Pekan-6 PIE (IEI2C2) Bahan Kuliah

FAKULTAS REKAYASA INDUSTRI
PENGANTAR ILMU EKONOMI (IEI2C2)

By: SIN, BYG, FRD, RKM, MDR
Lecture Note #6
MARKET STRUCTURE
PERFECT COMPETITION
IEI2C2 - PENGANTAR ILMU EKONOMI TEL U – FAK. REKAYASA
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Course Content
In this section, we examine four main topics:
 Perfect Competition
 Profit Maximization
 Competition in the Short Run
 Competition in the Long Run
Perfect Competition 2 of 34
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Market Structure, Why?

 One major question: how much a company should produce?  depends on
cost function and how much it can sell at a given price
 How much a company can sell depends on market demand and how much
the other firms behave
 Behavior of firms depend on the market structure
 Market Structure: the number of firms in the market, the ease with which
firms can enter and leave the market, and the ability of firms to
differentiate their products from their rivals.
 Market structure provides information about how firms operating in the
market will behave; it is a function of :
 the number of firms in the market
 the ease with which firms can enter and leave the market
 the ability of firms to differentiate their products from those of their rivals
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Perfect Competition
It is a market where economic forces operate unimpeded.
Properties of perfect competition :
No single firm’s actions can
raise or lower the price. Price
Each firm in the market is a price
Large taker: a firm cannot significantly
Individual firm’s demand curve Number Taker affect the market price.
is a horizontal line at market
price.
If all firms are selling identical Buyers and sellers have full
products, it is difficult for any information : Consumer knowledge
Identical Full of all firms’ prices makes it easy for
firm to raise the price above the Products Information consumers to buy elsewhere if any
going market price charged by one firm raised its price above
all firms. market price.
Negligible Transaction costs the Firms freely enter and exit the market.
expenses of finding a trading Negligiblle  There are no barriers to entry –
partner and completing the trade Transaction Freely Enter barriers to entry are social, political,
beyond the price paid for the Cost and Exit
or economic impediments that prevent
good or service—are low. firms from entering a market
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Perfect Competition
price taking
 Perfect competition is one type of market structure in which buyers and
sellers are price takers.  because each individual firm sells a
sufficiently small proportion of total market output, its decisions have no
impact on market price.
 Firm that has no influence over market price and thus takes the price as given.
 Neither firms nor consumers can sell or buy except at the market price.
 This is what most people mean when they talk about “competitive firms.”
product homogeneity
 When the products of all of the firms in a market are perfectly substitutable
with one another—that is, when they are homogeneous—no firm can raise
the price of its product above the price of other firms without losing most
or all of its business.
 In contrast, when products are heterogeneous, each firm has the
opportunity to raise its price above that of its competitors without losing all
of its sales.
 The assumption of product homogeneity is important because it ensures
that there is a single market price, consistent with supply-demand analysis.
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Perfect Competition
 free entry (or exit).
Condition under which there are no special costs that make it difficult for
a firm to enter (or exit) an industry.
With free entry and exit, buyers can easily switch from one supplier to
another, and suppliers can easily enter or exit a market.
example
• The 107,000 U.S. soybean farmers are price takers. If a typical grower drops out of
the market, market supply falls by only 1/107,000 or 0.00093%, so the market
price would not be significantly affected
• A soybean farm can sell any feasible output it produces at the prevailing market
equilibrium price  the firm’s demand curve is a horizontal line at the market
price
• Why horizontal?
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Perfect Competition
When Is a Market Highly Competitive?
 Many markets are highly competitive in the sense that firms face highly elastic demand
curves and relatively easy entry and exit. But there is no simple rule of thumb to
describe whether a market is close to being perfectly competitive.
 Because firms can implicitly or explicitly collude in setting prices, the presence of
many firms is not sufficient for an industry to approximate perfect competition.
 Conversely, the presence of only a few firms in a market does not rule out competitive
behavior.
Do Firms Maximize Profit?
 The assumption of profit maximization is frequently used in microeconomics because
it predicts business behavior reasonably accurately and avoids unnecessary analytical
complications.
 For smaller firms managed by their owners, profit is likely to dominate almost all
decisions. In larger firms, however, managers who make day-to-day decisions usually
have little contact with the owners.
 Firms that do not come close to maximizing profit are not likely to survive. The firms
that do survive make long-run profit maximization one of their highest priorities.
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Perfect Competition
Competitive Firm’s Demand
 Are perfectly competitive firms’ demand curves really flat?
 The residual demand curve,
Dr(p), that single office
furniture manufacturing firm
faces is the market demand
D(p), minus the supply of the
other firms in the market,
S0(p), or the portion of the
market demand that is not
met by other sellers at any
given price.
 The residual demand curve is
much flatter than the market
demand curve.
 A competitive firm supplies only a small portion of the total output of all the firms in an
industry. Therefore, the firm takes the market price of the product as given, choosing its
output on the assumption that the price will be unaffected by the output choice. In (a)
the demand curve facing the firm is perfectly elastic, even though the market demand
curve in (b) is downward sloping.
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Marginal Revenue, Marginal Cost, and Profit Maximization

