Market Structure and Perfect Competitive Firm

Hall and Lieberman, 3rd edition, Thomson South-Western, Chapter 8 South-

What you will learn from this lecture

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Market structure

3 Requirements for perfect competition Demand curve for a competitive firm Supply curve for a competitive firm How is the profit is maximized? At which output level? ± How is profit or loss is measured using graphs?


Part I Market Structure
Sellers want to sell at the highest possible price
± Buyers seek lowest possible price ± All trade is voluntary ± different goods and services are sold in vastly different ways

Economists think about market structure
± Characteristics of a market that influence behavior of buyers and sellers when they come together to trade

or can exit. we ask ± How many buyers and sellers are there in the market? ± Is each seller offering a standardized product. product.Types of Market For any particular market. outsiders easily enter and leave this market? Four basic types of market ± ± ± ± Perfect competition Monopoly Monopolistic competition Oligopoly 4 . more or less indistinguishable from that offered by other sellers? ± Are there any barriers to entry or exit.

The Three Requirements of Perfect Competition Large numbers of buyers and sellers ± Each buys or sells only a tiny fraction of the total quantity in the market Sellers offer a standardized product Sellers can easily enter into or exit from market ± Significant barriers to entry and exit can completely change the environment in which trading takes place Examples? 5 .Part II.

i. there must be many buyers and sellers ± How many? Number must be so large that no individual decision maker can significantly affect price of the product by changing quantity it buys or sells 6 . A Large Number of Buyers and Sellers In perfect competition.

Selling Standardized Products Buyers do not perceive significant differences between products of one seller and another ± For instance. buyers of wheat do not prefer one farmer¶s wheat over farmer¶ another 7 .ii.

Easy Entry into and Exit from the Market Easy Entry ± no significant barriers to discourage new entrants ± any firm wishing to enter can do business on the same terms as firms that are already there Easy exit ± A firm suffering a long-run loss must longbe able to sell off its plant and equipment and leave the industry for good. without obstacles 8 .iii.

iii. Easy Entry into and Exit from the Market In many markets there are significant barriers to entry ± Legal barriers ± Existing sellers have an important advantage that new entrants can not duplicate Brand loyalty ± Cost advantage of existing firms from significant economies of scale 9 .

Job Creation and Job Destruction. 1996. . Davis and Schuh.The U. MIT Press.S. Market is characterized by entry and exit Example: Job creation and destruction in manufacturing Annual averages ± 10% of jobs disappear forever ± 9% of jobs appear for the first time ± Shutdowns responsible for 23% of job destruction ± Start-ups responsible for 16% of Startjob creation Haltiwanger.

Is Perfect Competition Realistic? Assumptions are rather restrictive In reality. one or more of assumptions will be violated in vast majority of markets ± Yet economists use perfect competition more often than any other market structure Why? ± Model of perfect competition is powerful ± Many markets come reasonably close to be perfect competitive Perfect competition can approximate conditions and yield accurate-enough accuratepredictions in a wide variety of markets 11 .

Even if conditions for perfectly competitive markets are not satisfied« satisfied« Assumptions are close enough for predictions of ± Firm entry or exit ± Price increase or decrease ± Increase or decrease in industry quantity ± Increase or decrease in firm quantity 12 .

± entirely different picture In learning about competitive firm. The Perfectly Competitive Firm What is occurring in a competitive market is quite different from the view we get when looking at a perfect competitive firm.Part III. must also discuss competitive market in which it operates 13 .

The typical firm can sell all it wants at the market price« Firm Price per Ounce $400 D $400 Demand Curve Facing the Firm Ounces of Gold per Day 2.Figure 1: The Competitive Industry and Firm 1. determine the equilibrium market price Ounces of Gold per Day 4. The intersection of the market supply and the market demand curve« Price per Ounce Market S 3. so it faces a horizontal demand curve 14 .

Goals and Constraints Perfectly competitive firm faces a cost constraint when producing any given level of output ± Firm¶s production technology Firm¶ ± Prices it must pay for its inputs Cost function for a perfectly competitive firm is standard 15 .

it cannot make a noticeable difference in market quantity supplied So cannot affect market price ± Firm is a price taker Treats the price of its output as given and beyond its control Its only decision is how much output to produce and sell 16 .The Demand Curve Facing a Perfectly Competitive Firm Demand curve is horizontal. or infinitely price elastic Why? ± Output is standardized ± No matter how much a firm decides to produce.

Cost and Revenue MR at each quantity is the same as the market price ± MR = Price ± marginal revenue curve and demand curve facing firm are the same ± A horizontal line at the market price 17 .

