Transcript 11 Perfect Competition

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Managerial Economics
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In economics, market structure (also known as market form)
describes the state of a market with respect to competition.
The major market forms are:
Perfect competition, in which the market consists of a very large
number of firms producing a homogeneous product.
Monopolistic competition, also called competitive market, where
there are a large number of independent firms which have a very
small proportion of the market share.
Oligopoly, in which a market is dominated by a small number of
firms which own more than 40% of the market share.
Oligopsony, a market dominated by many sellers and a few buyers.
Monopoly, where there is only one provider of a product or service.
Natural monopoly, a monopoly in which economies of scale cause
efficiency to increase continuously with the size of the firm.
Monopsony, when there is only one buyer in a market.
The imperfectly competitive structure is quite identical to the
realistic market conditions where some monopolistic competitors,
monopolists, oligopolists, and duopolists exist and dominate the
market conditions.
These somewhat abstract concerns tend to determine some but
not all details of a specific concrete market system where buyers
and sellers actually meet and commit to trade.
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Market Structure/Form
Market
Structure
Seller Entry
Barriers
Seller
Number
Buyer Entry
Barriers
Buyer Number
Perfect
Competition
No
Many
No
Many
Monopolistic
competition
No
Many
No
Many
Oligopoly
Yes
Few
No
Many
Oligopsony
No
Many
Yes
Few
Monopoly
Yes
One
No
Many
Monopsony
No
Many
Yes
One
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Continued…
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• The correct sequence of the market
structure from most to least competitive
is perfect competition, imperfect
competition, oligopoly, and pure
monopoly.
• The main criteria by which one can
distinguish between different market
structures are: the number and size of
producers and consumers in the
market, the type of goods and services
being traded, and the degree to which
information can flow freely.
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Perfect Competition
• Firms are price-takers
• Each produces only a very small portion
of total market or industry output
• All firms produce a homogeneous
product
• Entry into & exit from the market is
unrestricted
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Demand for a Competitive
Price-Taker
• Demand curve is horizontal at price
determined by intersection of market
demand & supply
• Perfectly elastic
• Marginal revenue equals price
• Demand curve is also marginal revenue curve
(D = MR)
• Can sell all they want at the market price
• Each additional unit of sales adds to total
revenue an amount equal to price
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Demand for a Competitive
Price-Taking Firm
Price (dollars)
Price (dollars)
S
P0
P0
D = MR
D
0
Q0
Quantity
Panel A –
Market
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0
Quantity
Panel B – Demand curve
facing
a price-taker
Managerial Economics
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Profit-Maximization in the
Short Run
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In the short run, managers must make
two decisions:
1.
Produce or shut down?


If shut down, produce no output and hires no
variable inputs
If shut down, firm loses amount equal to TFC
2. If produce, what is the optimal output
level?


If firm does produce, then how much?
Produce amount that maximizes economic profit
Profit =   TR  TC
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Profit Margin (or Average Profit)