 profit. Difference between total revenue and total cost.
π(q) = R(q) − C(q)
 marginal revenue. Change in revenue resulting from a one-unit increase
in output.
 A firm chooses output q*, so that
profit, the difference AB between
revenue R and cost C, is
maximized.
 At that output, marginal revenue
(the slope of the revenue curve) is
equal to marginal cost (the slope of
the cost curve).
Δπ/Δq = ΔR/Δq − ΔC/Δq = 0
MR(q) = MC(q)
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Profit Maximization (in general)
 Profit maximization in this class always refers to economic profit, which

is revenue minus opportunity cost.
 Profit π = R – C, where R = p.q, p is price per unit, q is quantity sold
 If π < 0, the firm makes loss
 A firm’s profit varies with its output level
 Firm’s profit function is π(q) = R(q) – C(q)
 A firm must decide how much output to sell to maximize its profit
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Profit Maximization : Output Rules
 Maximizing profit involves two important questions:

• Output decision: If the firm produces, what output level (q*) maximizes
its profit or minimizes its loss?
• Shutdown decision: Is it more profitable to produce q* or to shut down
and produce no output?
 A firm can use one of three equivalent output rules to choose how
much output to produce:
1. A firm sets its output where its profit is maximized.
2. A firm sets its output where its marginal profit is zero.
3. A firm sets its output where its marginal revenue equals its marginal cost.
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Profit Maximization : Output Rules #1

 The firm sets output where the profit is maximized. The firm needs to
know its entire profit curve
 If the firm knows the profit curve, it can determine the output level
immediately
 If the firm does not know exactly the profit curve, it can do experiment :
increase its output and see the profit
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Profit Maximizing: Output Rules #2
 The goal of the firm is to maximize profits, the difference between

total revenue and total cost
 A firm maximizes profit when marginal revenue equals marginal cost
 Marginal profit is the change in profit a firm gets from selling one
more unit of output, Δπ/Δq.  Δπ(q) = MR(q) – MC (q)
 Marginal revenue (MR) is the change in total revenue associated with
a change in quantity
 Marginal cost (MC) is the change in total cost associated with a
change in quantity
 The profit-maximizing condition of a competitive firm is : MR = MC
 MC = P is equivalent to MC = MR because MR = P in perfect competition.
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Profit Maximizing
Total Revenue, MR, Total Cost , MC
Total Revenue and Total Cost Table
Table
Total
Total Total Cost Total Total Total
Q Q MR MC Profit
Revenue ($) ($) Profit ($) Revenue ($) Cost ($)
($)
0 0 40 -40 0 0 40 -40
1 35 68 -33 1 35 35 68 28 -33
2 70 88 -18 2 70 35 88 20 -18
3 105 104 1 3 105 35 104 16 1
4 140 118 22 4 140 35 118 14 22
5 175 130 45 5 175 35 130 12 45
6 210 147 63 6 210 35 147 17 63
7 245 169 76 7 245 35 169 22 76
8 280 199 81 8 280 35 199 30 81
9 315 239 76 9 315 35 239 40 76
10 350 293 57 10 350 35 293 54 57
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Profit Maximizing
MC, MR, and Price Table
Price = MR ($) Q Marginal Cost ($) The profit-maximizing condition
35 0 of a competitive firm is:
35 1 28 MC = MR = P
20
35 2
16 If MC < P,
35 3
14 increase production
35 4
12
35 5 Profit maximizing quantity
17
35 6 is where MC = P
22
35 7
30
35 8 If MC > P,
40 decrease production
35 9 54
35 10
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Profit Maximizing
• A firm maximizes total profit, not profit per unit
If MR < MC,  a firm can increase profit by decreasing its output
If MR > MC,  a firm can increase profit by increasing output
Marginal Cost, Marginal Revenue, and Price Graph
P Marginal
Cost
MC > P,
MC = P decrease output to
increase total profit
$35 P = D = MR
MC < P, MC = P at 8 units,
increase output to total profit is maximized
increase total profit
Q
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Profit Maximizing
The Marginal Cost Curve is the Supply Curve
Marginal Firm’s Supply

