market structure and perfect competitive firm hall and lieberman, 3 rd edition, thomson...

Market Structure and Market Structure and Perfect Competitive FirmPerfect Competitive Firm

Hall and Lieberman, 3Hall and Lieberman, 3rdrd edition, edition, Thomson South-Western, Chapter 8Thomson South-Western, Chapter 8

22

OverviewOverviewWhat you will learn from this lectureWhat you will learn from this lecture

– Market structureMarket structure– 3 Requirements for perfect competition3 Requirements for perfect competition– Demand curve for a competitive firmDemand curve for a competitive firm– Supply curve for a competitive firmSupply curve for a competitive firm– How is the profit is maximized? At which output How is the profit is maximized? At which output

level?level?– How is profit or loss is measured using graphs?How is profit or loss is measured using graphs?– Short Run EquilibriumShort Run Equilibrium– Long Run EquilibriumLong Run Equilibrium– Perfect Competition and Plant Size in the long runPerfect Competition and Plant Size in the long run– What happens when things change?What happens when things change?

33

Part I Market StructurePart I Market StructureSellers want to sell at the Sellers want to sell at the highest possible price highest possible price – Buyers seek lowest possible priceBuyers seek lowest possible price– All trade is voluntaryAll trade is voluntary– different goods and services are different goods and services are

sold in vastly different wayssold in vastly different waysEconomists think about market Economists think about market structurestructure– Characteristics of a market that Characteristics of a market that

influence behavior of buyers and influence behavior of buyers and sellers when they come together sellers when they come together to tradeto trade

44

Types of MarketTypes of MarketFor any particular market, we ask For any particular market, we ask – How manyHow many buyers and sellers are there in the buyers and sellers are there in the

market?market?– Is each seller offering a Is each seller offering a standardized productstandardized product, ,

more or less indistinguishable from that more or less indistinguishable from that offered by other sellers?offered by other sellers?

– Are there any Are there any barriers to entry or exitbarriers to entry or exit, or can , or can outsiders easily enter and leave this market?outsiders easily enter and leave this market?

Four basic types of marketFour basic types of market– Perfect competitionPerfect competition– MonopolyMonopoly– Monopolistic competitionMonopolistic competition– OligopolyOligopoly

55

Part II. The Three Requirements of Perfect Part II. The Three Requirements of Perfect CompetitionCompetition

Large numbers of buyers and sellersLarge numbers of buyers and sellers– Each buys or sells only a tiny fraction of the Each buys or sells only a tiny fraction of the

total quantity in the markettotal quantity in the market

Sellers offer a standardized productSellers offer a standardized product

Sellers can easily enter into or exit Sellers can easily enter into or exit from marketfrom market– Significant barriers to entry and exit can Significant barriers to entry and exit can

completely change the environment in completely change the environment in which trading takes place which trading takes place

Examples?Examples?

66

i. A Large Number of Buyers and Sellersi. A Large Number of Buyers and Sellers

In perfect competition, there In perfect competition, there must be many buyers and must be many buyers and sellerssellers– How many?How many?

Number must be so large that no Number must be so large that no individual decision maker can individual decision maker can significantly affect price of the significantly affect price of the product by changing quantity it product by changing quantity it buys or sellsbuys or sells

77

ii. Selling Standardized Productsii. Selling Standardized Products

Buyers do not perceive Buyers do not perceive significant differences between significant differences between products of one seller and products of one seller and anotheranother– For instance, buyers of wheat do For instance, buyers of wheat do

not prefer one farmer’s wheat over not prefer one farmer’s wheat over anotheranother

88

iii. Easy Entry into and Exit from the Marketiii. Easy Entry into and Exit from the Market

Easy EntryEasy Entry – no significant barriers to discourage no significant barriers to discourage

new entrants new entrants – any firm wishing to enter can do any firm wishing to enter can do

business on the same terms as firms business on the same terms as firms that are already therethat are already there

Easy exitEasy exit– A firm suffering a long-run loss must A firm suffering a long-run loss must

be able to sell off its plant and be able to sell off its plant and equipment and leave the industry for equipment and leave the industry for good, without obstaclesgood, without obstacles

99

iii. Easy Entry into and Exit from the Marketiii. Easy Entry into and Exit from the Market

