MARKET

Q-definition a mechanism of exchange between buyers and sellers of a good or service.

Q-Types of market and characteristics

Forms of market structure Number of firms Nature of products Degree of control over price Price elasticity of demand for a firm Part of economy where prevalent Entry Perfect competition Large Homogeneous None Infinite Financial and agricultural products Easy and free Imperfect competition a) Monopolistic competition Many Differentiated ( but close) Some Retail trade Relatively easy

Forms of market structure Number of firms Nature of products Degree of control over price Price elasticity of demand for a firm Part of economy where prevalent Entry Pure Oligopoly Few Homogeneous Some Small Retail trade Not easy Differentiated oligopoly few Differentiated ( but close) Monopoly One Unique Very large Very small Franchise monopolies Impossible

Q-A Perfectly Competitive Market A perfectly competitive market is one in which economic forces operate unimpeded.

A Perfectly Competitive Market A perfectly competitive market must meet the following requirements: Both buyers and sellers are price takers. The number of firms is large. There are no barriers to entry. The firms' products are identical. There is complete information. Firms are profit maximizers.

The Necessary Conditions for Perfect Competition Both buyers and sellers are price takers. A price taker is a firm or individual who takes the market price as given. In most markets, households are price takers – they accept the price offered in stores.

The Necessary Conditions for Perfect Competition Both buyers and sellers are price takers. The retailer is not perfectly competitive. A store is not a price taker but a price maker.

The Necessary Conditions for Perfect Competition The number of firms is large. Large means that what one firm does has no bearing on what other firms do. Any one firm's output is minuscule when compared with the total market.

The Necessary Conditions for Perfect Competition There are no barriers to entry. Barriers to entry are social, political, or economic impediments that prevent other firms from entering the market. Barriers sometimes take the form of patents granted to produce a certain good.

The Necessary Conditions for Perfect Competition There are no barriers to entry. Technology may prevent some firms from entering the market. Social forces such as bankers only lending to certain people may create barriers.

The Necessary Conditions for Perfect Competition The firms' products are identical. This requirement means that each firm's output is indistinguishable from any competitor's product.

The Necessary Conditions for Perfect Competition There is complete information. Firms and consumers know all there is to know about the market – prices, products, and available technology. Any technological advancement would be instantly known to all in the market.

The Necessary Conditions for Perfect Competition Firms are profit maximizers. The goal of all firms in a perfectly competitive market is profit and only profit. Firm owners receive only profit as compensation, not salaries.

Q-Demand Curves for the Firm and the Industry The demand curves facing the firm is different from the industry demand curve. A perfectly competitive firm’s demand schedule is perfectly elastic even though the demand curve for the market is downward sloping.

Demand Curves for the Firm and the Industry This means that firms will increase their output in response to an increase in demand even though that will cause the price to fall thus making all firms collectively worse off.

Market Demand Versus Individual Firm Demand Curve Market supply 1,000 3,000 Price $10 8 6 4 2 Quantity 10 20 30 Price $10 8 6 4 2 Quantity Market demand Individual firm demand

Q-Revenue-Perfect competition market Marginal revenue is the increase in total revenue when output sold goes up by one unit Output Price Total Revenue Marginal Revenue AR 1 $5 $ 5 $5 5 2 5 10 5 5 3 5 15 5 5 4 5 20 5 5 5 5 25 5 5 6 5 30 5 5

Revenue-Perfect competition market Output Price Total Revenue Marginal Revenue 1 $5 $ 5 $5 2 5 10 5 3 5 15 5 4 5 20 5 5 5 25 5 6 5 30 5 ,AR 21-4 Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.

Q-Profit-Maximizing Level of Output The goal of the firm is to maximize profits. When it decides what quantity to produce it continually asks how changes in quantity affect profit.

Profit-Maximizing Level of Output-MC-MR Method Since profit is the difference between total revenue and total cost, what happens to profit in response to a change in output is determined by marginal revenue (MR) and marginal cost (MC). A firm maximizes profit when MC = MR. And MC intersect MR from below

Profit-Maximizing Level of Output Marginal revenue (MR) – the change in total revenue associated with a change in quantity. Marginal cost (MC) -- the change in total cost associated with a change in quantity.

Marginal Revenue Since a perfect competitor accepts the market price as given, for a competitive firm, marginal revenue is price (MR = P).

Marginal Cost Initially, marginal cost falls and then begins to rise. Marginal concepts are best defined between the numbers.

