Download lec10. markets

Market Structure:
Perfect Competition
 Many
buyers and sellers
 Buyers
and sellers are price takers
 Product
is homogeneous
 Perfect
mobility of resources
 Economic
agents have perfect knowledge
INDUSTRY
FIRM
Diagrammatic representation
Cost/Revenue
MC
Q1
The MC is the cost of
producing additional
(marginal) units of
output. It falls at first
(due tothe
Given
theassumption
law of
The industry price is
diminishing
of
profit maximisation,
returns)
At
determined
this output
bythe
thefirm
thenfirm
the
rises
produces
as output
at an
is
demand
makingand
normal
supply
rises. where MC = MR
output
profit.
of the This
industry
is a long
as a
(Q1). This output level
AC
run
whole.
equilibrium
The firm is a
is a fraction of the total
position.
very small supplier
industry
supply.
The average
cost
within the industry
curve is the standard
and has no control
‘U’MR
– shaped
curve. MC
P=
= AR They
over price.
will
cuts the AC curve at
sell each extra unit
its lowest point
for the same price.
because of the
Price therefore = MR
mathematical
and AR
relationship between
marginal and average
Output/Sales
values.
Because the model
assumes perfect
knowledge,
firm
Average andthe
Marginal
gains
advantage
for
costs the
could
be
only
a short
time
expected
to be
lower
The
lower
AC
and
before
others
copy
the
but price,
in the
short
MC would
imply
idea
or are attracted
to
run, remains
the
that
the firm
ismakes
Now
assume
a firm
the
industry
by
the
same.
some
form
of
modification
now
earning
MC
existence
of abnormal
to its product or gains
abnormal
profit
MC1
some form
of cost
profit.
If new
firms
advantage (say a new
(AR>AC)
enter
the industry,
production method). What
AC represented
by
would happen?
supply
will increase,
the grey area.
AC1 price will fall and the
firm will be left making
normal profit once
P = MR
= AR
again.
Perfect Competition
Diagrammatic representation
Cost/Revenue
AC1
Abnormal profit
P1 = MR1 = AR1
Q1
Q2
Output/Sales
QD  625  5P
QD  QS
QS  175  5 P
625  5P  175  5P
450  10P
P  $45
QD  625  5P  625  5(45)  400
QS  175  5P  175  5(45)  400
Firm’s Demand Curve = Market Price
= Marginal Revenue
Firm’s Supply Curve = Marginal Cost
where Marginal Cost > Average Variable Cost
Total Profits = TR -TC
d = d(TR) - d(TC) = 0
dQ
dQ
dQ
MR - MC = 0
MR = MC
d(TR) = d(PQ) = P = MR
dQ
dQ
Losses and Shutdown Decision
Quantity
0
1
2
3
4
5
6
7
8
9
TFC
5
5
5
5
5
5
5
5
5
5
TVC
0
5
9
12
14
17
21
26
32
39
TC
5
10
14
17
19
22
26
31
37
44
Losses and Shutdown Decision
Quantity
0
1
2
3
4
5
6
7
8
9
TFC
5
5
5
5
5
5
5
5
5
5
TVC
0
5
9
12
14
17
21
26
32
39
TC
5
10
14
17
19
22
26
31
37
44
MC
AVC
ATC
5
4
3
2
3
4
5
6
7
5.00
4.50
4.00
3.50
3.40
3.50
3.71
4.00
4.33
10.00
7.00
5.67
4.75
4.40
4.33
4.43
4.63
4.89
Losses and Shutdown Decision
Price, cost 12
per unit
10
8
MC
65
C
ATC
AVC
4
3.35
2
0
0
1
2
3
4
5
6
7 Quantity
8 per9 period
10
Losses and Shutdown Decision
Price, cost 12
per unit
10
8
MC
65
C
AVC
B
4
3.35
ATC
2
0
0
1
2
3
4
5
6
7 Quantity
8 per9 period
10
Losses and Shutdown Decision
12
Price, cost
per unit
10
8
MC
6
C
5
4
ATC
AVC
B
3.35
A
2
0
0
1
2
3
4
5
6
7
8
9
Quantity per period
10
Consumer Surplus
Price per unit
S
P1
C
Pe
D
Qe
Quantity per period
PROFIT MAXIMISATION
TC = Q3 - 8Q2 + 57Q + 2
P = 45 - 0.5Q
 = 7.5Q2 - 12Q – 2 – Q3
d = 15Q -12 - 3Q2
dQ
Q = 1 and Q = 4
d 2
dQ2
= -6Q + 15
d 2 = 9
dQ2
d2 = -9
dQ2
 High
degree of competition helps allocate resources
to most efficient use
 Price = marginal costs
 Normal profit made in the long run
 Firms operate at maximum efficiency
 Consumers benefit
 Single
seller and many buyers
 No close substitutes for product
 Significant barriers to resource mobility
Control of an essential input (OPEC)
 Patents or copyrights (Medicines/drugs)
 Economies of scale at large output (China)
 Government franchise

