1. Perfect Competition Overheads

2. Market Structure Market structure refers to all characteristics of a market that influence the behavior of buyers and sellers, when they come together to trade Market structure refers to all features of a market that affect the behavior and performance of firms in that market

3. Key Factors Determining Market Structure Short run & long run objectives of buyers and sellers in the market Beliefs of buyers and sellers about the ability of themselves and others to set prices Degree of product differentiation Technologies employed by agents in the market Amount of information available to agents about the good and about each other Degree of coordination or noncooperation of agents Extent of entry and exit barriers

4. Definition of a competitive agent competitive A buyer or seller (agent) is said to be competitive if the agent assumes or believes that the market price is given and that the agent's actions do not influence the market price We sometimes say that a competitive agent is a price taker

5. Common Market Structures Perfect (pure) competition Agents take prices as given Entry and exit barriers are minimal or nonexistent

6. Common Market Structures Monopoly (seller) or Monopsony (buyer) Firm sets price (faces market demand or supply curve) Entry and exit barriers result in the existence of one seller or one buyer

7. Common Market Structures Oligopoly Firm sets prices (faces residual demand) Entry and exit barriers result in the existence of few sellers or buyers

8. Common Market Structures Monopolistic competition Firm sets prices (faces residual demand) Entry and exit barriers are minimal

9. Perfect Competition 1.Buyers and sellers are competitive or price takers 2.All firms produce homogeneous (standardized) goods and consumers view them as identical 3.All buyers and sellers have perfect information regarding the price and quality of the product 4.Firms can enter and exit the industry freely 5.There are no transaction costs to participate in the market 6.Each firm bears the full cost of its production process 7.There is perfect divisibility of output

10. Competitive agents Large number of agents What really matters are beliefs

11. Homogeneous Goods Price and nothing else matters The demand for your product goes to zero if you raise price

12. Perfect Information Buyers and sellers know everything quality opportunities to buy and sell factors affecting the market in the future

13. Ease of Entry and Exit New firms enter when there are profits Existing firms leave when there are losses

14. No Transactions Costs Firms are not dissuaded by participation fees Buyers can take advantage of opportunities

15. No Externalities What is good for this market is good for society The market fully accounts for all costs

16. Divisible output Small price changes don’t lead to large quantity jumps Examples such as buildings and machinery

17. Demand facing the perfectly competitive firm The demand curve facing a perfectly competitive firm is horizontal at the market price If the firm were to raise its price, even a tiny bit, above this price, its sales would go to zero And no matter how much the firm produces, this price will not change

18. Industry Supply-Demand Equilibrium $ Output S(p ) p0p0 Q0Q0 D(p) Demand for Individual Firm $ Output p0p0 D(p) The demand curve for a perfectly competitive firm is horizontal If the firm were to raise its price above this price, sales would go to zero And no matter how much the firm produces, the price will not change

19. Behavior of a Single Competitive Firm The firm’s goal is to maximize profit

20. What is profit? Profit is revenue minus costs or

21. The firm’s goal is then to maximize returns from the technologies it controls, taking into account: The demand for final consumption goods Opportunities for buying and selling factors / products The actions of other firms in the market

22. The Firm Solves the Problem

23. Example Problem P = $184

24. yFCVCCAFCAVCATCMC Price TRMRProfit 0.00 2000.00 200.00 1840-200.00 64.00 184.00 1.00 20064.00 264.00 200.00 64.00 264.00 184184-80.00 66.00 184.00 2.00 200130.00 330.00 100.00 65.00 165.00 18436838.00 74.00 184.00 3.00 200204.00 404.00 66.67 68.00 134.67 184552148.00 88.00 184.00 4.00 200292.00 492.00 50.00 73.00 123.00 184736244.00 108.00 184.00 5.00 200400.00 600.00 40.00 80.00 120.00 184920320.00 134.00 184.00 6.00 200534.00 734.00 33.33 89.00 122.33 1841104370.00 166.00 184.00 7.00 200700.00 900.00 28.57 100.00 128.57 1841288388.00 204.00 184.00 8.00 200904.00 1104.00 25.00 113.00 138.00 1841472368.00 248.00 184.00 9.00 2001152.00 1352.00 22.22 128.00 150.22 184 1656304.00 298.00 184.00 10.00 2001450.00 1650.00 20.00 145.00 165.00 184 1840190.00

25. Note that TR is linear with slope = 184 Total Revenue and Cost Curves 0 500 1000 1500 2000 2500 3000 3500 4000 024681012141618 Output $ TR C

26. Price Price = MR = Demand Price, Marginal Cost, and Average Cost 0 50 100 150 200 250 300 350 400 024681012141618 Output $ ATC MC