In many markets there are In many markets there are significant barriers to entrysignificant barriers to entry– Legal barriersLegal barriers– Existing sellers have an important Existing sellers have an important

advantage that new entrants can not advantage that new entrants can not duplicateduplicate

Brand loyaltyBrand loyalty– Cost advantage of existing firms from Cost advantage of existing firms from

significant economies of scalesignificant economies of scale

1010

Is Perfect Competition Realistic?Is Perfect Competition Realistic?Assumptions are rather restrictive Assumptions are rather restrictive

In reality, one or more of assumptions will In reality, one or more of assumptions will be violated in vast majority of marketsbe violated in vast majority of markets– Yet economists use perfect competition Yet economists use perfect competition

more often than any other market more often than any other market structurestructure

Why?Why?– Model of perfect competition is powerfulModel of perfect competition is powerful– Many markets come reasonably close to Many markets come reasonably close to

be perfect competitivebe perfect competitive

Perfect competition can Perfect competition can approximateapproximate conditions and yield accurate-enough conditions and yield accurate-enough predictions in a wide variety of marketspredictions in a wide variety of markets

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Even if conditions for perfectly competitive Even if conditions for perfectly competitive markets are not satisfied…markets are not satisfied…

Assumptions are close Assumptions are close enough for predictions ofenough for predictions of– Firm entry or exitFirm entry or exit– Price increase or decreasePrice increase or decrease– Increase or decrease in Increase or decrease in

industry quantityindustry quantity– Increase or decrease in firm Increase or decrease in firm

quantityquantity

1212

Part III. The Perfectly Competitive FirmPart III. The Perfectly Competitive Firm

What is occurring in a What is occurring in a competitive market is quite competitive market is quite different from the view we get different from the view we get when looking at a perfect when looking at a perfect competitive firm. competitive firm. – entirely different pictureentirely different picture

In learning about competitive In learning about competitive firm, must also discuss firm, must also discuss competitive market in which it competitive market in which it operatesoperates

1313

Figure 1: The Competitive Industry and FirmFigure 1: The Competitive Industry and Firm

Ounces of Gold per Day

Price per Ounce

D

$400

S

Market

Demand Curve Facing

the Firm

$400

Firm

1. The intersection of the market supply and the market demand curve…

3. The typical firm can sell all it wants at the market price…


Price per Ounce

2. determine the equilibrium market price

4. so it faces a horizontal demand curve

1414

Goals and ConstraintsGoals and Constraints

Perfectly competitive firm faces a Perfectly competitive firm faces a cost constraint when producing cost constraint when producing any given level of output any given level of output – Firm’s production technology Firm’s production technology – Prices it must pay for its inputsPrices it must pay for its inputs

Cost function for a perfectly Cost function for a perfectly competitive firm is standardcompetitive firm is standard

1515

The Demand Curve Facing a The Demand Curve Facing a Perfectly Competitive FirmPerfectly Competitive Firm

Demand curve isDemand curve is horizontal, or infinitely horizontal, or infinitely price elasticprice elasticWhy?Why?– Output is standardizedOutput is standardized– No matter how much a firm decides to No matter how much a firm decides to

produce, it cannot make a noticeable produce, it cannot make a noticeable difference in market quantity supplied difference in market quantity supplied

So cannot affect market priceSo cannot affect market price– Firm is a price takerFirm is a price taker

Treats the price of its output as given and Treats the price of its output as given and beyond its controlbeyond its controlIts only decision is how much output to Its only decision is how much output to produce and sellproduce and sell

1616

Cost and RevenueCost and Revenue

MR at each quantity is the MR at each quantity is the same as the market pricesame as the market price– MR = PriceMR = Price– marginal revenue curve and marginal revenue curve and

demand curve facing firm are demand curve facing firm are the samethe same

– A horizontal line at the market A horizontal line at the market priceprice

1717

Profit Maximization: The Total Revenue Profit Maximization: The Total Revenue and Total Cost Approachand Total Cost Approach

Firm’s profit per unitFirm’s profit per unit– ( Revenue per unit ) – ( cost per unit )( Revenue per unit ) – ( cost per unit )

profit per unit = P – ATCprofit per unit = P – ATC

Total Profit = TR – TC=Q(P-ATC)Total Profit = TR – TC=Q(P-ATC)TR and TC approachTR and TC approach– Pick out the output level where there Pick out the output level where there

is biggest difference between TR and is biggest difference between TR and TCTC

– Most direct way of viewing firm’s Most direct way of viewing firm’s search for the profit-maximizing search for the profit-maximizing output leveloutput level

