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Ch.7 Price-Taking Market

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Ch.7 Price-Taking Market What is a Market? Market( 市場) is a system governed by a set of rules or customs( 習俗) under which a well-defined good is exchanged. Foreign exchange market, stock market Food Market Four types of market Two extreme cases

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what is a market
What is a Market?
  • Market(市場) is a system governed by a set of rules or customs(習俗) under which a well-defined good is exchanged.

Foreign exchange market,

stock market

Food Market

four types of market
Four types of market

Two extreme cases

Imperfect competitive Market (Price-searcher尋價者市場 )

Perfect Competitive Market (Price-taker)

受價者市場

Monopoly

Market

完全壟斷

Monopolistic

Competition Market 壟斷性競爭

Oligopoly Market 寡頭壟斷

price taker s market or perfectly competitive market
Price-taker’s market (受價者市場) or(perfectly competitive market 完全競爭巿場)

Definition

Definition

  • A price-taker(受價者) who cannot affect the market price and hence it must take whatever price that the market determines.
  • Note: Because each seller only provides an insignificant part of the total market supply of some homogeneous goods (同類/同質的貨品)
conditions of a price taking market
Conditions of a Price-taking Market
  • A large number of sellers who are small in the market share市場估有率 (relative to the market quantity).
  • Homogeneous goods (無異物品) are goods that are completely identical. E.g. no brand name, no advertisement. Any firm selling at a higher price would lose all its customers.
  • Perfect information; no transaction costs: buyers know the price charged by each sellers, no buyers would buy an identical product from sellers charging a higher price.
  • Free entry and exit: If market composed of a large number of small buyers and sellers, no one has the power to restrict the entry or exit of others
violation of conditions
Violation(違反) of conditions
  • If any one of the first three conditions is violated, the market becomes price-searching(尋價者市場).
  • A market with only one seller is a
  • A market dominated by a few large sellers is an
  • A market with a large number of small sellers but selling heterogeneous goods or having imperfect information is a

monopoly (完全壟斷).

oligopoly (寡頭壟斷).

monopolistic competition. (壟斷性競爭)

slide7

尋價者市場

Price-searching Market

Monopolistic competition 壟斷性競爭

Monopoly完全壟斷

Oligopoly 寡頭壟斷

a price taker facing a horizontal demand curves why
A Price-taker facing a horizontal Demand CurvesWhy?

price-taker market/industry

Individual consumer demand curve

P

P

P

A price-taker

(ΣS)

S

P1=d=horizontal demand curve

+

+

P1

D

(ΣD)

D1

Q=10

Q=10000

Q=30

*a price-taker do not have power to change P1

*use the interception D and S to determine the market price at P1

a horizontal demand curve facing a price taker seller
A. Horizontal demandcurve:

Reason: A price-taker cannot influence the market price. If it charges ahigher price, as market information is perfect and exists a large no.s of sellers supplying identical goods, it will lose all its customers. Quantity demanded drops to zero.

The demand is perfectly elastic

A price-taker can sell whatever quantity at the

Individual / A price-taker

A horizontal Demand Curve Facing a Price-taker (seller).

P

P1

prevailing market

0

Q

price(主要市場價值)

questions for discussion
Questions for discussion

Q2 “As the demand curved faced by a price-taker is horizontal, the market demand curve, which is the horizontal sum of all individual demand curves, must also be horizontal.” Discuss.

q2 ans
Q2: Ans.
  • No,
  • The market demand curve is the horizontal sum of demand curves of all the consumers, not the horizontal sum of demand curves faced by all the price-takers.
  • Price-taker are not the buyers
  • Price-taker are sellers.
  • By the law of demand, as demand curves of consumers are downward sloping, the market demand curve is also downward sloping.
1 equations review
(1) Equations Review
  • Revenue(收入):
  • Total Revenue(總收入)=P*Q or AR*Q
  • Average Revenue=TR/Q

AR=P x Q

Q  AR=P

  • Marginal Revenue:(邊際收入)
  • MR= ▲TR/▲Q

or =

(TR2-TR1)

/(Q2-Q1)

slide15

Fill in the table

= P x Q

$50

$5

$5

$75

$5

$5

$5

$100

$5

$125

$5

$5

$150

$5

$5

explain the relationship between mr ar and d curve
Explain the relationship between MR, AR and d curve
  • Price-taker cannot influence the market price
  • Output is sold at the prevailing market price
  • So the marginal revenue(MR) and average revenue(AR) are equal the market price.

