1. Microeconomics I Undergraduate Programs Fernando Branco 2006-2007 Second Semester Sessions 5&6

2. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco Perfect competition A perfectly competitive market is characterized by: –Many sellers and buyers (“small”); –Products are perfect substitutes (homogeneous); –Agents have perfect information relative do products and prices; –There are no transaction costs; –There is free entry and exit.

3. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco Market demand and firm demand Clients will want to buy from the lowest cost seller.

4. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco How much does a firm want to supply in the market? –It depends on the market price. The firm chooses the quantity to maximize its profits: The second order condition requires that the marginal costs are increasing. Firm’s supply and marginal costs

5. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco Firm’s supply: short run and long run In the short run: –There is supply only if the price exceeds the average variable cost. In the long run: –There is supply only if the price exceeds the average (total) cost.

6. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco The market equilibrium in the short run results from the intersection of supply and demand: S SiSi D p* qi*qi*q* Market equilibrium: short run

7. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco The market equilibrium in the long run depends on the productive structure only. q C S (MC) AC p* qi*qi* The demand determines the number of active suppliers only. Market equilibrium: long run

8. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco Properties of the equilibrium The equilibrium in a competitive market allows for efficient transactions: –P=MC; –Global surplus is maximized; –In the long-run, the average cost is minimized.

9. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco Comparative statics in the equilibrium What is the impact on the equilibrium if the demand expands? What is the impact on the equilibrium if the price of an input increases? What is the impact on the equilibrium if there is a technological innovation that reduces costs?

10. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco Monopoly market A single firm serves the “relevant market”: –There are no close substitutes; –Monopolies are often “local” monopolies. The demand of the market is the same as the demand of the firm. The firm has control over the price: –But the price charged determines the quantity sold.

11. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco Sources of monopoly Entry barriers; Economies of scale; Economies of scope.

12. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco How much should the firm sell? The firm chooses a quantity to maximize its profit: The monopolist’s decision Graphical analysis. The impact of fixed costs. Why not a supply curve?

13. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco Q P, C D AC MR MC P* Q* The monopolist’s decision: a graph

14. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco P* Q* AC D MR MC AC D MR MC P* Q* AC D MR MC P* Q* The fixed costs

15. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco Q P, C D1D1 D2D2 MC P2*P2* Q* P1*P1* Why not a supply curve?

16. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco Topics in the monopoly A monopolist with two-plants: Price discrimination: –Perfect price dicrimination (first-degree); –Second-degree price discrimination; –Third-degree price discrimination: The monopolist with two markets.

17. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco How much to produce in each plant? Equalize the marginal cost in each plant. Graphic analysis. Monopolist with two plants

18. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco Q P, C D RMg CMg CMg 1 CMg 2 Q1*Q1*Q2*Q2* Q* P* Monopolist with two plants: graphic

19. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco Perfect price discrimination What if the monopolist could charge different prices for different transaction? –The monopolist could charge a price per transaction: exactly the amount that the buyer would be willing to pay. The volume of transactions would be maximzied; The monopolist would get the full surplus.

20. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco Q P Q3Q3 Q2Q2 Q1Q1 P1P1 P2P2 P3P3 CMg Q P P1P1 P2P2 P3P3 P4P4 P5P5 P6P6 P7P7 Q1Q1 Q2Q2 Q3Q3 Q4Q4 Q5Q5 Q6Q6 Q7Q7 Increasing discrimination

21. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco Second degree price discrimination Discrimination for several types of buyers. Examples: –Discounts, two-part tariffs, blocks. The monopolist increases the profit and the quantity transacted.

22. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco Third-degree price discrimination Charge different prices in different markets. Example of a monopolist with two-markets: –Marginal revenues are equalized.

23. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco Many buyers and sellers Firms produce differentiated goods: –Each has close substitutes. Free entry and exit. Product demand and entry. In the short-run, behave as a monopolist. In the long-run, demand adjusts and monopolist has zero profit. Monopolistic competition

24. Microeconomics IUndergraduate Programs 2006-2007 Second Semester Session 5&6©Fernando Branco Firms’ decisions Each firm maximizes profits as monopolists do: It is important to distinguish between the short-run (fixed n) and the long-run (n varies). –In the long-run demand adjusts so that: