Extremely Competitive Markets Part 1: Closed Economies

Characteristics of Extremely Competitive Markets  Many buyers and sellers, or  “Easy” entry and exit in the presence of significant extranormal profits  Little or no product differentiation Price takers

P = AR = MR MC Profit Maximization for a Firm in an Extremely Competitive Market Quantity 0 Price QcQc

P = AR = MR MC Why Qc is the Profit Maximizing Output Level Quantity 0 Price QcQc MC(Q 1 ) Q1Q1 MC(Q 2 ) Q2Q2 PcPc At Q 2 : MC(Q 2 ) > MR(Q 2 ) At Q 1 : MC(Q 1 ) < MR(Q 1 )

MC The Marginal Cost Curve is the Competitive Firm’s Supply Curve Quantity 0 Price P 2 =MR 2 P 1 =MR 1 Q1Q1 Q2Q2 Because it shows how much the firm is willing to produce at any given price

QcQc Measuring Profit for the Competitive Firm Quantity 0 Price P = AR = MR ATC MC PcPc ATC Profit

The Firm’s Short Run Supply Decision Quantity ATC AVC 0 Price MC If P < AVC, shut down If P > AVC, keep producing in the short run If P > ATC, keep producing In the longer run, at a profit

The Firm’s Short Run & Long Run Supply Curves Quantity 0 MC ATC AVC The firm’s SR supply curve The firm’s LR supply curve Price

Individual Firm and Industry Supply Firm Type A Firm Type B P/Q P/Q MC B MC A $20 $ 15 $ Q/t 2 3 4Q/t Firms Types A and B together P/Q $20 $ 15 $ Q/t Total Industry Supply P/Q $20 $ 15 $ Q/t Total industry = 50 firms type A 50 firms type B

Extremely Competitive Market Outcome Price Industry supply $20 $15 $10 Market demand Quantity

Industry LR Supply, all firms identical Individual identical firms Industry $/Q $/Q MC AC Industry Demand LR Supply q Q/t Q=nq Q/t

Industry LR Supply, all firms not identical Individual non-identical firms Industry P/Q MC AC2 AC1 q1 q2 Q/t Q1 Q2 Q/t D1 D2 D3 LR Supply

Strategy: What Size Plant to Build Output/day 0 Avg. total cost ATC with small plant ATC with medium plant ATC with large plant Small plantMedium plantLarge plant

Strategy: Identifying Economies of Scale Diseconomies of scale Output per day 0 Average total cost Economies of scale Constant Returns to scale

Strategy: Identifying Economies of Scope Cost of producing x alone = C(x) Cost of producing y alone = C(y) Cost of producing 2 goods together = C(x,y) Economies of scope are present if: C(x,y) < C(x) + C(y) Measure or degree of economies of scope: [C(x) + C(y)] – C(x,y) C(x,y)