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Figure 2a: Profit Maximization: find Figure 2a: Profit Maximization: find greatest TR - TCgreatest TR - TC

TR

550

$2,800

2,100

TC

Slope = 400


Dollars

1 2 3 4 5 6 7 8 9 10

Maximum Profit per Day = $700

1919

Profit Maximization: The Marginal Revenue Profit Maximization: The Marginal Revenue and Marginal Cost Approachand Marginal Cost Approach

Profit-maximizing output is Profit-maximizing output is found where MC curve found where MC curve crosses MR curve from crosses MR curve from belowbelow– Or where P =MCOr where P =MC

Firm should continue to Firm should continue to increase output as long as increase output as long as p=MR>MCp=MR>MC

2020

Figure 2b: Profit Maximization Figure 2b: Profit Maximization Find MR =MC from belowFind MR =MC from below

MC

$400 D = MR


Dollars

1 2 3 4 5 6 7 8 9 10

2121

Measuring Total Profit GraphicallyMeasuring Total Profit Graphically

How to measure profit or loss?How to measure profit or loss?1.1. Find the optimal output level Q* Find the optimal output level Q*

from profit maximizationfrom profit maximization– MR =MC or using TR & TC methodMR =MC or using TR & TC method

2.2. At Q* , find the ATC, unit cost for At Q* , find the ATC, unit cost for producing that amount of outputsproducing that amount of outputs

3.3. Pointing out the difference Pointing out the difference between P and ATC along the between P and ATC along the vertical axisvertical axis

4.4. The area (P-ATC) X Q* is The area (P-ATC) X Q* is – Profit if P>ATCProfit if P>ATC– Loss if P<ATCLoss if P<ATC

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Figure 3a: Measuring Profit if P Figure 3a: Measuring Profit if P > ATC> ATC

$400300

Profit per Ounce ($100)

d = MR

MC

ATC

Economic Profit


Dollars

1 2 3 4 5 6 7 8

2323

Figure 3b: Measuring Loss if P < ATCFigure 3b: Measuring Loss if P < ATC

MC

ATC

d = MR$300

200

Loss per Ounce ($100)

Economic Loss


Dollars

1 2 3 4 5 6 7 8

2424

The Firm’s Short-Run Supply CurveThe Firm’s Short-Run Supply Curve

A competitive firm is a price takerA competitive firm is a price taker– Then decides how much output it will Then decides how much output it will

produce at that priceproduce at that price– Whenever the market price is set at a Whenever the market price is set at a

new level, the best output level will be new level, the best output level will be determined by firms, using the MR and determined by firms, using the MR and MC approachMC approach

– ExceptionExceptionIf the firm is suffering a loss large enough to If the firm is suffering a loss large enough to justify shutting down, it will not produce justify shutting down, it will not produce along its MC curvealong its MC curve

– Zero output produced insteadZero output produced instead

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Figure 4: Short-Run Supply Under Perfect Figure 4: Short-Run Supply Under Perfect CompetitionCompetition

0.50

1,0002,000

4,0005,000

7,000

1.00

2.00

$3.50

2.50

MCATC

d1=MR1

AVC

(a)

Firm's Supply Curve

0.50

2,0004,000

5,000

7,000

1.00

2.00

$3.50

2.50

(b)

d2=MR2

d3=MR3

d4=MR4

d5=MR5

Bushels per Year

Dollars Price per Bushel

Bushels per Year

2626

The Shutdown Price and Supply CurveThe Shutdown Price and Supply Curve

Shutdown price is the price at which a Shutdown price is the price at which a firm is indifferent between producing firm is indifferent between producing and shutting downand shutting down

Supply curve has two partsSupply curve has two parts– Whenever P>AVC, supply curve coincides Whenever P>AVC, supply curve coincides

with MC curvewith MC curve– Whenever P<AVC, firm will shut downWhenever P<AVC, firm will shut down

A vertical line segment at zero units of outputA vertical line segment at zero units of output

Figure 4: For all prices below $1—the Figure 4: For all prices below $1—the shutdown price—output is zero and the shutdown price—output is zero and the supply curve coincides with vertical axissupply curve coincides with vertical axis

