Perfect Competition

‡ Many (small) firms, producing a homogeneous (identical) product, none of which having an impact on the price; each firm's product is non-distinguishable from other firms' product. b. Many buyers none of whom having any effect on the price. c. No barriers to entry and exit: in the long run firms can shut down and leave the industry or new firms can come into the industry freely. d. No interference in the market process: No price control or restrictions on production e. All firms have equal and complete access to the available inputs (input markets) and production technology; all firms have the same production and cost functions. f. All sellers and buyers have perfect information about the market conditions. g. Making above-normal profits by existing firms will result in new entries into the industry. Firms that have losses shut down and leave the industry in the long run. ‡ ‡

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How is the market price Determined?
‡ Market Supply: The (horizontal) sum of individual supply curves ‡ Market Demand: The (horizontal) sum of individual demand curves

P Smo Sm1 P S po p1 Do D1 Dm 0 Market Q 0 Q q1 qo A typical firm .

run the firm could have an economic profit .Perfect Competition:Profit Maximization in the Short Run ‡ An individual firm takes the market price as given. the demand each individual firm faces is horizontal. ‡ MR = P: Demand ‡ Set the price equal to MC ‡ In the short.

$ Profit Maximization in the Short Run SMC SATC AVC Pm a c b Df . MR 0 Qe Q .

Adjustments in the Long Run ‡ If economic profits are present new firms will come into the industry ‡ The Market price will fall ‡ The profit shrinks ‡ Input prices may go up ‡ Firms try to stay profitable by taking advantage of economies of scale ‡ Firms adopt an optimal size ‡ Economic profits tend toward zero .

$ T $ mo m m1 m2 m3 m4 0 Q4 Q3 Q2 Q1 Qo   c m1 m2 m3 . m4 m o KET m .

A competitive firm¶s long-run equilibrium SAC1 LATC SAC2 SAC3 SAC4 Pm D Q o Qe .

Long-Run Equilibrium in a Perfectly Competitive Market $ Sm SATC1 MC2 $P LATC SATC3 SATC2 Pe Dm o Market o Qe A typical firm Df Q .

Long-Run Equilibrium under Perfect Competition ‡ Many ³optimal-size´ firms. each producing at the minimum long run average cost and charging the market price where: P = MR= MC = SATC = LATC ‡ Allocative efficiency: MC = P ‡ Productive efficiency: MC= SATC = LATC ‡ Zero economic profit (normal profit) : P = ATC .

Pure Monopoly ‡ A single firm producing a homogenous or differentiated (unique) good and facing the market demand. ‡ No substitutes ‡ No new entries allowed ‡ The monopoly is a price maker ‡ P>MR ‡ Possibility of a sustained economic profit .

What circumstances lead to the formation of a monopoly? ‡ ‡ ‡ ‡ ‡ ‡ Extensive economies of scale: natural monopolies Exclusive patent rights Copy rights to intellectual properties Government franchises Exclusive access to a essential resource (input) Cartels A monopoly is a profit maximizer too! .

a $ Demand Faced by A Monopoly -2b -b 0 $ MR Dm Q TR Q 0 .

$ SMC P k m c SATC n D Q o Qe MR Qc .

The Dynamics of a Monopolistic Market ‡ As a profit maximizer a monopoly may try to take advantage of economies of scale ‡ A monopoly tends to try to protect its monopolistic position ‡ A monopoly may take advantage of technological advances ‡ A monopoly may face changes in demand ‡ A monopoly may try to promote its product to maintain demand .

P>ATC SMC P k SATC LATC n m D Q Qe L-R Positive Economic Profit o MR . P>MR. P>MC.$ ATC>MC.

8 Profit = 307..200 ± 10. MR = 80 .ATC). Q .0184 Q Set MR = MC Q = 4000.000 + .000 ‡ Profit = (P.200 ± 147.0008Q . MC = .Monopolies and Profit Maximization ‡ A monopoly faces the industry demand curve ‡ To maximize profit: MR = MC P = 80 . P = 76.0092Q2 ..000 = 150.0016Q TC = 10.

the monopolist may lower its price to near its average cost ‡ Rent seeking: an attempt to maintain its monopolistic position by influencing the political processes-e.g.Things Change ‡ Demand may go down ‡ Cost could increase ‡ In an attempt to keep the potential competitors out. zoning laws ‡ Closer substitutes may emerge ..

P>MC. P = ATC SMC SATC LATC P D Qe L-R Zero Economic Profit o MR Q .$ ATC>MC. P>MR.

the downward-sloping segment of the LATC curve extends to or beyond the market capacity (or market demand).The Case of Natural Monopolies ‡ A natural monopoly emerges out of competition among firms in an industry with extensive economies of scale. . ‡ Smaller firms are gradually driven out by the larger (more efficient) firms. ‡ The surviving firm would become a (natural) monopoly. ‡ If unchecked. a natural monopoly behaves like a monopoly. it under-produces and overcharges.

$ SAC1 Natural Monopolies SAC2 SAC3 LAC D o Q1 Q2 Q3 Q .

$ LATC Natural Monopolies Monopoly Pricing Pm p AC LMC SAC SMC D o Qm MR Qc Q .

$ A Comparison Pm Pc MC MR o Qm Qc D Q .

a monopoly can charge different prices in each market segment To price-discriminate ‡ The firm must identify consumer groups/classes with different downward-sloping demand curves ‡ The firm must be able to prevent consumers of one class from reselling its product to the consumers of another class.Price Discrimination ‡ Segmenting the market into separate classifications or regions ‡ Assuming that each class of consumers have different demand. no intermarket redistribution of the product is allowed .

$ P` MC. ATV P D D` Q MR Q o Q MR Q Price Discrimination .

Monopsony vs. Monopoly MCL Wu Wc Wm SL MRPL:DL MRL o Eu Em Ec .

C P.C P MCB MCA ATCA ATCB MC Dm MR o QA Firm A o QB Firm B o Industry Q .Cartels P.C P.

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