Conclusion:

P=MR=AR=demand curve

hkale mc 98 29
HKALE MC 98.29

Q.The demand curve facing a price-taker is perfectly elastic. This implies that

A. The market price will not change.

B. The law of demand cannot be applied in the price-takers’ industry.

C. The market price will not decrease even when a seller increases his output.

D. All of the above

hkale mc98 29
HKALE MC98.29
  • Answer: C
slide19

Example of a perfect competition Market (P-taker)?

In reality, no firm like perfect competition market. The very close one like is Gold Market.

  • abundant buyer and seller
  • Homogenous Goods e.g. 9999 gold bar
  • Freedom of entry and exit the market
  • It is easy to find information about the quantity and price in the market. But information is costly to obtain which is not a perfect information.
the conditions of p taker s market are not realistic is it still useful
The conditions of p-taker’s market are not realistic. Is it still useful?
  • The model is still useful
  • Use ideal(完美) situation as a standard(標準)
  • To analysis(分析) competition in the real world.
  • Evaluate(評估) and compare the efficiency of other market structure.
2 equations review
(2) Equations Review:
  • Cost (成本):
  • (總成本)TC=TVC+TFC --------------------------------(1)

=Average Cost*Quantity

  • (總可變成本)TVC=AVC*Q----------------------------(2)

= Average Variable Cost*Quantity

  • (總固定成本)TFC=AFC*Q-----------------------------(3)

= Average Fixed Cost*Quantity

  • Marginal Cost (邊際成本):
  • MC= ▲TC/▲Q
  • = --------------------------(4)

(TC2-TC1)/

(Q2-Q1)

3 equations review
(3) Equations Review
  • Profit=TR-TC (利潤 = 總收入-總成本)

= Total revenue - Total Cost

  • If profit =0 (normal profit or Breakeven)
  • If profit =+Ve economic profit
  • If Profit = -Ve  Loss
wealth maximizing output of a p taker
Wealth-maximizing output of a P-taker (受價者市場)

MC

P

before Q’ MC>MR Loss

MR>MC, you have to decide if the gain can cover the loss before Q*. Max-wealth at Q*, when MR=MC

Between Q’ & Q* MR>MC∴Gain

P*

MR=P*=AR=d curve

At Q*, MR=MC Marginal Revenue can cover its marginal cost

Q’

Q

Q*

slide26

Questions for Discussion

Q5 (a) At Q’, MR=MC. Explain why it is not wealth-maximizing?

(b) At Q*, MR>MC. The marginal gain is zero. Explain why it is wealth-maximizing?

q5 ans a b
Q5 Ans.: (a) & (b)

(a) At Q’, MR=MC

  • it is wealth-minimizing. Because MC curve cuts MR curve from above. At Q’, MC>MRLoss.

(b) At Q*, MR>MC

  • marginal gain is positive, more units would be produced even very small gain.

MC curve cuts the MR curve from below

at which marginal equal to zero.

short run of a p taking model
In short run:

the no.s of firms is fixed.

TC=TVC+TFC

Maximizing-wealth output at MR=MC

P or AR≧AVC (收入≧可變成本) E.g labour wage, monthly rent, water fees..etc.

Short Run of a P-taking Model
slide30

Case A) In short-run, a price-taking firm is earning an

economic profit (P>AC) ref. P.158(4)

At P1: MR = MC

Produce at Q1

Total Revenue = P x Q

Area =

Total Cost = AC x Q

Area =

Profit per unit =P-AC =

Total Profit = (P – AC) x Q

Area=

MC

P

A

MR=AR=P1=d

P1

Profit

AC

P1AQ1O

AC1

B

AVC

AC1BQ1O

AB

P1ABAC1

O

Q

Q1

slide31

Case B) In short run, a Price-taker firm is earning a normal profit (Breakeven), if P=AC

ref. P.157(3)

MC

P

At P2: MR = MC

Produce at Q2

TR = P x Q

=

Total Cost = AC x Q

=

Since P = AC

Profit per unit =P-AC =

Total Profit = (P – AC) x Q

=

AC

C

P2 CQ2 O

AC2=

P2

MR=AR=P=d

AVC

AC2CQ2O

0

Q

O

Q2

0

slide32

Case C) In short run, a Price-taker firm, continuing production, if P>AVC but not cover the AFC ref. P.157(2)

MC

P

At P3: MR = MC

Produce at Q3

TR = P x Q

=

Total Cost = AC x Q

=

Since AC>P

Loss per unit AC - P =

Total Loss = (AC - P) x Q

=

AC

D

P3 EQ3 O

AC3

Loss

MR=AR=P=d

P3

E

AVC

AC3DQ3O

DE

Q

O

Q3

AC3DEP3

slide33

Case D) In short run, a Price-taker firm is suspending production immediately, if P<AVC ref. P.157(1)

