Transcript What are competitive markets?

Market Structures
Competitive
Markets
MONOPOLISTIC
COMPETITION
OLIGOPOLY
MONOPOLY
What is a market structure?
• The way consumers and producers are
organized in a market
– Amount of firms?
– Variety of goods?
– Control over prices?
– Barriers to entry?
How many firms are in the market?
Variety of goods
• How different are the goods in the market?
Control over prices
• How much control does a firm have over their
prices?
Competitive Markets & the Profit
Maximizing Firm
Chapter 14
What does this have to do with
competition?
Do you think economists would consider
this a competitive market?
What are competitive markets?
• Two main conditions that must be
met:
–Many buyers and sellers
–Goods offered are identical or largely
the same
• Also:
–Firms can freely enter and exit the
market
Economists sometimes call
competitive markets perfect
competition. So, whether you hear a
firm is in a competitive market or in a
perfectly competitive market, it is the
same thing!
There are very few markets that
compete perfectly
The market for wheat is a competitive market. This is
because there are many buyers and sellers of wheat AND all
wheat is largely identical.
Most markets are not perfectly
competitive, but very close.
The burger market is close to perfectly competitive because there
are many buyers and sellers, but the product they sell is NOT
identical. So, these firms are monopolistically competitive.
Monopolistic Competition
• Firms that produce differentiated products.
– Products that are slightly different than one
another
We’ll talk more about monopolistic
competition in chapter 17!
So which market do you think buyers
have more control over price?
The perfectly competitive firm
If Joe the farmer sells wheat
for $5 a bushel, then I’ll just
go buy wheat from Bob
instead who sells it for $4 a
bushel. What do I care? All
wheat is the same so I just
want the cheapest price!
Price Takers
• Firms that are competing in a perfectly
competitive market are the “price takers.”
• The firms have no control over price, so the
only thing they can control is how much they
produce.
Nike has SOME control
over the price of
sweaters because they
can offer a slightly
different version than
their competitors.
Joe the farmer has NO
control over prices because
his wheat is exactly the same
as his competitors. So if he
raises the price of his wheat,
the customers will buy from
his competitors instead.
Therefore, Joe the farmer is a
price taker.
Political Cartoon Contest
• Think of a market that is monopolistically
competitive.
• Draw a political cartoon of what that market
would look like if it was perfectly competitive.
– Make it unique and eye catching
– Creativity and humor definitely helps
– Using popular figures also helps dramatically
• The top three will be chosen by the Social
Studies Department
• Then, the residents of Econville will vote for
the best cartoon in the class
Profit Maximization for competitive firms
Review: Key Concepts for
Competitive Markets
•
•
•
•
•
Market price = MR and AR
Profit maximization occurs where MR = MC
If MR > MC, the firm should increase output
If MR < MC, the firm should decrease output
The MC curve is also the firms supply curve
– This is because the MC curve shows the quantity
supplied by the firm at any given price
The firms short run decision
to shut down
What does shut down mean?
• Shutting down is a short-run decision not to
produce anything for a specific period of time
• When firms decide to close down forever and
leave the market, that is called an exit.
Most golf courses shut
down in the winter.
In 2011, Borders exited the
book market.
THE SUPPLY CURVE IN A COMPETITIVE
MARKET
• Short-Run Supply Curve
– The portion of its marginal cost curve that lies
above average variable cost.
• Long-Run Supply Curve
– The marginal cost curve above the minimum point
of its average total cost curve.
Costs
and
Long run supply curve starts here
Revenue
MC
ATC
AVC
Quantity
Short run supply curve starts here
So when does a firm decide
to shut down?
• Even if a firm does not make profit, there are
instances where it is a rationale decision to
stay open. Why?
• Because there are still fixed costs to pay!
Lets analyze a firm’s cost and revenue
graph to understand the shut down
decision
At what market price(s) will this
firm have guaranteed profit?
Optimal
P4
P3
Q3
Q4
Optimal
P1 and P2
At what market price(s) will this
firm have guaranteed losses?
Optimal
P4
P3
Q3
Q4
Optimal
P3 and P4
If market price was at P4, should
the firm shut down?
Optimal
P4
P3
Q3
Q4
Optimal
NO!
At P4, the MR is greater than AVC. That means the
quantity produced at P4 will cover all of the firm’s
variable costs plus some of its fixed costs.
Optimal
P4
P3
Q3
Q4
Optimal
So, this is better than shutting down and having
to pay all of the firm’s fixed costs
If market price was P3, should
the firm shut down?
Optimal
P4
P3
Q3
Q4
Optimal
Yes!
At P3, the MR is less than AVC. That means the
quantity produced at P3 will not cover all of the
firm’s variable costs.
Optimal
P4
P3
Q3
Q4
Optimal
So, the firm won’t be able to cover its variable
costs and even its fixed costs. Shut down!
Review: Shut Down Key Concepts
• The short run supply curve is the portion of
the MC curve that lies above AVC.
• The shut down decision only happens on the
short run supply curve (short run decision)
• If MR > AVC, the firm does not shut down
• If MR < AVC, the firm does shut down
Questions?
sh
Optimal
P4
P3
Q3
Q4
Optimal
The firms long run decision
to exit the market
Remember, the long run supply curve starts at the MC
curve above the minimum point of ATC curve
Costs
Long run supply curve starts here
MC
ATC
Quantity
So this is what a long run cost decision looks like
(notice there is no AVC curve)
The rules of long run decisions
• When MR < ATC, the firm exits the market
• When MR > ATC, new firms enter the market
If market price was P1, the firm should exit the market
because the revenue does not cover the total costs.
MC
Costs
P3
ATC
P2
P1
Q1
Q2
Q3
Quantity
If market price was P3, more firms will enter the market
because the revenue not only covers the costs, but earns
profit for the firm.
MC
Costs
P3
ATC
P2
P1
Q1
Q2
Q3
Quantity
What would happen if market price was P2?
MC
Costs
P3
ATC
P2
P1
Q1
Q2
Q3
Quantity
If market price was P2, no firms would exit or enter the market.
This is because profits in this market have been driven to zero.
MC
Costs
P3
ATC
P2
P1
Q1
Q2
Q3
Quantity
Competitive Markets in the Long Run
How did the energy shot market
go from this…
TO THIS?
The Long Run: Market Supply with
Entry and Exit
• Firms will enter or exit the market until profit
is driven to zero.
• In the long run, price equals the minimum of
average total cost.
• The long-run market supply curve is horizontal
at this price.
So lets look at the long run
energy shot market
The beginning days the energy shot
(a) Initial Condition
Market
Firm
Price
Price
MC
Short-run supply, S 1
A
P1
Long-run
supply
ATC
P1
Demand, D 1
0
Q1
Quantity (market)
The energy shot market began
in long run equilibrium.
0
Quantity (firm)
And the firms earned zero profit.
Teens start to get hooked on energy shots
An increase in market demand…
The higher P encourages firms to produce
more…
…and generates short-run profit.
…raises price and output.
(b) Short-Run Response
Market
Firm
Price
Price
B
P2
P1
MC
S1
ATC
P2
A
Long-run
supply
P1
Quantity (market)
0
D2
D1
0
Q1
Q2
Quantity (firm)
New firms enter the energy shot market
Profits induce entry and
market supply increases.
(c) Long-Run Response
Market
Firm
Price
Price
S1
B
P2
A
C
P1
S2
Long-run
supply
MC
ATC
P1
D2
D1
0
Q1
Q2
Q3
Quantity (market)
The increase in supply lowers market price.
0
Quantity (firm)
In the long run market
price is restored, but
market supply is greater.
We now have…