How to Maximize Profit To maximize profits, a firm should produce where marginal cost equals marginal revenue.

How to Maximize Profit If marginal revenue does not equal marginal cost, a firm can increase profit by changing output. The supplier will continue to produce as long as marginal cost is less than marginal revenue.

How to Maximize Profit The supplier will cut back on production if marginal cost is greater than marginal revenue. Thus, the profit-maximizing condition of a competitive firm is MC = MR = P. MC intersect MR from below

Marginal Cost, Marginal Revenue, and Price MC 1 2 3 4 5 6 7 8 9 10 $28.00 20.00 16.00 14.00 12.00 17.00 22.00 35.00 40.00 54.00 68.00 Price = MR Quantity Produced Marginal Cost $35.00 Costs 1 2 3 4 5 6 7 8 9 10 Quantity 60 50 40 30 20 C A P = D = MR A B

Profit Maximization Using Total Revenue and Total Cost method Profit is maximized where the vertical distance between total revenue and total cost is greatest. At that output, MR (the slope of the total revenue curve) and MC (the slope of the total cost curve) are equal.

Profit Determination Using Total Cost and Revenue Curves TC TR Total cost, revenue $385 350 315 280 245 210 175 140 105 70 35 Quantity 1 2 3 4 5 6 7 8 9 Loss Maximum profit =$81 Profit $130 Loss

Total Profit at the Profit-Maximizing Level of Output While the P = MR = MC condition tells us how much output a competitive firm should produce to maximize profit, it does not tell us the profit the firm makes.

Q-Determining Profit and Loss From a Table of Costs- Profit can be calculated from a table of costs and revenues. Profit is determined by total revenue minus total cost.

Costs Relevant to a Firm

Costs Relevant to a Firm

Explain the short run equilibrium for Perfect competitive market Two condition for equilibrium MC=MR MC intersect MR from below

Determining Profit and Loss From a Graph Find profit per unit where MC = MR. To determine maximum profit, you must first determine what output the firm will choose to produce. See where MC equals MR, and then drop a line down to the ATC curve. This is the profit per unit.

Determining Profits Graphically Quantity Price 65 60 55 50 45 40 35 30 25 20 15 10 5 1 2 3 4 6 7 8 9 12 D MC A P = MR B ATC AVC E Profit C Loss (a) Profit case (b) Zero profit case (c) Loss case Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2000

Zero Profit or Loss Where MC=MR In all three cases (profit, loss, zero profit), determining the profit-maximizing output level does not depend on fixed cost or average total cost, by only where marginal cost equals price.

The Shutdown Point The firm will shut down if it cannot cover average variable costs. A firm should continue to produce as long as price is greater than average variable cost. Once price falls below that point it makes sense to shut down temporarily and save the variable costs.

The Shutdown Point The shutdown point is the point at which the firm will gain more by shutting down than it will by staying in business.

The Shutdown Point As long as total revenue is more than total variable cost, temporarily producing at a loss is the firm’s best strategy since it is taking less of a loss than it would by shutting down.

The Shutdown Decision MC P = MR 2 4 6 8 Quantity Price 60 50 40 30 20 10 ATC AVC Loss A $17.80

Long-Run Competitive Equilibrium Profits and losses are inconsistent with long-run equilibrium. Profits create incentives for new firms to enter, output will increase, and the price will fall until zero profits are made. Only zero profit will stop entry.

Long-Run Competitive Equilibrium The existence of losses will cause firms to leave the industry. Zero profit condition is the requirement that in the long run zero profits exist. The zero profit condition defines the long-run equilibrium of a competitive industry.

Long-Run Competitive Equilibrium Zero profit does not mean that the entrepreneur does not get anything for his efforts.

Long-Run Competitive Equilibrium In order to stay in business the entrepreneur must receive his opportunity cost or normal profits the owners of business would have received in the nest-best alternative.

Long-Run Competitive Equilibrium Normal profits are included as a cost and are not included in economic profit. Economic profits are profits above normal profits.

Long-Run Competitive Equilibrium The zero profit condition is enormously powerful. It makes the analysis of competitive markets far more applicable to the real world than can a strict application of the assumption of perfect competition.

Long-Run Competitive Equilibrium MC 60 50 40 30 20 10 Price 2 4 6 8 Quantity SRATC LRATC P = MR

A Real World Example: A Shutdown Decision Price Quantity MC ATC Loss AVC P = MR