P Cost = Curve
$61
Because the marginal cost
curve tells us how much of a
good a firm will supply at a
$35 given price, the marginal
cost curve is the firm’s
$19.50 supply curve
Q
6 8 10
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Profit Maximizing
Profit Maximization using Total Revenue and Total Cost
An alternative method to
Total Total Cost
determine the profit- Q
Revenue ($) ($)
Total Profit ($)
maximizing level of output is
to look at the total and total 0 0 40 -40
cost curves
1 35 68 -33
• Total cost is the cumulative 2 70 88 -18
sum of the marginal costs, 3 105 104 1
plus the fixed costs 4 140 118 22
• Total profit is the difference 5 175 130 45
between total revenue and 6 210 147 63
total cost curves 7 245 169 76
Total profit is
8 280 199 81 maximized at 8
9 315 239 76 units of output
10 350 293 57
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Profit Maximizing
Profit Maximization using Total Revenue and Total Cost
Total Cost, Total
Revenue
TC The total revenue curve is a
TR straight line
Max profit = $81 at
8 units of output
The total cost curve is
$280 bowed upward at most
quantities reflecting
increasing marginal cost
$175
$130
Profits are maximized
when the vertical distance
Losses Profits Losses between TR and TC is
greatest
Q
Perfect Competition 3 5 8 19 of 34
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Profit Maximizing
Determining Profits Graphically : A Firm with Profit

P Find output where
MC MC = MR, this is the
profit maximizing Q
MC = MR
ATC
Find profit per unit where
P Profits
P = D = MR the profit max Q intersects
AVC ATC
ATC
ATC at Qprofit max
Since P>ATC at the
profit maximizing quantity,
this firm is earning profits
Q
Qprofit max
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Profit Maximizing
Determining Profits Graphically : A Firm with Zero Profit or Losses
P
Find output where MC
MC = MR, this is the
profit maximizing Q
ATC
Find profit per unit where MC = MR
the profit max Q intersects AVC
ATC P P = D = MR
=ATC
ATC at Qprofit max
Since P=ATC at the
profit maximizing
quantity,
this firm is earning Q
zero profit or loss
Qprofit max
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Profit Maximizing
Summary : How a competitive firm
maximize profit
 (a) A competitive lime manufacturing
firm produces 284 units of lime so as
to maximize its profit at π* = $426,000
(Robidoux and Lester, 1988).
 (b) The firm’s profit is maximixed
where its marginal revenue, MR, which
is the market price, p = $8, equals its
marginal cost, MC.
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Profit Maximization : Shutdown Rule

 A firm shuts down only if it can reduce its loss by doing so.
• Shutting down means that the firm stops producing (and thus stops
receiving revenue) and stops paying avoidable costs.
• Only fixed costs are unavoidable because they are sunk costs.
• Firms compare revenue to variable cost when deciding whether to
stop operating.
• Shutting down may be temporary.
 The shut down decision is a short run decision because, in the long run,
all costs are avoidable.
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Profit Maximizing : Shutdown Rule

 If the firm is making a loss, does it shut down?
• Shutdown Rule 1: The firm shuts down only if it can reduce its loss by
doing so.
• Shutdown Rule 2: The firm shuts down only if its revenue is less than
its avoidable cost.
 Suppose that the weekly firm’s revenue is $2,000, and its variable cost is
VC $1000, and its fixed cost F is $3,000 (it is the price it paid for a
machine that it cannot resell or use for any other purpose)
• This firm is making a short-run loss:
π = R - VC - F = 2,000 - 1,000 - 3,000 = -2,000.
• If the firm shuts down, it loses its fixed cost, $3,000, so it is better off operating
• However, if its revenue is only $500, its loss is $3,500, and it is greater than the loss
from the fixed cost alone of $3,000.
• Because its revenue is less than its avoidable, variable cost, the firm reduces its loss
by shutting down.
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Profit Maximizing : Shutdown Rule

Determining Profits Graphically : The Shutdown Decision
• The shutdown point is the P
point below which the firm
will be better off if it shuts MC
down than it will if it stays
in business
ATC
• If P > min of AVC, then the
firm will still produce, but
earn a loss
AVC
• If P < min of AVC, the firm
will shut down PShut P = D = MR
• If a firm shuts down, it still down
has to pay its fixed costs.