 Abnormal
profits in long run
 Possibility of price discrimination
 Prices in excess of MC
 Demand
curve for the firm is the market
demand curve
 Firm
produces a quantity (Q*) where
marginal revenue (MR) is equal to marginal
cost (MC)
P = a - bQ
TR = PQ = (a - bQ)Q = aQ - bQ2
MR = d(TR) = a - 2bQ
dQ
Monopoly
Short-Run
Equilibrium
P
D
O
Q
MR
Monopoly
Short-Run
Equilibrium
P
MC
AC
Pm
D
O
Q
Qm
MR
Q* = 500
P* = $11
Q* = 700
P* = $9
Advantages:
Encourages R&D
 Encourages innovation
 Economies of scale can be gained – consumer may benefit

Disadvantages:
Exploitation of consumer – higher prices
 Potential for supply to be limited - less choice
 Potential for inefficiency

 Many
sellers of differentiated (similar but not
identical) products
 Limited monopoly power (based on the uniqueness of
their product)



Dominoes : quick delivery
Maggi : 2 minutes
Dettol : Hygiene
 Perfect mobility of resources
 Downward-sloping demand curve
 Increase in market share by competitors
causes
decrease in demand
 Easy entry and exit
 Differentiated products : Advertising costs
Profit = 0
Cost with selling expenses
Cost without selling expenses
In Mumbai, the movie market is monopolistically
competitive. The long run demand equation & AC
is given
P = 5 – 0.002Q
AC = 6 – 0.004Q + 0.000001Q2
(a)
(b)
To maximize profits, what should be the price &
Q. (Q = 1000 & P = 3)
How much profit will the firm earn? (0)
 Hyundai
has taken Mahindra Renault to High
Court objecting to Mahindra’s plan to launch a
compact car with the name 'Sandero' alleging
that Mahindra is trying to cash on its popular
brand Santro.
 Asian
Paints (label "Utsav”) vs Jaikishan Paints &
Allied Products (label “ Utkarsh”) with similar
name, color, layout.
 Few
sellers of a product
 Duopoly - Two sellers
 Pure oligopoly - Homogeneous product
 Differentiated oligopoly - Differentiated product
 Non-price competition
 Barriers to entry
 High degree of interdependence between firms
 Abnormal profits
 Potential for collusion?
 Economies
of scale (Exide: distribution, Walmart)
 Large capital investment required (Steel)
 Patented production processes (Drugs)
 Brand loyalty (Tata Salt)
 Control of a raw material or resource (Cement)
 Government franchise (Licenses)
 Collusion
Cooperation among firms to restrict competition in order
to increase profits
 Market-Sharing Cartel
 Collusion to divide up markets
 Centralized Cartel
 Formal agreement among member firms to set a monopoly
price and restrict output

Examples: OPEC
De Beers
 Firms
can ask for an equitable distribution of
profits.
 Cartel
members have a strong incentive to
cheat by selling more.
 Monopoly
profits may attract other firms.