1. 1 ECONOMICS 200 PRINCIPLES OF MICROECONOMICS Professor Lucia F. Dunn Department of Economics

2. 2 Market Structure Refers to the degree of competitiveness in the market for any commodity. The concept “market” is defined by a particular kind of product or service. — is interchangeable with the word “industry”.

3. 3 Perfect Competition A. Characteristics 1. Homogeneous Products 2. Customer Information 3. Output of firm at minimum of LRAC is small relative to the industry. 4. Price Taker (or Quantity Searcher) 5. Free Entry and Exit

4. 4 Perfect Competition — Firm feels it must always sell at the going market price.  So demand curve is horizontal  Perfectly Elastic B. If firm is a price taker, its actions have no noticeable impact on prices. Q D 0 Q1Q1 Q2Q2 Q3Q3

5. 5 Perfect Competition C. Aggregate over all small competitive firms gives the “industry” or “total market” demand curve. Q Total Market Demand 0 Competitive Industry Demand Curve

6. 6 Perfect Competition D. How is the going market price determined? Q D 0 Industry S Q D Individual Competitive Firm 0

7. 7 Revenue Concepts 1. Total Revenue (or Total Expenditure) 2. Average Revenue 3. Marginal Revenue MR = Change in revenue that comes from selling an extra unit

8. 8 Perfect Competition Q D = AR = MR 0 Demand = Price = AR = MRFor Competitive Firm:

9. 9 Rule for Profit-Maximization I. Should shut down down if if: TVC > TR TR or AVC > AR = P So if AVC > P  Shut Down. II. Firm should expand production production up to the point where: MC = MR (All Type of Firms)

10. 10 Rule for Profit-Maximization (2) (All Type of Firms) Q MR=AR=P=D 0 MC Q*Q*Q*Q* Q1Q1 Q2Q2  Loss

11. 11 Profit-Maximization for Competitive Firm Q D=P=MR=AR 0 MC QEQEQEQE AVC 1. P > AVC 2. MC = MR or MC = P since MR = P QEQE QEQE is an equilibrium point. – Market forces will automatically keep the firm at that point.

12. 12 Profit-Maximization for Competitive Firm Q 0 MC Q1Q1Q1Q1 AVC D o = MR 0 D 1 = MR 1 D 2 = MR 2 Q2Q2Q2Q2 D 3 = MR 3 Q3Q3Q3Q3 D 4 = MR 4 Q4Q4Q4Q4 1 2 3 4 Supply for competitive firm is same as its MC curve above AVC. – with P o, firm will shut down.

13. 13 Profit-Maximization for Competitive Firm Q 0 S Q1Q1Q1Q1 Q2Q2Q2Q2 Q3Q3Q3Q3 Q4Q4Q4Q4 1 2 3 4

14. 14 Profit-Maximization for Competitive Firm Result: The Supply Curve of a perfectly competitive firm is identical to its Marginal Cost curve in the range above the average variable cost. Wow!! MC and Supply Curve!!

15. 15 Profit Short-Run Equilibrium of Competitive Firm Q D 1 = MR 1 0 MC Q1Q1Q1Q1 ATC  = TR – TC TC =ATC  Q So:  = OP 1 BQ 1 – OACQ 1 = AP 1 BC (Shaded Area) B C

16. 16 Reaching Long-Run Equilibrium of Competitive Firm 1 2 With positive , new firms enter industry and price will fall as supply shifts right. Price will fall.

17. 17 Reaching Long-Run Equilibrium of Competitive Firm So for individual firm : Q 0 MC Q3Q3Q3Q3 SRATC A Price and demand will continue to shift downward until  = 0. At Q3 Q3 : TR = OP 3 AQ 3 TC = So: = 0 * For competitive firm there is zero economic profit in the long-run equilibrium. D 1 = MR 1 D 2 = MR 2 D 3 = MR 3

18. 18 Short-Run Equilibrium of Competitive Firm with Losses Q 0 MC Q1Q1Q1Q1 SRATC D 1 =MR A B C  = TR – TC = OP 1 AQ 1 – OBCQ 1 = P 1 BCA (Shaded Area is loss)

19. 19 Reaching Long-Run Equilibrium of Competitive Firm 1 2 When loss occurs, firms will exit industry.  Supply will shift left. Price will rise.

20. 20 Reaching Long-Run Equilibrium of Competitive Firm Q 0 MC SRATC Q3Q3Q3Q3 So price and demand will rise until the loss is eliminated. Things settle down and reach long-run equilibrium at Q3Q3 with P3 P3 and  = 0. D 1 = MR 1 D 2 = MR 2 D 3 = MR 3

21. 21 Profit-Maximization for Competitive Firm NOTE: In the long run, the demand curve is just tangent to SRATC curve.  It will be tangent at the minimum point of SRATC. (It is geometric fact that when a U-shaped curve is tangent to a horizontal line, it is tangent at its minimum point). $ (Costs) Q (Output) 0 LRATC Q MIN SRATC 1 SRATC 2 SRATC 3 MC

22. 22 Profit-Maximization for Competitive Firm So in the long run equilibrium in competitive industries, firm produce at the minimum point of both the short-run and long-run ATC curve.  Very Efficient Long-Run Equilibrium Is Efficient!

23. 23