MC

P

At P4: MR = MC

Produce at Q3

TR = P x Q

=

Total Cost = AC x Q

=

Since AC>P

Loss per unit AC - P =

Total Loss = (AC - P) x Q

=

AC

F

P4 GQ4 O

AC4

Loss

AVC

AC4FQ4O

P4

G

MR=AR=P=d

FG

Q

O

AC4FGP4

Q4

short run supply curve of a p taker35
Short Run Supply curve of a P-taker

MC

P-taker’s supply curve

P

The S.R. supply curve:

1. Q* at MC=MR

2. P greater than or equal to AVC in Short Run.

3. The supply curve coincides with the MC curve.

AC

Min AVC

AVC

P*

MR=AR=P*=d

TR=TVC

Q*

Q

S.R. supply curve of a P-taker’s

the market equilibrium price p eq
The market equilibrium Price (Peq)

P

Market/Industry

P

P

Individual A’

Individual B’

S(=Σs)

+…+

Q

Q

P*

P

Firm A’

P

Firm B’

+…+

D(=Σd)

Q

Q

Q*

Q

Peq is determined by the intersection of market D and S

long run model l r of a p taker
L.R, Freedom of entry and exist

L.R, TC=TVC

L.R, max-wealth output at MR=LRMC, P or AR≧LRAC(收入≧總成本)

Profitnew firm entry (S↑) supply curve to the right forcing P↓until Profit =0

Long Run Model(L.R) of a P-taker

P

S

S’

P↓

D

Q

long run supply response if p lrac profit exist entry of new firm
P

P

Long Run Supply Response: If P>LRACProfit existEntry of new firm

S

Individual P-taker firm

P-taker market

LRMC

S’

(2)

New firm entry(S↑)

MR=P=AR=d

P*

Profit (1)

LRAC

(3)

AC2

P1=AC2

MR=MC

TC=TVC

D

Q*

Q

Profit is a signal for entry of new firms in L.R.

Forcing Price↓until the profit = 0. Then no more new firm entry

long run 1 entry of new firms when p lrac
Long Run (1) Entry of new firms: When P>LRAC
  • In Long run, if P>LRAC
  • Profit
  • Supply
  • Price   until profit fall to
  • Finally, all firms just earn profit in the long run. (Breakeven)

new firm entry

S ↑

zero.

P↓

normal

long run 2 exit of firms when lrac p
PLong Run (2) Exit of firms: When LRAC>P

S’

Individual P-taker firm

P-taker market

S

LRMC

LRAC

P

(2)

New firm exit (S↓)

AC2

P↑

Loss(1)

(3)

P*

MR=MC

TC=AC*Q

D

Q

Q*

Q

S↓ Forcing P↑, the P< LRAC. ∴ no more firms exit

Loss is a signal for exit of existing firms in L.R.

long run 2 exit of firms
Long Run: (2) Exit of firms

In L.R.: If LRAC>P

  • Loss occur
  • Supply 
  • Price driving market
  • Firm , only the firm who has a lower LRAC can survive

(S ) Supply curve to the left

P

Exit

2 no entry and exit when p lrac
P(2) No entry and exit: When P=LRAC

Individual P-taker firm

P-taker market

S

LRMC

P

Profit = 0 no firm entry or exit

LRAC

P*=AC

MR=MC

TC=AC*Q =TR=P**Q*

D

Q

Q*

Q

Zero Profitin L.R.TR just cover TC and earning no more than their highest-valued alternative.(Breakeven)

why profit is zero in the long run
AC’Why Profit is Zero in the Long Run

P

MC

AC ↑due to the increase in factor price, raising the firm’s total cost

P

AC

AC1

Q

why profit is zero in the long run45
Why Profit is Zero in the Long Run?
  • Under ‘competitive conditions’  always pressure on
  • Profit exists 
  • S  output in the industry  price of the good move  an existing firm’s total revenue
  •  Factor price total cost
  • Profit is squeezed from above and from below

Profit

firm will enter the market

share the existing profit

increase

expand

downward

Lowering

increase

increase

how profit is eliminated by an increase in factor price
How profit is eliminated by an increase in factor price?
  • Factor price  Cost of Production
  • In reality, factors of production are heterogeneous. Different firms produce with different production cost.
  • In long run, market price of good to the minimum point of the LRAC curve (marginal firm) firm’s with superior factors by offering extra payment (imputed rent)

increase

increase

Fall

distinguish between three types of firm
Distinguish between three types of firm
  • Marginal firm or fringe firm
  • Intra-marginal firm
  • Extra-marginal firm
marginal firm p ac
Marginal firm (P=AC)
  • With the highest average cost curve
  • Lowest productive power or efficiency
  • Only cover its full costs (TVC+TFC)
  • Earn only negligibly more within the industry than outside
  • First to leave the industry if the price

increase

marginal firm p ac49
Marginal firm (P=AC)