2727

The (Short-Run) Market Supply CurveThe (Short-Run) Market Supply Curve

The shut run market supply curve is The shut run market supply curve is obtained from the aggregation of obtained from the aggregation of individual firm’s supply curveindividual firm’s supply curve– summing quantities of output supplied summing quantities of output supplied

by all firms in market at each priceby all firms in market at each price

As we move along the market supply As we move along the market supply curve, we are assuming that two curve, we are assuming that two things are constantthings are constant– Fixed inputs of each firmFixed inputs of each firm– Number of firms in marketNumber of firms in market

2828

Figure 5: Deriving The Market Supply CurveFigure 5: Deriving The Market Supply Curve

0.501.00

2.00

$3.50

2.50

Market Supply Curve

200,000400,000

500,000700,000

Firm's Supply Curve

0.50

2,000 4,0005,000

7,000

1.00

2.00

$3.50

2.50

1. At each price . . .3.The total supplied by all firms at different

prices is the market supply curve.

Firm Market

Bushels per Year

Price per Bushel

Price per Bushel

Bushels per Year

2. the typical firm supplies the profit-maximizing quantity.

2929

Figure 6: Perfect CompetitionFigure 6: Perfect CompetitionQuantity

Demanded at Different Prices

Quantity Supplied at

Different Prices

Quantity Supplied by Each Firm

Quantity Demanded by

Each Consumer

Individual Demand

Curve

Individual Supply Curve

Quantity Demanded by All Consumers at

Different Prices

Quantity Supplied by All Firms at Different

Prices

Market Demand

Curve

Market Supply Curve

P S

D

Q

Market Equilibrium

Added together Added together

3030

Part IV. Short-Run EquilibriumPart IV. Short-Run EquilibriumIn In perfect competition, market sums perfect competition, market sums buying and selling preferences of buying and selling preferences of individual consumers and producers, individual consumers and producers, and determines market priceand determines market price

– Each buyer and seller then takes Each buyer and seller then takes market price as givenmarket price as given

– Each is able to buy or sell desired Each is able to buy or sell desired quantityquantity

Competitive firms Competitive firms can earncan earn an economic an economic profit or suffer an economic lossprofit or suffer an economic loss– Example: Figure 2Example: Figure 2

Figure 7Figure 7 Short-run Profit Maximization Short-run Profit Maximization10 firms each producing 100 units10 firms each producing 100 units

Short-run equilibrium conditions met (K fixed)Short-run equilibrium conditions met (K fixed)

FirmFirm IndustryIndustry

P P

q Q

D

S

MC ATC

P0P0

1000100

But firm is making positive economic profit :But firm is making positive economic profit :Long Run equilibrium?Long Run equilibrium?Incentive for entry or exit?Incentive for entry or exit?


P P

q Q

D

S

MC ATC

P0P0

1000100

Profit>0

Part V. Long-run equilibrium conditionsPart V. Long-run equilibrium conditions

Short-runShort-runFirm: Price = Marginal Cost: Firms Firm: Price = Marginal Cost: Firms

maximize profitsmaximize profits

Industry: supply = demandIndustry: supply = demand

Long-run Long-run Firm: Price = ATC: Zero economic Firm: Price = ATC: Zero economic

profitprofit

No incentive to enter or exitNo incentive to enter or exit

3434

Profit and Loss in the Long RunProfit and Loss in the Long RunEconomic profit and loss are the forces Economic profit and loss are the forces driving long-run changedriving long-run change– Entry of outsiders if expecting continued Entry of outsiders if expecting continued

economic profit economic profit – Exit of insiders if expecting lossesExit of insiders if expecting losses

In real world entry and exit occur literally In real world entry and exit occur literally every dayevery dayIn some cases, we see entry occur through In some cases, we see entry occur through formation of an entirely new firm or occur formation of an entirely new firm or occur when an existing firm adds a new product when an existing firm adds a new product to its lineto its lineExit can occur in different waysExit can occur in different ways– Selling off its assets and freeing itself once and Selling off its assets and freeing itself once and

for all from all costsfor all from all costs– Switches out of a particular product line, even Switches out of a particular product line, even

as it continues to produce other thingsas it continues to produce other things

Figure 8 Positive Economic Profit Invites Entry in Figure 8 Positive Economic Profit Invites Entry in the Long-run and Causes Industry Supply to Risethe Long-run and Causes Industry Supply to Rise