Fixed cost is unavoidable Q
Qprofit max
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Competition in the Short Run

Short-Run Market Supply and Demand
• While the firm’s demand curve is perfectly elastic, the industry’s demand curve
is downward sloping
• The market (industry) supply curve is the horizontal sum of all the firms’
marginal cost curves
• The market supply curve takes into account any changes in input prices that
might occur
P Market P Firm
Market MC
Supply
ATC
P P P = D = MR
Profits
ATC
Market
Demand
Qprofit max
Perfect Competition Q Q 26 of 34
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Competition in the Long Run

 Long-Run Output Decision
• The firm chooses the quantity that maximizes profit using the same
rule as in the SR : MC = MR.
 Long-Run Shutdown Decision

• Because all costs are variable in the LR, the firm shuts down if it
would suffer an economic loss by continuing to operate.
• Graphically, relevant shutdown point is the minimum of the LR
average cost curve.
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Market Response to an Increase in Demand Graph
P Market P Firm
MC
S0(SR)
S1(SR) ATC
2
P1 P1
1 2 SR Profits 1 2
P0 P0
S(LR)
1 1
D1
1 2
D0 2
Q Q
Q0 Q1 Q2 Q0,2 Q1
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Long-Run Competitive Equilibrium
 At long run equilibrium, economic profits are zero
 Profits create incentives for new firms to enter, market supply will increase,
and the price will fall until zero profits are made.
 The existence of losses will
cause firms to leave the P
industry, market supply will At long-run equilibrium,
economic profits are zero MC
decrease, and the price will
increase until losses are zero. LRATC
 Zero profit does not mean that SRATC
the entrepreneur does not get
anything for his efforts
P = D = MR
 Normal profit is the amount
the owners would have
received in their next best
alternative
 Economic profits are profits
above normal profits Q
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Long-Run Market Supply Curve
Three scenarios in which LR market supply is not flat:
1. LR market supply when entry is limited
• Upward-sloping if government restricts number of firms, firms need a
scarce resource, or if entry is costly
2. LR market supply when firms differ
• Upward-sloping if firms with relatively low minimum LRAC are
willing to enter market at lower prices than others
3. LR market supply when input prices vary with output
• In an increasing-cost market input prices rise with output and LR
market supply is upward-sloping
• In a decreasing-cost market input prices fall with output and LR market
supply is downward-sloping
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Long-Run Market Supply
 If the long-run industry supply curve is perfectly elastic,
the market is a constant-cost industry
 If the long-run industry supply curve is upward sloping,
the market is an increasing-cost industry
 If the long-run industry supply curve is downward sloping,
the market is a decreasing-cost industry
 In the short run, the price does more of the adjusting, and in
the long run, more of the adjustment is done by quantity
Application : Kmart
• Although Kmart was making losses, Kmart decided to keep 300
stores open because P > AVC.
• After 2 years of losses, Kmart realized that the decrease in demand
was permanent
• They moved from the short run to the long run and closed the stores
because prices had fallen below their long-run average costs
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Summary
 The necessary conditions for perfect competition are :
1). Buyers and sellers are price takers;
2).The number of firms is large;
3). There are no barriers to entry;
4). Firms’ products are identical;
5) There is complete information;
6). Sellers are profit-maximizing entrepreneurial firms.
 Competitive firms maximize profit where MR = MC
 Profit is (P – ATC)(Q) at the profit-maximizing level of output
 Perfectly competitive firms shut down if P < AVC
 The supply curve of a competitive firm is its MC curve above min. AVC
 The short-run market supply curve is the horizontal sum of the MC curves above
AVC for all the firms in the market
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Summary
 In the short run, competitive firms can make a profit or loss. In the
long run they make zero profits.
If there are profits If there are losses:
• Firms enter the industry • Firms leave the industry
• Supply increases • Supply decreases
• Price decreases, eliminating profit • Price increases, eliminating losses
 The long-run industry supply curve is a schedule of quantities supplied

where firms are making zero profit
 Constant-cost industries have horizontal long-run supply curves
 Increasing-cost industries have upward sloping long-run supply curves
 Decreasing-cost industries have downward sloping supply curves
 The slope of the long-run supply curve depends on what happens to
factor costs when output increases
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Referensi
 Perloff, Jeffrey M., 2012, Microeconomics. 6th edition. Boston:
Pearson
 Colander, David (2017), Economics

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FAKULTAS REKAYASA INDUSTRI

PENGANTAR ILMU EKONOMI (IEI2C2)

Market Structure, Why?

Marginal Revenue, Marginal Cost, and Profit Maximization

Profit Maximization (in general)

 Profit maximization in this class always refers to economic profit, which

Profit Maximization : Output Rules

 Maximizing profit involves two important questions:

Profit Maximization : Output Rules #1

Profit Maximizing: Output Rules #2

 The goal of the firm is to maximize profits, the difference between

The Marginal Cost Curve is the Supply Curve

Marginal Firm’s Supply

Determining Profits Graphically : A Firm with Profit

Profit Maximization : Shutdown Rule

Profit Maximizing : Shutdown Rule

Profit Maximizing : Shutdown Rule

has to pay its fixed costs.

Competition in the Short Run

Competition in the Long Run

 Long-Run Shutdown Decision

Competition in the Long Run

Competition in the Long Run

Competition in the Long Run

Competition in the Long Run

 The long-run industry supply curve is a schedule of quantities supplied

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