Download Micro Review- Market Structures and Elasticity

Micro AP Review
Market Structures and
Elasticity
Pure Competition
• Very large number of firms producing a
standardized product (corn)
• “Price Takers”- individual firms cannot change
the market price, only react to changes
• Maximize profit by producing up to the point
where MR = MC
Profit Maximization in the Short
Run Pure Competition
W 21.2
Cost and Revenue
$200
150
MR = MC
P=$131
MC
MR = P
ATC
Economic Profit
100
AVC
A=$97.78
50
0
1
2
3
4
5
6
Output
7
8
9
10
Profit Maximization in the Short
Run Pure Competition
Loss Minimizing Case
Cost and Revenue
$200
Lower the Price to $81 and
Observe the Results!
150
MC
Loss
A=$91.67
ATC
AVC
100
MR = P
P=$81
50
0
V = $75
1
2
3
4
5
6
Output
7
8
9
10
Profit Maximization in the
Short
Run
Marginal Revenue-Marginal Cost Approach
MR = MC Rule
Short-Run Shut Down Case
$200
Lower the Price Further to
$71 and Observe the Results! MC
Cost and Revenue
150
ATC
V = $74
100
AVC
MR = P
50
0
P=$71
1
Short-Run
Shut Down Point
P < Minimum AVC
$71 < $74
2
3
4
5
6
Output
7
8
9
10
2. Monopolistic Competition
• Relatively large number of sellers producing
differentiated products (clothing, furniture,
books)
• Ex- Retail stores, shoes
Price and Output Determination
In Monopolistic Competition
Short-Run Profits
Price and Costs
MC
ATC
P1
A1
Economic
Profit
D1
MR = MC
MR
0
Q1
Quantity
Price and Output Determination
In Monopolistic Competition
Long-Run Equilibrium
MC
Price and Costs
ATC
P3=
A3
D3
MR = MC
MR
0
Q3
Quantity
Profit Maximization
By A Pure Monopolist
$200
Price, Costs, and Revenue
175
MC
150
125
100
75
Pm=$122
Economic
Profit
ATC
D
A=$94
MR=MC
50
25
0
Socially Optimal @ MC = D
Fair Return @ ATC = D
MR
1
2
3
4
5
Quantity
6
7
8
9
10
3. Oligopoly
• Involves only a few sellers of a standardized
(identical to competitors) or differentiated
product… difficult to enter industry
• Ex- Steel, automobiles, household appliances
Price Elasticity of Demand
• Responsiveness or sensitivity of consumers to
a price change
Calculating Elasticity
• Ed=
Change in Quantity
Sum of Quantities/2
• Or Ed= %
÷
Change in Price
Sum of Prices/2
Qd/%
P
> 1 = Elastic (luxury good)
< 1 = Inelastic (Necessity)
= 1 is unit elastic
W 18.1
Determinants of Elasticity
• P- the proportion of income spent on the
good (the bigger the proportion, the more
elastic)
• A- availability of close substitutes (the more
subs. The more elastic)
• I- the importance of a good (luxury v
necessity)
• D- the ability to delay the purchase (the more
time, the more elastic)
Price
Price Elasticity
$8
7
6
5
4
3
2
1
0
0
Elastic
Ed > 1
Unit Elastic
Ed = 1
Inelastic
Ed < 1
a
b
c
d
e
f
g
h
1
2 3
4 5
6
Quantity Demanded
7 8
D
Total Revenue Test
• Note what happens to total revenue when
prices change?
• If TR changes in opposite direction of price,
demand is elastic
• If TR changes in the same direction as price,
demand is inelastic
• If TR doesn’t change when price changes,
demand is unit-elastic
Cross Elasticity of Demand
• Exy = Percentage change in Q demanded
x/ Percentage change in price of Y
• Cross elasticity < 0, X and Y are
complements
• If Cross elasticity is > 0, x and Y are
substitutes
Income Elasticity of Demand
• Ei = % change in quantity demanded/ % change in
income
• Measures the degree to which consumers respond to
a change in income in buying more or less of a
particular good
• Ei > 0 they are normal goods
• Ei < 0 they are inferior goods
Perfectly Inelastic
• A price change results in no change at all in
the quantity demanded
• Price elasticity coefficient is zero
• Ex- diabetic needing insulin or a heroin addict
needing drugs
Perfectly Elastic
• Small price reduction causes buyers to
increase their purchases from zero to all they
can obtain
• Elasticity coefficient is infinity