P P

q Q

D

S

MC ATC

P0P0

1000100

P1 P1

S’

90 1080

Long-run equilibrium Long-run equilibrium Number of firms rises to12 firms = 1080/90Number of firms rises to12 firms = 1080/90

P = ATCP = ATC


P P

q Q

D

S

MC ATC

P0P0

1000100

P1 P1

S’

90 1080

3737

From Short-Run Profit to Long-Run EquilibriumFrom Short-Run Profit to Long-Run Equilibrium-- start with profit in the short run-- start with profit in the short run

Positive economic profit will attract new Positive economic profit will attract new entrantsentrantsIncreasing number of firms in marketIncreasing number of firms in market

As number of firms increases, market supply As number of firms increases, market supply curve will shift rightward causing several curve will shift rightward causing several things to happenthings to happen

1.1. Market price fallsMarket price falls

2.2. Then demand curve facing each firm Then demand curve facing each firm shifts downwardshifts downward

3.3. Each then slide down its marginal Each then slide down its marginal cost curve, decreasing outputcost curve, decreasing output

3838

From Short-Run Profit to Long-Run EquilibriumFrom Short-Run Profit to Long-Run Equilibrium-- start with profit in the short run-- start with profit in the short run

This process of adjustment continues, This process of adjustment continues, requiring market supply curve to shift requiring market supply curve to shift rightward enough, and the price to fall rightward enough, and the price to fall enoughenoughUntil when the reason for entry—positive Until when the reason for entry—positive profit—no longer exitsprofit—no longer exits– So that each existing firm is earning So that each existing firm is earning

zero economic profitzero economic profitIn sum, in a competitive market, positive In sum, in a competitive market, positive economic profit continues to attract new economic profit continues to attract new entrants until economic profit is reduced entrants until economic profit is reduced to zeroto zero

Figure 9 : Short-run Profit MaximizationFigure 9 : Short-run Profit Maximization15 firms each producing 80 units15 firms each producing 80 units



P P

q Q

D

S

MC ATC

P0P0

120080

AVC

Short-run Profit MaximizationShort-run Profit Maximization15 firms each producing 80 units15 firms each producing 80 units



P P

q Q

D

S

MC ATC

P0P0

120080

AVC

LOSS


P P

q Q

D

S

MC ATC

P0P0

120080

AVC

Negative Economic Profit Induces Negative Economic Profit Induces Exit in the Long-run, Industry Supply FallsExit in the Long-run, Industry Supply Falls Number of firms falls to 12 firms = Number of firms falls to 12 firms = 1080/90 1080/90

P1 P1

S’

90 1080

4242

From Short-Run Profit to Long-Run EquilibriumFrom Short-Run Profit to Long-Run Equilibrium-- start with loss in the short run-- start with loss in the short run

In a competitive market, In a competitive market, economic losses continue to economic losses continue to cause exit until losses are cause exit until losses are reduced to zeroreduced to zero– Raising market price until Raising market price until

typical firm breaks even againtypical firm breaks even again

4343

Distinguishing Short-Run from Long-Run Distinguishing Short-Run from Long-Run OutcomesOutcomes

In short-run equilibrium, competitive In short-run equilibrium, competitive firms can earn profits firms can earn profits oror suffer losses suffer lossesIn long-run equilibrium, after entry or In long-run equilibrium, after entry or exit has occurred, economic profit is exit has occurred, economic profit is always always zerozeroWhen economists look at a market, When economists look at a market, they choose the period more they choose the period more appropriate for question at handappropriate for question at hand

4444

Figure 10a/b: From Short-Run Profit To Figure 10a/b: From Short-Run Profit To Long-Run EquilibriumLong-Run Equilibrium

S1

d1ATC

MC

$4.50

With initial supply curve S1, market price is $4.50…

$4.50

900,000 9,000

So each firm earns an economic profit.

AA

Price per Bushel

Market

Bushels per Year

Dollars

Firm

Bushels per Year

D

4545

Figure 10c/d: From Short-Run Profit To Figure 10c/d: From Short-Run Profit To Long-Run EquilibriumLong-Run Equilibrium

S1

d1ATC

MC

$4.50

Profit attracts entry, shifting the supply curve rightward…

$4.50

900,000 9,0005,000

until market price falls to $2.50 and each firm earns zero economic profit.

