Market Equilibrium We will consider the two extreme cases Perfect Competition Monopoly

Market Equilibrium Perfect Competition Supply forces (producers) and demand forces (consumers) seek a balance Price below perceived value increases demand Price above ATC provides pure profit, an incentive to increase supply Supply curve Demand curve Q P Pe

Individual Firm’s Demand and MR Curve Q P Pe Highly elastic demand One firm’s change in Q has little effect on price ∆Q ∆P

Market Equilibrium Perfect Competition Price above ATC provides pure profit, an incentive to increase output Pure profit equals (P1 x Q1) – (P2 x Q2) P1P1 MC ATC Price (P) P2P2 Q2Q2 Q1 Individual Firm

Market Equilibrium Perfect Competition All firms are price takers Market price (P 1 ) equals marginal revenue (MR) and average revenue (AR) Optimal level of output is where MR = MC = P 1 In long-run P will go to P 2 where pure profit is eliminated P1P1 MC ATC Price (P) P2P2 Q2Q2 Q1 Individual Firm

Market Supply Curve Summation of supply curves for individual firms Joe’s sawmill Pete’s sawmill Tracy’s sawmill Janet’s sawmill Market supply curve Q P Sum vertically = Qm Qj Qt Qp Qj Demand Pm (same P for all firms and market)

Perfect Competition - Example Given supply and demand functions, Q s = P Q d = 230 – 45 P Determine marginal revenue, MR, i.e. Pe, from supply and demand curves for total market. Calculate Pe from market supply equals demand equilibrium condition, Q s = Q d P = 230 – 45 P 100 P = 200 P = 2 = MR Use P to get equilibrium quantity, Q e Q e = 230 – 45 x 2 = 230 –90 = 140

Apply Market Price to Individual Firm – “Pete’s Sawmill” P = $2 from market equilibrium Determine quantity Pete should produce from Pete’s marginal cost (MC) curve, which is, Qs = P = x 2 = 16.6

Market Equilibrium Monopoly Only one producer –Producer is a price “setter”, not a price taker Demand curve restricts ability to set price –Demand curve determines marginal revenue (MR) Only way to change quantity sold is to change market price Marginal revenue (MR) is not constant What forces lead to a monopoly

Market Equilibrium Monopoly Q P Monopolists MC curve Market demand curve Monopolists MR curve MC = MR to max. profit Qe determine first, then get P from demand curve Pe Down to get Q Up & over to get P e stands for equilibrium

Market Equilibrium Monopoly compared to competitive equilibrium Q P Monopolists MC curve Market demand curve Monopolists MR curve Qm Pm Qc Pc m – monopoly equilibrium c – competitive equilibrium

Market Equilibrium Monopoly Compared to competitive market equilibrium – M onopolist produces (sells) smaller quantity at higher price

Monopoly – Example Given, same supply and demand curves as in competitive example, Q d = 230 – 45 P (given), or P = 5.11 – 1/45 Q Q s = P (given), or P = /55 Q Determine marginal revenue curve: Revenue = P x Q = Q (5.11 – Q) = 5.11 Q – Q 2 MR = 5.11 – Q

Monopoly – Example, cont. Equate MC and MR to determine Q: 5.11 – Q = Q 4.57 = Q Q = 74 Substitute Q into demand curve to get P, P = 5.11 – x 74 = 3.48 Compare the solutions for the two types of markets, Competition: P = 2.00, Q = 130 Monopoly: P = 3.48, Q = 74