27. Price MC AVC ATC AFC Add average variable and average fixed costs 0 50 100 150 200 250 300 350 400 024681012141618 Output $

28. Maximizing profit Choose the level of output where the difference between TR and TC is the greatest

29. yCMCPriceTRMRProfit 3 404 184552148 88.00 184.00 4 492 184736244 108.00 184.00 5 600 184920320 134.00 184.00 6 734 1841104370 166.00 184.00 7 900 1841288388 204.00 184.00 8 1104 1841472368 248.00 184.00 9 1352 1841656304

30. Profit Max Using MR and MC An increase in output will always increase profit if MR > MC An increase in output will always decrease profit if MR < MC

31. The rule is then Increase output whenever MR > MC Decrease output if MR < MC

32. Should we increase output from 5 to 6? Should we increase output from 6 to 7? Should we increase output from 7 to 8? Yes No ! yCMCPriceTRMRProfit 4.00 492.00 184736244.00 108.00 184.00 5.00 600.00 184920320.00 134.00 184.00 6.00 734.00 1841104370.00 166.00 184.00 7.00 900.00 1841288388.00 204.00 184.00 8.00 1104.00 1841472368.00 248.00 184.00 9.00 1352.00 1841656304.00

33. Measuring Total Profit Profit is always given by Graphically it is the distance between total revenue and total cost

34. Total Revenue and Cost Curves 0 500 1000 1500 2000 2500 3000 3500 4000 024681012141618 Output $ TR C

35. Profit, price, and average total cost Profit per unit is given by

36. MC The distance between price and ATC at the optimum output level is profit per unit Cost Curves and Profit 0 50 100 150 200 250 300 350 024681012141618 Output $ ATC Price ATC Opt Q Opt

37. Total profit is given by the area of the box bounded by price, the optimum quantity, average total cost at the optimum quantity, and the price axis

38. MC Cost Curves and Profit 0 50 100 150 200 250 300 350 024681012141618 Output $ ATC Price ATC Opt Q Opt

39. The firm earns a profit whenever p > ATC yCAVCATCMCPriceTRProfit 5.00 600.00 80.00 120.00 184920320.00 134.00 6.00 734.00 89.00 122.33 1841104370.00 166.00 7.00 900.00 100.00 128.57 184 1288388.00 204.00 8.00 1104.00 113.00 138.00 1841472368.00 (184 - 128.5714) = 55.4286 (55.4286) (7) = $388

40. A firm suffers a loss whenever p < ATC at the optimum level of output Let p = $97 We can show that the optimum quantity is 4 units

41. yCAVCATCMC Price TR Profit 0.00 200.00 97 0-200.00 64.00 1.00 264.00 64.00 264.00 97 97-167.00 66.00 2.00 330.00 65.00 165.00 97194-136.00 74.00 3.00 404.00 68.00 134.67 97291-113.00 88.00 4.00 492.00 73.00 123.00 97 388-104.00 108.00 5.00 600.00 80.00 120.00 97 485-115.00 134.00 6.00 734.00 89.00 122.33 97582-152.00 166.00 7.00 900.00 100.00 128.57 97679-221.00

42. Cost Curves and Profit 0 50 100 150 200 250 300 350 400 024681012141618 Output $ ATC MC Price ATC Opt Q Opt Loss

43. yFCVCCAFCAVCATCMCPriceTRMRProfit 0.00 2000.00 200.00 970- 200.00 64.00 97.00 1.00 20064.00 264.00 200.00 64.00 264.00 9797 -167.00 66.00 97.00 2.00 200130.00 330.00 100.00 65.00 165.00 97194 -136.00 74.00 97.00 3.00 200204.00 404.00 66.67 68.00 134.67 97291-113.00 88.00 97.00 4.00 200292.00 492.00 50.00 73.00 123.00 97388- 104.00 108.00 97.00 5.00 200400.00 600.00 40.00 80.00 120.00 97485-115.00 134.00 97.00 6.00 200534.00 734.00 33.33 89.00 122.33 97582- 152.00 166.00 97.00 7.00 200700.00 900.00 28.57 100.00 128.57 97679 -221.00 204.00 97.00 8.00 200904.00 1104.00 25.00 113.00 138.00 97776 -328.00 248.00 97.00 9.00 2001152.00 1352.00 22.22 128.00 150.22 97 873-479.00 298.00 97.00 10.00 2001450.00 1650.00 20.00 145.00 165.00 97 970-680.00

