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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.