Micro AP Review Market Structures and Elasticity

Pure Competition Very large number of firms producing a standardized product (corn) “Price Takers”- individual firms cannot change the market price, only react to changes Maximize profit by producing up to the point where MR = MC

Cost and Revenue $ Output Economic Profit Profit Maximization in the Short Run Pure Competition MR = P MC MR = MC AVC ATC P=$131 A=$97.78 W 21.2

Lower the Price to $81 and Observe the Results! Cost and Revenue $ Output Loss Profit Maximization in the Short Run Pure Competition MR = P MC AVC ATC Loss Minimizing Case P=$81 A=$91.67 V = $75

Lower the Price Further to $71 and Observe the Results! Cost and Revenue $ Output Marginal Revenue-Marginal Cost Approach MR = MC Rule Profit Maximization in the Short Run MR = P MC AVC ATC Short-Run Shut Down Case P=$71 Short-Run Shut Down Point P < Minimum AVC $71 < $74 V = $74

2. Monopolistic Competition Relatively large number of sellers producing differentiated products (clothing, furniture, books) Ex- Retail stores, shoes

Price and Output Determination In Monopolistic Competition Short-Run Profits Quantity Price and Costs MR = MC MC MR D1D1 ATC Economic Profit Q1Q1 A1A1 P1P1 0

Price and Output Determination In Monopolistic Competition Long-Run Equilibrium Quantity Price and Costs MR = MC MC MR D3D3 ATC Q3Q3 P3=A3P3=A3 0

Profit Maximization 0 $ Price, Costs, and Revenue Quantity By A Pure Monopolist D MR ATC MC MR=MC P m =$122 A=$94 Economic Profit Socially MC = D Fair ATC = D

3. Oligopoly Involves only a few sellers of a standardized (identical to competitors) or differentiated product… difficult to enter industry Ex- Steel, automobiles, household appliances

Responsiveness or sensitivity of consumers to a price change Price Elasticity of Demand

E d= Or Ed= % Qd/% P > 1 = Elastic (luxury good) < 1 = Inelastic (Necessity) = 1 is unit elastic Calculating Elasticity Change in Quantity Sum of Quantities/2 ÷ Change in Price Sum of Prices/2 W 18.1

P- the proportion of income spent on the good (the bigger the proportion, the more elastic) A- availability of close substitutes (the more subs. The more elastic) I- the importance of a good (luxury v necessity) D- the ability to delay the purchase (the more time, the more elastic) Determinants of Elasticity

Price Elasticity Quantity Demanded Price $ a b c d e f g h Elastic E d > 1 Unit Elastic E d = 1 Inelastic E d < 1 D

Note what happens to total revenue when prices change? If TR changes in opposite direction of price, demand is elastic If TR changes in the same direction as price, demand is inelastic If TR doesn’t change when price changes, demand is unit-elastic Total Revenue Test

Cross Elasticity of Demand Exy = Percentage change in Q demanded x/ Percentage change in price of Y Cross elasticity < 0, X and Y are complements If Cross elasticity is > 0, x and Y are substitutes

Income Elasticity of Demand E i = % change in quantity demanded/ % change in income Measures the degree to which consumers respond to a change in income in buying more or less of a particular good E i > 0 they are normal goods Ei < 0 they are inferior goods

A price change results in no change at all in the quantity demanded Price elasticity coefficient is zero Ex- diabetic needing insulin or a heroin addict needing drugs Perfectly Inelastic

Small price reduction causes buyers to increase their purchases from zero to all they can obtain Elasticity coefficient is infinity Perfectly Elastic