44. Another example problem P = $120

45. yPriceTRMRFCVCCAFCAVCATCMCProfit 0.00 12001202000.00 200.00 - 200.00 0.25 1203012020024.14 224.14 800.00 96.56 896.56 93.19 -194.14 0.50 1206012020046.63 246.63 400.00 93.25 493.25 86.75 -186.63 1.00 12012012020087.00 287.00 200.00 87.00 287.00 75.00 -167.00 2.00 120240120200152.00 352.00 100.00 76.00 176.00 56.00 -112.00 3.00 120360120200201.00 401.00 66.67 67.00 133.67 43.00 -41.00 4.00 120480120200240.00 440.00 50.00 60.00 110.00 36.00 40.00 5.00 120600120200275.00 475.00 40.00 55.00 95.00 35.00 125.00 6.00 120720120200312.00 512.00 33.33 52.00 85.33 40.00 208.00 7.00 120840120200357.00 557.00 28.57 51.00 79.57 51.00 283.00 8.00 120960120200416.00 616.00 25.00 52.00 77.00 68.00 344.00 9.00 1201080120200495.00 695.00 22.22 55.00 77.22 91.00 385.00 10.00 1201200120200600.00 800.00 20.00 60.00 80.00 120.00 400.00 11.00 1201320120200737.00 937.00 18.18 67.00 85.18 155.00 383.00 12.00 1201440120200912.00 1112.00 16.67 76.00 92.67 196.00 328.00 14.00 12016801202001400.00 1600.00 14.29 100.00 114.29 296.00 80.00 16.00 12019201202002112.00 2312.00 12.50 132.00 144.50 420.00 -392.00

46. For a given price we can find optimal output HOW ? Choose output level where MC = MR = P

47. AVC MC ATC P = 120 Short Run Equilibrium 0 50 100 150 200 250 300 024681012141618 Output $ P = MC  y* = 10 Q Opt  = $400 Profit

48. yPriceTRMRCostMCProfit 7.00 120840120557.00 51.00 283.00 8.00 120960120616.00 68.00 344.00 9.00 1201080120695.00 91.00 385.00 10.00 1201200120800.00 120.00 400.00 11.00 1201320120937.00 155.00 383.00 12.00 12014401201112.00196.00 328.00  = $400 The firm is happy!! And R - VC (ROVC) = $600

49. AVC MC ATC P = 120 Short Run Equilibrium 0 50 100 150 200 250 300 024681012141618 Output $ P = MC  y* = 10 Q Opt ROVC = $600 ROVC

50. yPriceTRMRVCCMCProfit 691546913125124034 791637913575575180 8917289141661668112 9918199149569591124 109191091600800120110 119110019173793715564 12911092919121112196-20 Now let p = $91 y* = 9,  = $124 The firm is still happy!! And R - VC (ROVC) = $324

51. AVC MC ATC P = 120 Short Run Equilibrium 0 50 100 150 200 250 300 024681012141618 Output $ P = 91

52. AVC MC ATC Short Run Equilibrium 0 50 100 150 200 250 300 024681012141618 Output $ P = 91 P = MC  y* = 9  = $ 124 ROVC = $324 Q Opt Profit ROVC

53. yPriceTRMRVCCMCProfit 6684086831251240-104 7684766835755751-81 8685446841661668-72 9686126849569591-83 106868068600800120-120 116874868737937155-189 1268816689121112196-296 Now let p = $68 y* = 8,  = $-72 The firm is not so happy!! But R - VC (ROVC) = $128

54. AVC MC ATC P = 120 P = 68 Short Run Equilibrium 0 50 100 150 200 250 300 024681012141618 Output $ P = 91

55. AVC MC ATC P = 68 Short Run Equilibrium 0 50 100 150 200 250 300 024681012141618 Output $ P = MC  y* = 8  = $-72 ROVC = $128 ROVC Q Opt Loss

56. yPriceTRMRVCCMCProfit 6513065131251240-206 7513575135755751-200 8514085141661668-208 9514595149569591-236 105151051600800120-290 115156151737937155-376 1251612519121112196-500 Now let p = $51 y* = 7,  = $ -200 The firm may as well shut down  

57. AVC P = 51 MC ATC P = 120 P = 68 Short Run Equilibrium 0 50 100 150 200 250 300 024681012141618 Output $ P = 91

58. AVC P = 51 MC ATC Short Run Equilibrium 0 50 100 150 200 250 300 024681012141618 Output $ P = MC  y* = 7  = $-200 ROVC = $0 ROVC Q Opt Loss

59. yPriceTRMRCMCProfit 5402004047535-275 6402404051240-272 7402804055751-277 8403204061668-296 9403604069591-335 104040040800120-400 114044040937155-497 Now let p = $40 y* = 6,  = $ -272 The firm should get out in a hurry!

