1 QTCTFCTVCATCAFCAVCMC

2 $ per time period Q 3 Q 2 Q 1 Output per time period (units) (b) Unit costs MC ATC AVC AFC Why these shapes? Relationships between costs?

3 Chapter 6 Market Structure I: Perfect Competition Market Structure Perfect Competition Vs Monopoly What determines the level of competition? Perfect Competition in Detail

4 Market Structure Competitive environment for a good or service Market – all firms and individuals willing and able to buy or sell a particular product

5 Factors that determine the level of competition Product Differentiation Barriers to Entry Number of Buyers and Sellers Information availability

6 Types of Markets Perfect Competition Monopoly Monopolistic Competition Oligopoly

7 Perfect Competition Large number of buyers and sellers – each firm produces small amount of industry supply and each customer buys a small part of the total. Product Homogeneity – Output of each firm is essentially the same. Free Entry – firms are not restricted from entering the market. Perfect Information – costs, prices and quality is know by all buyers and sellers Buyers and Sellers are “price takers” as they can’t influence the price, must take as given (market price). An Extreme? Practical Examples?

8 GE Stock Individual has 1000 shares of GE common stock 9.93 Billion shares outstanding Value of stock is obtained from broker (or internet) Market determines price, can sell or buy as many as you want at this price. Can’t sell any above the price or buy any below the price. Buyers and Sellers are Price Takers!

9 Milk Market No single buyer can influence price Seller has little price control as products are exactly the same as their competition Can sell all you want at market price – little incentive to charge less – charge more buyers substitute Buyers and sellers take market price as given Entry and Exit?

10 The Market Price in Perfect Competition Industry Supply and Industry Demand Individuals and firms have no control Sum supply and demand for all firms and all consumers to get industry

11 Market Price in Perfect Competition Industry Supply Quantity per time period (millions) Price per unit ($) P =– $ $ Q P = $40– $0.0001Q Industry Demand

12 Mathematics Demand = P = 40 – Q Supply = P = Q 40 – Q = Q Q = 322, 032 P = 40 – *322,032 $7.80 Check Graph

13 Why can’t a firm influence prices in this market structure? Look at impact of them pulling all of their goods off of the market!

14 Firm pulls all output off market. D S $ Q S’ Supply shift very small. Equilibrium price increases. However, price increase is so small (e.g., 1/10 penny) that it is not noticed in the market. PePe Pe’Pe’

15 P = 6 = “Price Takers” Profit Max: P = AR =MR = MC QTRTCProfitMRARMC

16 Price Taking Firm Firm Market D S d f =MR=AR=P e $ q $ Q Q 1

17 The Price Output Decision for a Firm under Perfect Competition Profit Max requires that MR = MC Under PC price is constant (market price) MR = P AR = MR if price is constant (AR = TR/Q = P*Q/Q = P) Profit Max: P = MR = AR = MC Firms have horizontal demand curve Think about GE stock example!

18 Firm Demand Curve under PC Price per unit ($) Demand Quantity per time period (000) Under PC demand curve is basically flat, price is not a function of output. Firms are price takers. Higher price, no demand

19 Profit Maximizing in Perfect Competition MR = MC: MR>MC – produce more, MR<MC -produce less Market Price is constant – price taker (horizontal line) If price is constant then AR=MR=P So we can say profit is maximized where MR = MC = P = AR MC curve is the firms supply curve!

20 Profit Maximization for Firm Firm Market D S d f =MR=AR=P e MC=s f $ q $ Q q 1 Q 1

21 The Graph Firm sells Q* where MR=MC Average cost of C dollars Market Price is P Economic Profits = P (AR) – C (from ATC) dollars per unit Total economic profit = (P-C)*Q = shaded area on the graph Above normal rate of return – see that AR>ATC so economic profit In SR positive economic profits

22 SR Perfect Competition ATC Cost and revenue per unit ($) Output per time period Q* N M MC P = AR = MRP C Economic Profit

23 In the Long Run … Positive Economic Profits (above normal rate of return – shaded area on pervious graph) attract competitors (free firm entry) Expanding supply pushes prices down Expanding supply pushes costs of inputs up Long-Run equilibrium: all economic profits and losses have been eliminated for each firm in the industry Only receiving “normal rate of return” that is included in economic costs (opportunity cost)

24 The Long Run Graph P = MR = AR = ATC – no economic profits or losses Prices fall from SR and ATC increases from SR No firms enter or exit Prices are stable Each firm is operating at minimum ATC Shareholders get adequate rate of return based on risk (and that is all).

25 Long Run PC ATC Cost and revenue per unit ($) Output per time period Q* MC P = AR = MR P

26 Questions for Class? Under Perfect Competition: 1. When would a firm shut down production? 2. When would a firm exit the market?

Answer to question Under Perfect Competition: 1. When would a firm shut down production? When AVC is not being covered. The shut down point is where AR=AVC 2. When would a firm exit the market? If AVC is not covered it will shut down. 27

28 Application: Tax Incidence In Perfect Competition Q P Market Demand Market Supply P C = P P No tax: P C = P P

29 Application: Tax Incidence In Perfect Competition In the Long Run, Consumers pay all of the tax (100%) Producers pay none of tax (0%) There are no firms making losses

30 Monopoly Single Seller Unique Product Blocked entry (exit) May not be perfect information about prices, quality, etc. Industry demand curve equal to firm demand curve Downward Sloping demand (industry is firm)

31 Monopoly Demand Curve Demand Quantity per time period Price per unit ($) 6 Monopolist picks point on Demand curve – Which point?

32 Monopoly Price and Output MR = MC for profit maximization Since demand curve is not horizontal, MR is not equal to price (except first output) MR < Price = AR = Demand Curve MR = MC simultaneously determines output and price

33 Monopoly Price and Quantity TR = P*Q Output Effect: increase output increase revenue Same as Perfect Competition Price Effect: Monopolist sells one more unit, he must lower price. This will lower revenue. For a monopolist output is a function of price, not true for perfect competition (no price effect under PC)

34 Price = Demand Curve =AR P>MR (except first point) QPriceTRARMR

35 Profit Max for Monopoly C' Price and cost per unit ($) P' P C MR Demand = Price MC ATC Quantity per time period Q MR = MC P>ATC economic profits are earned

36 Long Run Monopoly Market Less Output Higher Prices Incentive to under produce and drive up price Social Costs?

37 Comparison Perfect Competition 75,000 haircuts Price = $20 Economic Profits = 0 Monopoly 37,500 haircuts Price = $50 Economic Profits = $1,125,000

38 Monopoly Always Bad? Natural Monopoly Microsoft? Antitrust Laws Government Regulation

Monopolistic Competition 39

40 Profit Max for Monopolistic Competition Price and cost per unit ($) P C Demand = Price MC ATC Quantity per time period Q MR = MC P>ATC economic profits are earned MR The profit

Oligopoly 41