Types of market structure: Perfect Competition Monopoly Monopolistic Competition Oligopoly Discussions: Characteristics of each market Demand curve (AR) and MR Profits-maximization rule Short run and long run output decision

Perfectly competitive market Characteristics: Large number of buyers and sellers in the market. Firms are price takers because the individual sales volume is relatively small compared to market volume. Each firm/ seller or each buyer acts independently, rather than coordinating decisions collectively Each firm produces a homogeneous (an identical) product: buyers cannot distinguish the product of one seller from that of another. Perfect information about prices The prices of all sellers are known A consumer will purchase at the lowest price available in the market No sale can be made at any higher price. Free entry into and exit from market: Equal access to resources Absence of promotion strategy and transport cost.

Demand (AR) and MR curve Total revenue (TR) = P x Q Average revenue (AR) = TR / Q = P Marginal revenue (MR) = ΔTR / ΔQ P Q TR=P x Q AR= TR/Q MR= ΔTR/ ΔQ 10 1 2 3 20 30 P, AR, MR P = AR = MR 10 Kuantiti (Q) 1 2 3

Demand at the market and firm level under perfect competition Market (industry) Firm P P D S P = AR = MR RM10 RM10 D S D 2000 Output 1 2 Output

Equilibrium of a Firm A firm is in equilibrium when it earns maximum profit or when minimum losses occur. Equilibrium output = output level which gives the maximum profit to a firm. Profit maximization Total revenue and total cost approach Profit = TR – TC Profit maximization: the highest vertical distance between TR and TC. Marginal revenue and marginal cost approach Profit maximization: MR = MC

Profit maximization under perfect competition Short-run output decision: MR = MC P > AC firm earns economic profits/abnormal profit P = AC zero economic profits/ normal profit P < AC firm suffers economic losses P < AC but P ≥ AVC loss by operating, but this loss < FC P < AVC shut down Long-run output decision

Short-run output decision P > AC P = AC Price & costs Price & costs MC MC AC AC A P1 AR=MR=P=DD P P2 A B AR=MR=P=DD Q Output (Q) Q Output (Q) TR = 0QAP1 TC = 0QBP2 Profit = TR – TC = P1ABP2 TR = 0PAQ TC = 0PAQ Profit =TR –TC = 0

Firm incurs a loss P < AC but P > AVC P < AC – a loss Harga & kos MC AC Harga & kos MC AC A P2 AVC P1 A C1 B AR=MR=P P B AR=MR=P C2 E Q output TR = 0QBP1 TC = 0QAP2 TR < TC, firm incurs a loss = P1BAP2 This firm can reduce cost by using a better technology to obtain normal profit. AC shifts downwards. output Q TR = 0PBQ = 0C2EQ + C2EBP TC = 0C1AQ = 0C2EQ + C2EAC1 The firm incurs a loss, but TR > VC or AR > AVC

MC and short-run supply curve for a competitive firm AVC MC Po P1 P2 P3 Qo Q1 Q2 Q3 J K L M MC curve at points JKLM = a firm’s SS curve Output Price

Long-run competitive equilibrium Free entry into and exit from market: if profits were +ve, entry would occur and P would fall. If profits were –ve, exit would occur and P would rise. Ultimately P = AC, all firms in the market earn zero economic profits/ normal profit. P = MR= MC, P = minimum AC. Harga & kos LMC LAC SMC SAC AR=MR=P P Output Q

Calculation approach: 1. The cost function for a firm is given by C = 5 + Q2 If the firm sells output in a perfectly competitive market and other firms in the industry sell output at a price of RM20, what price should the manager of this firm put on the product? What level of output should be produced to maximize profits? How much profits will be earned?

Answer: The manager should price the product at RM20 Profit-maximizing output: MC = P. MC = 2Q = 20, Q = 10 Profits = TR – TC = PxQ – (5 + Q2) = 10(20) – 5 – 100 = RM95

Suppose the cost function for a firm is given by C = 100 + Q2 Suppose the cost function for a firm is given by C = 100 + Q2. If the firm sells output in a perfectly competitive market and other firms in the industry sell output at a price of RM10, what level of output should the firm produce to maximize profits or minimize losses? What will be the level of profits or losses if the firm makes the optimal decision?

Answer: P = RM10, MC = 2Q. Profit maximizing output: P = MC, 10 = 2Q, Q = 5 units. Profit = TR – TC =10(5) – 100 – 52 = 50 – 100 – 25 = -RM75 The firm incurs a loss of RM75, which is less than the loss of RM100 (fixed costs) that would result if the firm shut down its plant in the short run.

A vegetable seller faces a horizontal demand curve A vegetable seller faces a horizontal demand curve. Total variable costs are given by TVC=150Q – 20Q2 + Q3. At what price should the firm shut down? Solution: Shut down point occurs when AVC is at the minimum point. It also happens when P=MR=MC=AVC. Derive TVC to obtain MC. MC = dTVC/dQ = 150 – 40Q +3Q2 Divide TVC by Q to obtain AVC: AVC = TVC/Q = 150 – 20Q + Q2 To find shut down price, set MC = AVC: 150 – 40Q + 3Q2 = 150 – 20Q + Q2 2Q2 – 20Q = 0, 2Q(Q - 10) = 0 Q = 0 or Q = 10 Substitute Q = 10 into the MC equation to obtain P P = MC = 150 – 40(10) + 3(10)2 = 50 Shut down price is RM50.