Market Structure: Perfect Competition Market Structure: Perfect Competition Chapter 7 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall * Market Structure Characteristic Perfect...

Market Structure: Perfect Competition
Market Structure: Perfect Competition
Chapter 7
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
*
Market Structure
    
Characteristic    Perfect
Competition    Monopolistic
Competition    
Oligopoly    
Monopoly
    Number of firms competing    Large number    Large number    Small number    Single firm
    Nature of the product    Undifferentiated    Differentiated    Undifferentiated or differentiated    Unique
    Entry    No ba
iers    Few ba
iers    Many ba
iers    Blocked
    Information availability    Complete    Relatively good    Asymmetric    Asymmetric
    Firm’s control over price    None    Some    Some    Substantial
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Model of Perfect Competition
    A large number of firms and consumers in the market
    An undifferentiated product
    Ease of entry into the market or no ba
iers to entry
    Complete information available to all market participants
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Industry XXXXXXXXXXFirm
S
D
Q
P
QE
PE
MC
ATC
D = P = MR
Q*
P
Q
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Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
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Profit Maximizing Level of Output
    Profit is the difference between total revenue and total cost:
    π = TR - TC
    where
    π = profit
    TR = total revenue
    TC = total cost
    To maximize profits, a firm should produce the level of output where marginal revenue equals marginal cost.
    MR = MC
    where
    MR = ΔTR / ΔQ
    MC = ΔTC / ΔQ
    
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Marginal Revenue
    The marginal revenue curve for the perfectly competitive firm is horizontal because the firm can sell all units of output at the market price therefore price equals marginal revenue for the perfectly competitive firm.
$
Q
P = MR
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Supplement File
    Look at the supplement file.
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Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall
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Calculation of Profit
    π = TR - TC
    π = (P)(Q) - (ATC)(Q)
    π = (P - ATC)(Q), therefore
If P > ATC, π > 0
If P < ATC, π < 0
If P = ATC, π = 0
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Shutdown Point for a Perfectly Competitive Firm
    The price, which equals a firm’s minimum average variable cost, below which it is more profitable for the perfectly competitive firm to shut down than to continue to produce.
MC
ATC
AVC
Psd
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Supply Curve for the Perfectly Competitive Firm
    The portion of a firm’s marginal cost curve that lies above the minimum average variable cost.
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$
Q
SRATC
SRAVC
SRS =MC
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Long-Run Adjustment in Perfectly Competitive Industry
    An increase in industry demand will result in a positive economic profit for a perfectly competitive firm. However, this profit will be competed away by the entry of other firms into the market in the long run. The zero economic profit point or the point where price equals average total cost is the equili
ium point for the perfectly competitive firm.
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Long-Run Adjustment in Perfectly Competitive Industry - Graphical
D1
D2
S1
S2
PE1
PE2
QE1
QE3
QE2
MC
ATC
D1=P1=MR1
D2=P2=MR2
Q1
Q2
P
P
Q
Q
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Long-Run Adjustment in Perfect Competition: The Optimal Scale of Production
    In the long run, the perfectly competitive firm has to choose the optimal scale of operation. This decision, combined with entry and exit, will force price to equal long-run average cost.
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Long-Run Adjustment in Perfect Competition: The Optimal Scale of Production - Graphical
$
Q
SMC1
SMC2
SATC1
SATC2
LRAC
P1=MR1
P2=MR2
Q1
Q2
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Examples of Competitive Industries
    Agriculture
    Boiler Chickens
    Red-Meat
    Milk
    Trucking
Managers are trying to reduce the competitive pressure on their firms by differentiating their product.
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Examples of Competitive Industries
    A perfectly competitive industry is unconcentrated and each firm does not have any market power.
    Industry Concentration: A measure of how firms produce the total output of an industry. The more concentrated the industry, the fewer the firms operating in that industry.
    Differentiation comes from quality, backing, product form, merger and service.
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Market Structure: Monopoly and Monopolistic Competition
Market Structure: Monopoly and Monopolistic Competition
Chapter 8
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Firms With Market Powe
    The ability of a firm to influence the prices of its products and develop other competitive strategies that enable it to earn large profits over longer periods of time.
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The Monopoly Model
    A market structure characterized by a single firm producing a product with no close substitutes.
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Monopoly Model - Graphical
P
Q
PM
ATCM
QM
D
MR
MC
ATC
LOSS
P
Q
PM
QM
ATCM
D
MR
MC
ATC
PROFIT
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A monopolist's marginal revenue is always less than or equal to the price
of the good. Marginal revenue is the amount of revenue the firm receives fo
each additional unit of output. It is the difference between total revenue { price
times quantity { at the new level of output and total revenue at the previous
output (one unit less).
http:
www.albany.edu/~aj4575/LectureNotes/Lecture30.pdf
Therefore the monopolist's marginal cost curve lies below its demand curve.
Another way to see this:
When a monopoly increases amount sold, it has two e
ects on total revenue:
{ the output e
ect: More output is sold, so
Q
is higher.
{ the price e
ect: To sell more, the price must decrease, so
P
is lower.
For a competitive �rm there is no price e
ect. The competitive �rm can sell
all it wants at the given price.
For a monopoly there is a price e
ect. It must reduce price to sell additional
output. So the marginal revenue on its additional unit sold is lower than the
price, because it gets less revenue for previous units as well (it has to reduce
price to the same amount for all units).
Marginal revenue can even become negative { that is, the total revenue
decreases from one output level to the next.
*
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Comparing Monopoly and Perfect Competition
    The Perfectly Competitive Firm
    At QPC :
MR = MC
P = ATC
P = MC
    Minimum Point of ATC Curve
    Price-Take
    Firm Has Supply Curve
    The Monopoly Firm
    At QM :
MR = MC
P > ATC
P > MC
    Not at Minimum Point of ATC
    Price-Searche
    Firm Has No Supply Curve
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Comparing Monopoly and Perfect Competition - Graphical
D
MR
ATC
MC
P
Q
PM
QM
MC
ATC
D = P = MR
PC
QC
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Another Look at Monopoly vs. Perfect Competition
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PM
PC
QC
QM
AC=MC
D
MR
$
Q
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Sources of Market Powe
    Economies of scale –banking sector, large fixed cost, example: Emirates NBD
    Ba
iers created by government
    Input ba
iers
    Brand loyalties
    Consumer lock-in and switching costs
    Network externalities
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Economies of Scale
    Economies of scale can act as a ba
ier to entry in different industries because only large-scale firms can achieve the cost-reduction benefits of these economies.
    Merger has increased market power and reduced cost in banking industry.
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Ba
iers Created by Government
    Licenses – Psychiatrist and psychologist
    Patents and Copyrights – Pharmaceuticals – monopolies more conducive to innovation than perfect competition
    Government may block a sector for national security.
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Input Ba
iers
    Other ba
iers to entry include control over raw materials or other key inputs in a production process and ba
iers in financial capital markets.
    Example: De beers, Southwest Airline for Midway, Emirates for DXB?
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Brand Loyalties
    The creation of
and loyalties through advertising and other marketing efforts is a strategy that many managers use to create and maintain market power.
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i.e. Sta
ucks, Al Ain water, iPhone…
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Consumer Lock-In and Switching Costs
    Ba
iers to entry can also result if consumers become locked