( P  ATC )Q
Average profit  
Q
Q
 P  ATC  Profit margin
• Level of output that maximizes total
profit occurs at a higher level than the
output that maximizes profit margin (&
average profit)
• Managers should ignore profit margin
(average profit) when making optimal
decisions
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Short-Run Output Decision
• Firm’s manager will produce output
where P = MC as long as:
• TR  TVC
• or, equivalently, P  AVC
• If price is less than average variable
cost (P  AVC), manager will shut down
• Produce zero output
• Lose only total fixed costs
• Shutdown price is minimum AVC
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Profit Maximization: P = $36
TotalProfit
revenue
=$36 x -600
= $21,600
$11,400
= $21,600
= $10,200
Total cost = $19 x 600
= $11,400
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Profit Maximization: P = $36
Panel A: Total revenue
& total cost
Panel B: Profit curve
when P = $36
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Short-Run Loss Minimization:
P = $10.50
Profitcost
= $3,150
Total
= $17 -x$5,100
300
= -$1,950
= $5,100
Total revenue = $10.50 x 300
= $3,150
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Irrelevance of Fixed Costs
• Fixed costs are irrelevant in the
production decision
• Level of fixed cost has no effect on
marginal cost or minimum average
variable cost
• Thus no effect on optimal level of
output
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Summary of Short-Run Output
Decision
• AVC tells whether to produce
• Shut down if price falls below minimum
AVC
• SMC tells how much to produce
• If P  minimum AVC, produce output
at which P = SMC
• ATC tells how much profit/loss if
produce
•   ( P  ATC )Q
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Short-Run Supply Curves
• For an individual price-taking firm
• Portion of firms’ marginal cost curve
above minimum AVC
• For prices below minimum AVC,
quantity supplied is zero
• For a competitive industry
• Horizontal sum of supply curves of all
individual firms
• Always upward sloping
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Derivation of Short-Run Supply
Curves
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Long-Run Profit-Maximizing
Equilibrium
Profit = ($17 - $12) x 240
= $1,200
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Long-Run Competitive Equilibrium
• All firms are in profit-maximizing
equilibrium (P = LMC)
• Occurs because of entry/exit of
firms in/out of industry
• Market adjusts so P = LMC = LAC
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Long-Run Competitive
Equilibrium
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Long-Run Industry Supply
• Long-run industry supply curve
can be flat (perfectly elastic) or
upward sloping
• Depends on whether constant cost
industry or increasing cost industry
• Economic profit is zero for all
points on the long-run industry
supply curve for both types of
industries
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Long-Run Industry Supply
• Constant cost industry
• As industry output expands, input prices
remain constant, & minimum LAC is
unchanged
• P = minimum LAC, so curve is horizontal
(perfectly elastic)
• Increasing cost industry
• As industry output expands, input prices
rise, & minimum LAC rises
• Long-run supply price rises & curve is upward
sloping
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Long-Run Industry Supply for a
Constant Cost Industry
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Long-Run Industry Supply for an
Increasing Cost Industry
Firm’s output
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Economic Rent
• Payment to the owner of a scarce,
superior resource in excess of the
resource’s opportunity cost
• In long-run competitive equilibrium
firms that employ such resources
earn only normal profit
• Economic profit is zero
• Potential economic profit is paid to
the resource as rent
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Economic Rent in Long-Run
Competitive Equilibrium
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Profit-Maximizing Input Usage
• Profit-maximizing level of input
usage produces exactly that level
of output that maximizes profit
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Profit-Maximizing Input Usage
• Marginal revenue product (MRP)
• MRP of an additional unit of a variable input is
the additional revenue from hiring one more unit
of the input
TR
MRP 
 P  MP
L
• If choose to produce:
• If the MRP of an additional unit of input is
greater than the price of input, that unit should
be hired
• Employ amount of input where MRP = input price
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Profit-Maximizing Input Usage
• Average revenue product (ARP)
• Average revenue per worker
TR
ARP 
 P  AP
L
• Shut down in short run if ARP < MRP
• When ARP < MRP, TR < TVC
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Profit-Maximizing Labor Usage
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Implementing the ProfitMaximizing Output Decision
• Step 1: Forecast product price
• Use statistical techniques
• Step 2: Estimate AVC & SMC
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•
AVC  a  bQ  cQ
•
SMC  a  2bQ  3cQ
2
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Implementing the ProfitMaximizing Output Decision
• Step 3: Check shutdown rule
• If P  AVCmin, produce
• If P < AVCmin, shut down
• To find AVCmin, substitute Qmin into
AVC equation
Qmin
b

2c
2
AVC min  a  bQmin  cQmin
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Implementing the ProfitMaximizing Output Decision
• Step 4: If P  AVCmin, find output
where P = SMC
• Set forecasted price equal to
estimated marginal cost & solve for Q*
P  a  2bQ  3cQ
*
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Implementing the ProfitMaximizing Output Decision
• Step 5: Compute profit or loss
• Profit = TR - TC
 P  Q*  AVC  Q*  TFC
 ( P  AVC )Q  TFC
*
• If P < AVCmin, firm shuts down &
profit is -TFC
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