60. AVC P = 51 MC ATC P = 120 P = 68 Short Run Equilibrium 0 50 100 150 200 250 300 024681012141618 Output $ P = 40 P = 91

61. AVC P = 51 MC ATC P = 120 P = 68 Short Run Equilibrium 0 50 100 150 200 250 300 024681012141618 Output $ P = 40 P = 91 P = MC  y* = 6  = $- 272 ROVC = $-72 Loss ROVC

62. AVC P = 51 MC ATC P = 196 P = 120 P = 68 Short Run Equilibrium 0 50 100 150 200 250 300 024681012141618 Output $ P = 40 P = 91

63. Short run supply At different prices we know how much the firm will choose to supply By plotting these points we can obtain the short run supply curve

64. Short-run supply curve AVC P = 51 MC P = 196 P = 120 P = 68 0 50 100 150 200 250 300 024681012141618 Output $ P = 40 P = 91

65. MC AVC ATC Short Run Supply Curve 0 50 100 150 200 250 01234567891011121314 Output $ Supply 024681012141618 Output Short Run Equilibrium 0 50 100 150 200 250 300 $

66. We can connect the dots? Not really Short Run Supply Curve 0 50 100 150 200 250 01234567891011121314 Output $ Supply

67. We connect, but with a discontinuity Short Run Supply Curve 0 50 100 150 200 250 01234567891011121314 Output $ Supply

68. The competitive firm's supply curve has two parts To summarize For all prices above the minimum point on the firm’s average variable cost (AVC) curve, the supply curve coincides with the marginal cost curve (MC) For prices below the minimum point on the average variable cost curve (AVC), the firm will shut down, so its supply curve is a vertical line at zero units of output

69. MC AVC Short Run Supply 0 50 100 150 200 250 300 024681012141618 Output $

70. AVC MC Short Run Supply 0 50 100 150 200 250 300 024681012141618 Output $

71. AVC ATC Short Run Supply 0 50 100 150 200 250 300 024681012141618 Output $ MC

72. We write the individual supply curve as p - price of output w 1, w 2, w 3, … - prices of inputs z - fixed inputs

73. Assumptions about the industry in the short-run The number of firms is fixed The firm is operating on a short-run cost curve Some inputs are fixed

74. Short run industry or market supply It is constructed by summing the quantities supplied by the individual firms Shows the quantity supplied by the industry at each price when the plant size of each firm and the number of firms remain constant

75. The market or industry supply curve, Q S, is the horizontal summation of the individual firm supply curves We account for the fact that will be zero at some price levels

76. The market supply curve is then a curve indicating the quantity of output that all sellers in a market will produce at different prices. If there are L identical firms, each with supply, then

77. Example L = 50 P = $120 y i = 10 Q S = (50)(10) = 500

78. Example L = 50 P = $196 y i = 12 Q S = (50)(12) = 600

79. Individual Short Run Supply Curve 0 50 100 150 200 250 01234567891011121314 Output $ Supply P = 51, y = 7 P = 68, y = 8 P = 120, y = 10

80. Short Run Market Supply Curve 0 50 100 150 200 250 0100200300400500600700 Output $ Supply P = 51, y = 350 P = 68, y = 400 P = 120, y = 500

81. Short Run Market (Industry) Equilibrium Market Demand Curve 0 50 100 150 200 250 0100200300400500600700 Output $ D

82. Short Run Market Supply & Demand Curves Finding the market equilibrium P = $120, Q = 500 0 50 100 150 200 250 0100200300400500600700 Output $ Supply Demand P Q*

83. D1 Increase the demand to P = $196, Q = 600 Short Run Market Supply & Demand Curves 0 50 100 150 200 250 300 0100200300400500600700800 Output $ Supply Demand P Q* P1 Q1*

84. D1 Decrease the demand to P = $68, Q = 400 Short Run Market Supply & Demand Curves 0 50 100 150 200 250 300 0100200300400500600700800 Output $ Supply Demand P Q* Q1* D2 P2 Q2* P1

85. AVC MC Going back to the individual firm y i = 10 Life is good ATC P = 120 0 50 100 150 200 250 300 024681012141618 Output $  i = 400

86. What about the equilibrium price of $68.00? Not what the managers had in mind! AVC MC ATC P = 68 0 50 100 150 200 250 300 024681012141618 Output $

87. With short run losses, the firm will only stay in the industry in the short run In the long run, a firm with losses will exit the industry At the same time, short run profits will encourage firms to enter the industry

88. And so we must consider the long run!

89. The End

90. AVC P = 91 MC P = 51 ATC P = 196 P = 120 P = 68 Short Run Equilibrium 0 50 100 150 200 250 300 024681012141618 Output $ P = 40 P = MC  y* = 10  = $400

91. P1 Increase the demand to P = $196, Q = 600 Short Run Market Supply & Demand Curves 0 50 100 150 200 250 300 0100200300400500600700800 Output $ Supply Demand P Q* D1 Q1* D2 P2 Q2*