Monopolistic Competition Perfect Competition aka Pure Competition Oligopoly Monopoly

Perfect Competition Monopolistic Competition Oligopoly Monopoly

Pure Competition Monopolistic Competition Oligopoly Monopoly Number of Firms Barriers to Entry Non-price Competition Price Taker/Maker Product type Many small A few large one Diff or Homog one Differentiated Homogeneous large none maker taker/seeker taker yes no Considers action or reaction of other firms Need to stress differences? Long run profits possible? Ability to influence market price? As important as price?

1. Many Sellers 2. Identical Products Characteristics? 4. No Non-Price competition 6. Price Taker 3. Easy Entry and Exit 5. SR profits/losses, no LR profits

Output Price Firm Output Price Market Perfect Competition Market supply & demand determine price. The firm’s demand will be perfectly elastic. Firms can sell as much as they want at P Above P, they lose business Below P they lose revenue. P Market demand Market supply Firm’s demand P Firms must take the market price

Number of Cakes Marginal Revenue Marginal Cost

$ Number of Cakes M a r g i n a l C o s t a n d M a r g i n a l R e v e n u e Marcia’s Marginal Cost and Marginal Revenue Profits Losses

The two conditions necessary for long-run equilibrium in a price-taker market are depicted here. At the price established in the market, firms in the industry earn zero economic profit The quantity supplied and the quantity demanded must be equal in the market, as shown below at P 1 with output Q 1. Output Price Firm P1P1 q1q1 MC ATC d1d1 Long-run Equilibrium Output Price Market P1P1 D S sr Q1Q1

Price Quantity $6 $5 $4 $3 $2 $ Price = Demand = MR Operating at Minimum ATC Equilibrium ATC MC

Normal Profit Earn economic profit MR > ATC MR = ATC Short Run Profits Short Run Losses Shut Down Firm can’t cover AVC, minimize losses by shutting down MR < AVC Output Price Firm MC ATC AVC P3P3 Firm covers AVC, but not AFC: MR < ATC, but MR > AVC MR

Output Price Firm MC ATC AVC The marginal cost curve (MC) is the firm’s supply curve. At P 2 MR = MC at q 2. Below MC = AVC, the firm will shut down Output = 0 below P 1,, At P 3 MR = MC at q 3. The Supply Curve P2P2 P3P3 q2q2 q3q3 P1P1 q1q1 MC is the firm’s Supply Curve

Entry or Exit? Supply Profits? Case 1: Prices rise

Output Price Output Price Consider the market for toothpicks. A new candy that sticks to teeth causes the market demand for toothpicks to increase from D 1 to D 2 … market price increases to P 2 … Market Firm P1P1 P1P1 q1q1 Q1Q1 D1D1 S1S1 MC ATC d1d1 An Increase in Market Demand shifting the firm’s demand curve upward. At the higher price, firms expand output to q 2 and earn short-run profits. Economic profits will draw competitors into the industry, shifting the market supply curve from S 1 to S 2. P2P2 d2d2 q2q2 D2D2 S2S2 Q2Q2 P2P2

Output Price Output Price After the increase in market supply, a new equilibrium is established at the original market price P 1 and a larger rate of output (Q 3 ). As the market price returns to P 1, the demand curve facing the firm returns to its original level. In the long-run, economic profits are driven down to zero. The Adjustment Market Firm P 1 P 1 q 1 Q1Q1 D1D1 S1S1 MC ATC d1d1 P2P2 d2d2 q2q2 D2D2 S2S2 Q2Q2 P2P2 S lr Q3Q3 d1d1

Price Quantity $6 $5 $4 $3 $2 $ Price = Demand = MR SR Profits 1. Price goes up ATC 2. Firms enter, Supply increases 3. Price goes down 4. No LR Profits MC

Entry or Exit? Supply Case 2: Prices fall Profits?

Output Price Output Price A Decrease in Demand Market Firm P1P1 P1P1 q1q1 Q1Q1 D1D1 S1S1 MC ATC d1d1 P2P2 d2d2 q2q2 Q2Q2 P2P2 If, instead, something causes market demand for toothpicks to decrease from D 1 to D 2 … the market price falls to P 2 shifting the firm’s demand curve downward, leading to a reduction in output to q 2. The firm is now making losses. Short-run losses cause some competitors to exit the market, and others to reduce the scale of their operation, shifting the market supply curve from S 1 to S 2. S2S2 D2D2

Output Price Output Price The Adjustment: Market Firm P 1 P 1 q 1 Q1Q1 D1D1 S1S1 MC ATC P2P2 d2d2 d1d1 q2q2 D2D2 S2S2 Q2Q2 P2P2 After the decrease in market supply, a new equilibrium is established at the original market price P 1 and a smaller rate of output Q 3. As the market price returns to P 1, the demand curve facing the firm returns to its original level. In the long-run, economic profit returns to zero. Note the long-run market supply curve is flat S lr. Q3Q3 S lr d1d1

Price Quantity $6 $5 $4 $3 $2 $ P = D = MR SR Losses 1. Price goes down ATC 2. Firms leave, Supply decreases 3. Price goes up 4. No LR Losses MC

Short Run Profits Supply shifts out and price drops Cause firms to enter the market Short Run Losses Cause firms to leave the market Supply shifts in and price rises

In competitive price-taker markets, firms a.can sell all of their output at the market price. b.produce differentiated products. c.can influence the market price by altering their output level. d.are large relative to the total market. When we say that a firm is a price taker, we are indicating that the a.firm takes the price established in the market then tries to increase that price through advertising. b.firm can change output levels without having any significant effect on price. c.demand curve faced by the firm is perfectly inelastic. d.firm will have to take a lower price if it wants to increase the number of units that it sells. In price-taker markets, individual firms have no control over price. Therefore, the firm’s marginal revenue curve is a.a downward-sloping curve. b.indeterminate. c.constant at the market price of the product. d.precisely the same as the firm’s total revenue curve.

If marginal revenue exceeds marginal cost, a price-taker firm should a. expand output. b.reduce output. c.lower its price. d.do both a and c. When firms in a price-taker market are temporarily able to charge prices that exceed their production costs, a.the firms will earn long-run economic profit. b.additional firms will be attracted into the market until price falls to the level of per-unit production cost. c.the firms will earn short-run economic profits that will be offset by long-run economic losses. d.the existing firms must be colluding or rigging the market, otherwise, they would be unable to charge such high prices. Suppose a restaurant that is highly profitable during the summer months is unable to cover its total cost during the winter months. If it wants to maximize profits, the restaurant should a.shut down during the winter, even if it is able to cover its variable costs during that period. b.continue operating during the winter months if it is able to cover its variable costs. c.go a out of business immediately; losses should never be tolerated. d.lower its prices during the summer months. expand output

This graph illustrates a firm a.capable of earning economic profit. b.that is only able to break even when it maximizes profit. c.taking economic losses. d.that should shut down immediately This graph depicts the cost curves of a firm in a price-taker industry. At what output would the firm’s per-unit cost be at a minimum? a.100 c.150 b.125d.an output > 150 For the above graph, if the market price is $30, what is the firm’s profit-maximizing output and maximum profit. a.output, 125; economic profit, zero b.output, 125; economic profit, between $1,000 and $1,250 c.output, 150; economic profit, $1,500 d.output, 150; economic profit, between $1,250 and $1,500