Profit Maximization: The Total Revenue and Total Cost Approach Firm¶ Firm¶s profit per unit ± ( Revenue per unit ) ± ( cost per unit ) profit per unit = P ± ATC Total Profit = TR ± TC=Q(P-ATC) TC=Q(PTR and TC approach ± Pick out the output level where there is biggest difference between TR and TC ± Most direct way of viewing firm¶s firm¶ search for the profit-maximizing profitoutput level 18 .

Figure 2a: Profit Maximization: find greatest TR .800 2.100 TR TC Maximum Profit per Day = $700 550 Slope = 400 1 2 3 4 5 6 7 8 9 10 Ounces of Gold per Day 19 .TC Dollars $2.

Profit Maximization: The Marginal Revenue and Marginal Cost Approach ProfitProfit-maximizing output is found where MC curve crosses MR curve from below ± Or where P =MC Firm should continue to increase output as long as p=MR>MC Requires no new concepts or techniques 20 .

Figure 2b: Profit Maximization Find MR =MC from below Dollars MC $400 D = MR 1 2 3 4 5 6 7 8 9 10 Ounces of Gold per Day 21 .

unit cost for producing that amount of outputs 3. At Q* . Pointing out the difference between P and ATC along the vertical axis 4.Measuring Total Profit Graphically How to measure profit or loss? 1. find the ATC. Find the optimal output level Q* from profit maximization ± P =MC or using TR & TC method 2. The area (P-ATC) X Q* is (P± ± Profit if P>ATC Loss if P<ATC 22 .

Figure 3a: Measuring Profit if P > ATC Economic Profit Dollars ATC Profit per Ounce ($100) $400 300 MC d = MR 1 2 3 4 5 6 7 8 Ounces of Gold per Day 23 .

Figure 3b: Measuring Loss if P < ATC Economic Loss Dollars MC Loss per Ounce ($100) ATC $300 200 4 d = MR Ounces of Gold per Day 1 2 3 5 6 7 8 24 .

the best output level will be determined by firms. using the MR and MC approach ± Exception If the firm is suffering a loss large enough to justify shutting down.The Firm¶s Short-Run Supply Curve ShortA competitive firm is a price taker ± Then decides how much output it will produce at that price ± Whenever the market price is set at a new level. it will not produce along its MC curve ± Zero output produced instead 25 .

00 AVC 1.000 (b) Price per Bushel $3.00 1.000 per Year 26 Firm's Supply Curve .000 4.000 5.50 2.00 0.00 0.000 per Year 2.000 5.000 7.50 2.Figure 4: Short-Run Supply Under Perfect ShortCompetition (a) Dollars ATC $3.50 2.50 2.0004.50 MC d1=MR1 d2=MR2 d3=MR3 d4=MR4 d5=MR5 Bushels 1.000 Bushels 7.50 2.

supply curve coincides with MC curve ± Whenever P<AVC.The Shutdown Price and Supply Curve Shutdown price is the price at which a firm is indifferent between producing and shutting down Supply curve has two parts ± Whenever P>AVC. firm will shut down A vertical line segment at zero units of output Figure 4: For all prices below $1²the $1² shutdown price²output is zero and the price² supply curve coincides with vertical axis 27 .

we are assuming that two things are constant ± Fixed inputs of each firm ± Number of firms in market 28 .The (Short-Run) Market Supply Curve (ShortThe shut run market supply curve is obtained from the aggregation of individual firm¶s supply curve firm¶ ± summing quantities of output supplied by all firms in market at each price As we move along the market supply curve.

000 3.50 2.00 1.50 2.50 2. the typical firm supplies the profit-maximizing quantity.Figure 5: Deriving The Market Supply Curve 1. Market Market Supply Curve 29 .000 7. .50 2.00 0.00 0.000 Bushels per Year 5.000 4.000 Bushels per Year 200.000 2. At each price .00 1. Firm's Supply Curve Price per Bushel $3.50 2.000 700.000 500. .The total supplied by all firms at different prices is the market supply curve. Firm Price per Bushel $3.50 400.

Summary ± 3 Requirements for perfect competition many sellers and buyers standardized products free entry and exit ± Demand curve for a competitive firm is perfect elastic (horizontal line) MR = P ± Supply curve for a competitive firm is discrete is MC when P> AVC is zero when P<AVC ± 2 approaches to maximize profit by choosing output level Maximized difference between TR and TC MR = MC ± Profit can be measured using graphs 30 .

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