Transcript Lecture 1(b) Models

Lecture 4(a) Competition
and Monopoly
Why Bother?
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The first part of this course looked at the
motivation and calculation of individual
consumers and producers. Now we need to
examine how these groups interact in a
marketplace.
The actual models are so unrealistic as to border
on the absurd, but they provide a kind of a
benchmark against which we can judge markets
in the real world.
What Would a Perfectly Competitive
Market Look Like?
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Many Buyers and Sellers, of more or less the same size.
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Homogenous Product
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No Walmarts or Dept. of Defense
Meaning the output of one firm is indistinguishable from
that of another (i.e., a commodity)
Perfect Information (about prices and costs)
No Entry Barriers (we’ll have to think more carefully
about exactly what this means later).
Firm Demand is Perfectly Elastic
(that is, firms are price takers)
Firm Demand
Market Demand
P
Q
All This Really Means Is That MR=P
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This makes perfect sense: the firm doesn’t have
to cut price in order to sell more. Thus, every
added unit sold increases revenue by the price of
the good.
Of course if you like calculus:
R = Pq and so
MR = dR/dq = P
The Next Step is Describe What an
Equilibrium Will Look Like in a Competitive
Market
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An “equilibrium” is defined in economics (and most
other sciences) as a state of the world in which none of
the relevant variables will have a tendency to change.
In analyzing markets it is useful to distinguish between
“short run” equilibrium and “long run” equilibrium.
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The short run describes a period of time that is too short for
new firms to enter the market or for existing firms to make
significant adjustments to their productive capacity. (Think
about how that fits in with the discussion of fixed costs and
time from the previous lecture.)
The long run refers to a time period sufficiently long to
permit new entry (or exit) and maybe capacity adjustment.
Short Run Equilibrium Part I: How Much Does a Typical
Firm Produce?
(Obvious Answer: The q such that MC=MR=P
Firm Demand
MC
P
q
Short Run Equilibrium Part II: Short Run Supply
Market Supply With N
Firms
Firm Demand
The “supply curve” is really
just a reflection of MC
MC
Po
P1
q1
qo
Nq1
Nqo
Short Run Equilibrium Part III: Putting It All Together
Market Supply With N
Firms
Firm Demand
MC
Think About Why This
is Equilibrium
Supply
Po
Demand
qo
Nqo
Short Run Equilibrium IV: Summing
Up
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A Short Run Equilibrium is Characterized by
P=MR=MC
“Market Clearing Prices” (i.e., Quantity
Demanded = Quantity Supplied
Long Run Equilibrium I: What
Does it Mean
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Since the defining characteristic of the “short
run” was the assumption of no entry, the “long
run” will be defined as the period of time long
enough for firms to enter (or change scale).
This means we need to ask about profits.
This Can’t Happen in the Long Run
Market Supply With N
Firms
Firm Demand
AC
Positive
Profits
Supply
MC
Po
Demand
qo
Nqo
So What Would Happen in the Long Run With Positive
Profits?
Market Supply With N
Firms
Firm Demand
AC
Positive
Profits
Supply
MC
Entry and
Lower Price
Po
Demand
qo
Nqo
What Would Happen in the Long Run If There Were
Negative Profits?
Market Supply With N
Firms
Firm Demand
Loss
Exit and
Higher
Price
AC
Supply
MC
Po
Demand
qo
Nqo
The Long Run Equilibrium
Market Supply With N
Firms
Firm Demand
No
(economic)
profit or loss
AC
Supply
MC
Po
Demand
qo
Nqo
Long Run Equilibrium: Summing
Up
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A Short Run Equilibrium is Characterized by
P=MR=MC
“Market Clearing Prices” (i.e., Quantity
Demanded = Quantity Supplied)
No (economic) profits or loss (P=ACmin)
Issue: Can You Make Money (i.e.,
earn positive economic profits) In a
Competitive Market
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The model says no but….
A note on “stability” and competitive
equilibrium
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An equilibrium may exist but not be “stable”
Think about the “cattle cycle” or “bubbles”.
Applying the Model: SR
Equilibrium and the Burden of a Tax
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Consider a “per unit” tax on some good (like the
tax on a pack of cigarettes).
Does it matter whether the tax is imposed on
the buyer or seller?
Suppose the Producer Must Pay $5
Tax
Ptax
Supply (tax)
Supply (no tax)
Ptax
Tax shifts the Supply by $5
Pno tax
Pnet
Demand
Suppose the Consumer Must Pay $5
Tax
Ptax
Supply
Pnet
Pno tax
Tax shifts the demand by $5
Ptax
Demand (tax)
Demand (no tax)