S2

d1

AA

2.502.50EE

Market Firm

Price per Bushel

Bushels per Year

Dollars

Bushels per Year

D

1,200,000

4646

Part VI. The Notion of Zero Profit in Part VI. The Notion of Zero Profit in Perfect CompetitionPerfect Competition

The same forces—entry and exitThe same forces—entry and exit—that cause all firms to earn zero —that cause all firms to earn zero economic profit also ensureeconomic profit also ensure– in long-run equilibrium, every in long-run equilibrium, every

competitive firm will select its competitive firm will select its plant size and output level so plant size and output level so that it operates at that it operates at minimum minimum point of its LRATC curvepoint of its LRATC curve

4747

Perfect Competition and Plant SizePerfect Competition and Plant SizeFigure 6 illustrates a firm in a perfectly Figure 6 illustrates a firm in a perfectly competitive marketcompetitive market– Left panel does not show a true long-run Left panel does not show a true long-run

equilibriumequilibriumIn long-run typical firm will want to expand In long-run typical firm will want to expand by sliding down its LRATC curve and by sliding down its LRATC curve and produce more output at a lower cost per produce more output at a lower cost per unitunit

– potentially earn an economic profitpotentially earn an economic profitSame opportunity to earn positive Same opportunity to earn positive economic profit will attract new economic profit will attract new entrants that will establish larger plants entrants that will establish larger plants from the outsetfrom the outset

Entry and expansion must continue in this Entry and expansion must continue in this market until the price falls to Pmarket until the price falls to P* where each * where each firm earn zero economic profitfirm earn zero economic profit

4848

Figure 11: Perfect Competition and Plant SizeFigure 11: Perfect Competition and Plant Size

P1

q1

d1 = MR1

LRATCMC1 ATC1

E

d2 = MR2

LRATC

MC2 ATC2

P*

q*4. and all firms earn zero economic profit and produce at minimum LRATC.

.

Dollars Dollars

Output per Period

Output per Period

3. As all firms increase plant size and output, market price falls to its lowest possible level . . .

1. With its current plant and ATC curve, this firm earns zero economic profit.

2. The firm could earn positive profit with a larger plant, producing here.

4949

A Summary of the Competitive Firm in the Long-RunA Summary of the Competitive Firm in the Long-Run

At each competitive firm in long-run equilibriumAt each competitive firm in long-run equilibriumP = MC = minimum ATC = minimum P = MC = minimum ATC = minimum LRATCLRATC

This equality is satisfied when the typical firm This equality is satisfied when the typical firm produces at point E in figure 6 produces at point E in figure 6 – Where its demand, marginal cost, ATC, and Where its demand, marginal cost, ATC, and

LRATC curves all intersectLRATC curves all intersectIn perfect competition, consumers are getting In perfect competition, consumers are getting the best deal they could possibly getthe best deal they could possibly get

5050

Part IV. What Happens When Things Change? Part IV. What Happens When Things Change? -- 1. A Change in Demand-- 1. A Change in Demand

Short-run impact of an increase in demand isShort-run impact of an increase in demand is– Rise in market priceRise in market price– Rise in market quantityRise in market quantity– Economic profitsEconomic profits

This will cause:This will cause:– More entrants and higher market supplyMore entrants and higher market supply– Market equilibrium will move from point A to point Market equilibrium will move from point A to point

CCLong-run supply curveLong-run supply curve– indicating quantity of output that all sellers in a indicating quantity of output that all sellers in a

market will produce at different prices after all market will produce at different prices after all long-run adjustments have taken placelong-run adjustments have taken place

5151

Figure 12a/b: An Increasing-Cost IndustryFigure 12a/b: An Increasing-Cost Industry

INITIAL EQUILIBRIUM

D1

S1

AP1

Q1

P1

q1

MC

A

ATC1

d1 = MR1

Output per Period

MarketDollars

Firm

Output per Period

Price per Unit

5252

Figure 12c/d: An Increasing-Cost IndustryFigure 12c/d: An Increasing-Cost Industry

NEW EQUILIBRIUM

MC

ATC1

DollarsFirm

P1

q1

Ad1 = MR1

Output per Period

Market

S1

Output per Period

Price per Unit

D1

AP1

Q1

dSR = MRSR

d2 = MR2P2

PSR

P2

PSR ATC2C

BB

C

QSR Q2q1 qSR

S2

SLR

D2

5353

Increasing Cost IndustryIncreasing Cost Industry

This type of industry (which is the most This type of industry (which is the most common) is called common) is called an increasing cost an increasing cost industryindustry