MC

P

P*Q*=AC*Q*

TR=TC

Just cover its full cost

AC

P=d=AR=MR

P=AC

MC=MR

Q

Q*

intra marginal firm p ac
Intra-marginal firm (P>AC)

profit

  • Earning an amount of rent in excess of the initial cost of fixed factor (TR>TC)
  • Lower cost in the industry (P>AC)
  • Poor alternative elsewhere
  • survive at a lower price
  • Only a larger fall in price will force it to exit
intra marginal firm p ac51
Intra-Marginal firm (P>AC)

MC

Profit: Earning excess of initial cost

P

AC

P1

Profit

P=MR=AR=d

AC1

TC

Q

Q*

extra marginal firm ac p
Extra-marginal firm(AC>P)

AC>P

  • AC>P
  • The firm has a higher cost
  • Better alternative elsewhere
  • So it is not enter the industry
extra marginal firm ac p53
Extra-Marginal firm(AC>P)

Loss, not enter the industry

MC

P

AC

AC1

P=d=AR=MR

Total Cost

Loss

P1

Q

Q1

slide54
Q: Explain why in a competitive industry like farming, some farmers are able to earn a much higher income than other competitors?
slide55
Ans.
  • First comers of the industry are able to earn a much higher income.
  • They usually own more fertile lands and save other variable costs. E.g. costs of pesticide of fertilizer.
  • Late comers, earn less income. E.g. lands are usually poorer quality and higher variable cost
  • Late comers can only incomes close to or equal to the costs of providing other inputs.
  • They earn smaller amounts of rents, or even no rent at all.
short run model s r long run model l r
L.R, Freedom of entry and exist

L.R, TC=TVC

L.R, max-wealth output at MR=LRMC, AR≧LRAC(收入≧總成本)

Profitnew firm entry (S↑) P↓until Profit =0

S.R, the no. of firms is fixed.

S.R, TC=TVC+TFC

S.R, max-wealth output at MR=MC, AR≧AVC (收入≧可變成本)

Price↑(caused by D↑)  induce the existing firms to produce more and enjoy profit.

Short Run Model (S.R.)≠ Long Run Model(L.R)

S

P

S’

P↓

S

P↑

D’

D

Q

D

Q

wealth maximizing output of a p taker firm in s r and l r
Wealth-maximizing Output of a P-taker firmin S.R and L.R.

1.MR=MC

2.L.RP≧AC ∴Produce

P

MC

AC

MR=AR=P2=d curve

P2

AVC

MR=AR=P1=d curve

P1

1.MR=MC Maximize wealth output

2.S.RP≧AVC∴Produce

Q

SR-Q*

Q*-LR

vilfredo pareto identified a condition of resource allocation p 154
Vilfredo Pareto identified a condition of resource allocationp.154

Which is now know as the Pareto condition.

the meaning of pareto efficiency in allocation
The meaning of Pareto Efficiency in Allocation

Definition:

  • A state where it is no longer possible reallocate the use of resources so that one individual will gain without loss to another.

P

P-taker model

MC

MR=AR=P=d

P*

P = MR=MC=MUV

Q

Q*

functions of pareto efficiency
Functions of Pareto Efficiency
  • The Pareto condition forms the basis for an evaluation of the efficiency of resources allocation.
  • If the market is not function well, it may not attain the Pareto EfficiencyMarket failure
  • Government intervention is called for to correct this situation.
resource allocation efficiency
Resource Allocation Efficiency
  • Production Efficiency: Revenue cover the cost:P = MC
  • Consumption Efficiency: P=MUV, the market price is equal to the marginal use value
  • Allocation Efficiency: P =MC =MUV
slide63

Efficiency in Resource Allocation

(P=MC=MUV)

  • It is no longer be possible to ↑or↓output to improve social welfare.

P

MC

dead weight loss

P=MC=MUV

MR=AR=P=d Curve

P*

dead weight loss

↑or↓ output will decrease social welfare. ∴Social cost > benefit

Q

Q1

Q*

Q2

slide64

Pareto condition in Price-taking Market

In a perfectly competitive market, the coordination of

production is not the role of a

There is an in the market

Which coordinates

And to achieve the maximum for the whole economy

single individual

‘invisible hand’

consumption, production, and allocation

benefit

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