2
4
6
8
10
12
14
16
Output
P = MC  y* = 7
 = $-200
ROVC = $0
18
Now let p = $40
y
5
6
7
8
9
10
11
Price
40
40
40
40
40
40
40
TR
200
240
280
320
360
400
440
MR
40
40
40
40
40
40
40
C
475
512
557
616
695
800
937
MC
35
40
51
68
91
120
155
Profit
-275
-272
-277
-296
-335
-400
-497
y* = 6,  = $ -272
The firm should get out in a hurry!
AVC
Short Run Equilibrium
ATC
300
$
MC
250
P = 40
200
P = 51
150
P = 68
100
P = 91
P = 120
50
0
0
2
4
6
8
10
12
14
16
Output
18
AVC
Short Run Equilibrium
ATC
300
$
MC
250
P = 40
Loss
200
P = 51
P = 68
ROVC
150
P = 91
100
P = 120
50
0
0
2
4
6
8
10
P = MC  y* = 6
 = $- 272
12
14
16
Output
ROVC = $-72
18
AVC
Short Run Equilibrium
ATC
300
$
MC
250
P = 40
200
P = 51
150
P = 68
100
P = 91
P = 120
50
P = 196
0
0
2
4
6
8
10
12
14
16
Output
18
Short run supply
At different prices we know how much
the firm will choose to supply
By plotting these points we can obtain
the short run supply curve
Short-run supply curve
AVC
300
$
MC
250
P = 40
200
P = 51
150
P = 68
100
P = 91
P = 120
50
P = 196
0
0
2
4
6
8
10
12
14
16
Output
18
Short Run Equilibrium
300
$ 250
200
150
100
50
0
ATC
AVC
MC
0
2
4
6
8
10
12
14
16
Output
18
Short Run Supply Curve
250
$
200
150
Supply
100
50
0
0
1
2
3
4
5
6
7
8
9
10 11 12 13 14
Output
We can connect the dots?
Short Run Supply Curve
250
$
200
150
Supply
100
50
0
0
1
2
3
4
5
6
7
Not really
8
9 10 11 12 13 14
Output
We connect, but with a discontinuity
Short Run Supply Curve
250
$
200
150
Supply
100
50
0
0
1
2
3
4
5
6
7
8
9 10 11 12 13 14
Output
To summarize
The competitive firm's supply curve has two parts
For all prices above the minimum point
on the firm’s average variable cost (AVC) curve,
the supply curve coincides with the
marginal cost curve (MC)
For prices below the minimum point
on the average variable cost curve (AVC),
the firm will shut down,
so its supply curve is a vertical line at zero units of output
Short Run Supply
300
$
250
200
MC
AVC
150
100
50
0
0
2
4
6
8
10
12
14
16
Output
18
Short Run Supply
300
$
250
200
MC
AVC
150
100
50
0
0
2
4
6
8
10
12
14
16
Output
18
Short Run Supply
300
$
250
200
150
MC
ATC
100
AVC
50
0
0
2
4
6
8
10
12
14
16
Output
18
We write the individual supply curve as
yi  yi (p, w1 , w2 , , wn , z)
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
Shows the quantity supplied by the industry
at each price when the plant size of each firm
and the number of firms remain constant
It is constructed by summing the quantities
supplied by the individual firms
The market or industry supply curve, QS, is the horizontal
summation of the individual firm supply curves
yi  yi (p, w1 , w2 , , wn , z)
We account for the fact that
yi  yi (p, w1 , w2 , , wn , z )
will be zero at some price levels
L
Q S  Σ yi (p, w1 , w2 , , z)
i 1
The market supply curve is then a curve indicating
the quantity of output that all sellers in a market
will produce at different prices.
If there are L identical firms, each with supply,
yi  y (p, w1 , w2 , , wn , z) then
Q S  L
y(p, w1 , w2 , , z)
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
250
P = 51, y = 7
200
P = 68, y = 8
$
150
P = 120, y = 10
Supply
100
50
0
0
1
2
3
4
5
6
7
8
9 10 11 12 13 14
Output
Short Run Market Supply Curve
250
P = 51, y = 350
$
200
P = 68, y = 400
150
P = 120, y = 500
Supply
100
50
0
0
100 200 300 400 500 600 700
Output
Short Run Market (Industry) Equilibrium
Q D  1250 6.25 P
 P  200 0.16 Q D
Market Demand Curve
250
$
200
150
100
50
0
D
0
100
200
300
400
500
600
Output
700
Finding the market equilibrium
Short Run Market Supply & Demand Curves
250
$
Supply
Demand
P
Q*
200
150
100
50
0
0
100
200
300
400
P = $120, Q = 500
500 600 700
Output
Increase the demand to
Q D  1825 6.25P  P  292 0.16Q D
Short Run Market Supply & Demand Curves
300
$
Supply
Demand
P
Q*
D1
250
200
150
P1
Q1*
100
50
0
0
100
200
300
400
500
P = $196, Q = 600
600 700
Output
800
Decrease the demand to
Q D  825 6.25P  P  132 0.16 Q D
Short Run Market Supply & Demand Curves
300
$
Supply
Demand
P
Q*
D1
250
200
150
P1
Q1*
100
D2
50
P2
Q2*
0
0
100
200
300
400
500
P = $68, Q = 400
600 700
Output
800
Going back to the individual firm
Q D  1250 6.25P  P  200 0.16Q D
P  120, Q S  500
AVC
300
$
Life is good
ATC
250
MC
200
P = 120
150
yi = 10
100
i = 400
50
0
0
2
4
6
8
10
12
14
16
Output
18
What about the equilibrium price of $68.00?
300
$
250
AVC
200
ATC
150
MC
100
P = 68
50
0
0
2
4
6
8
10
12
14
16
Output
18
Not what the managers had in mind!
With short run losses, the firm will only
stay in the industry in the short run
In the long run, a firm with losses will
exit the industry
At the same time, short run profits will
encourage firms to enter the industry
And so we must consider the long run!
The End
AVC
Short Run Equilibrium
ATC
300
$
MC
250
P = 40
200
P = 51
150
P = 68
100
P = 91
P = 120
50
P = 196
0
0
2
4
6
8
10
12
P = MC  y* = 10
 = $400
14
16
Output
18
Increase the demand to
Q D  1825 6.25P  P  292 0.16Q D
Short Run Market Supply & Demand Curves
300
$
Supply
Demand
P
Q*
D1
250
200
150
P1
Q1*
100
D2
50
P2
Q2*
0
0
100
200
300
400
500
P = $196, Q = 600
600 700
Output
800