Entry Entry Increase in demand for inputs Increase in demand for inputs price of those inputs increasesprice of those inputs increases– Shifts up typical firm’s ATC curveShifts up typical firm’s ATC curve

Raises market price at which firms earn Raises market price at which firms earn zero economic profitzero economic profit

As a result, long-run supply curve slopes As a result, long-run supply curve slopes upwardupward

5454

Decreasing and Constant Cost IndustriesDecreasing and Constant Cost Industries

A constant cost industry -- A constant cost industry -- entry has no effect entry has no effect on input priceson input prices– Industry might use such a small percentage of total Industry might use such a small percentage of total

inputs that there is no noticeable effect on input inputs that there is no noticeable effect on input pricesprices

– Typical firm’s ATC curve stays putTypical firm’s ATC curve stays putMarket price at which firms earn zero economic profit Market price at which firms earn zero economic profit does not changedoes not changeLong-run supply curve is horizontalLong-run supply curve is horizontal

Decreasing cost industryDecreasing cost industry -- entry by new -- entry by new firms actuallyfirms actually decreases input pricesdecreases input prices– Causes typical firm’s ATC curve to shift downwardCauses typical firm’s ATC curve to shift downward– Lowers market price at which firms earn zero Lowers market price at which firms earn zero

economic profiteconomic profit– Long-run supply curve slopes downwardLong-run supply curve slopes downward

5555

Small SummarySmall Summary

Increasing Increasing Cost Cost

IndustryIndustry

Constant Constant Cost Cost

IndustryIndustry

DecreasinDecreasing Cost g Cost

IndustryIndustry

Entry effect Entry effect on input on input pricesprices

UpUp No effectNo effect DownDown

ATC curveATC curve Shifts upShifts up StaysStays Shifts downShifts down

Zero profit Zero profit market market PricePrice

UpUp Not changeNot change Down Down

Long-run Long-run supply supply curvecurve

Slope Slope upwardupward

HorizontalHorizontal Slope Slope downwarddownward

5656

Part V. Using the Theory: Changes in TechnologyPart V. Using the Theory: Changes in Technology

Technological advance that results in increasing returns to Technological advance that results in increasing returns to scale will scale will

– Induce some firms to change technologies and produce Induce some firms to change technologies and produce moremore

– lead to a rightward shift of market supply curve, lead to a rightward shift of market supply curve, decreasing market pricedecreasing market price

– In short-run, early adopters may enjoy economic profitIn short-run, early adopters may enjoy economic profit– in long-run, more will adopt, economic profit falls to zero in long-run, more will adopt, economic profit falls to zero – Firms that refuse to use the new technology will not Firms that refuse to use the new technology will not

survivesurvive– Some technologies are biased toward large firms, others Some technologies are biased toward large firms, others

toward smaller firms. If technologies lower minimum toward smaller firms. If technologies lower minimum efficient scale, more firms will enter as industry price efficient scale, more firms will enter as industry price fallsfalls

5757

SummarySummary– 3 Requirements for perfect competition3 Requirements for perfect competition

many sellers and buyersmany sellers and buyers standardized productsstandardized products free entry and exitfree entry and exit

– Demand curve for a competitive firm is perfect Demand curve for a competitive firm is perfect elastic (horizontal line)elastic (horizontal line)

MR = PMR = P– Supply curve for a competitive firm is discreteSupply curve for a competitive firm is discrete

is MC when P> AVCis MC when P> AVC is zero when P<AVCis zero when P<AVC

– 2 approaches to maximize profit by choosing 2 approaches to maximize profit by choosing output leveloutput level

Maximized difference between TR and TC Maximized difference between TR and TC MR = MCMR = MC

– Profit can be measured using graphsProfit can be measured using graphs– Short run equilibrium: profits or lossShort run equilibrium: profits or loss– Long run equilibrium: zero economic profitsLong run equilibrium: zero economic profits P=marginal cost=minimum ATC=minimum LRATCP=marginal cost=minimum ATC=minimum LRATC

market structure and perfect competitive firm hall and lieberman, 3 rd edition, thomson...

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