Competitive markets
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Competitive Markets. Structure. Fragmented Undifferentiated Products : Homogeneous Perfect Information about Price Equal Access to Resources. Three Implication. Price Takers Law of one Price Free Entry & Free Exit. Profit Maximization. Profit Maximization Condition. TR. TR,TC. TC.

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Competitive markets

Competitive Markets


Structure

Structure

  • Fragmented

  • Undifferentiated Products : Homogeneous

  • Perfect Information about Price

  • Equal Access to Resources


Three implication

Three Implication

  • Price Takers

  • Law of one Price

  • Free Entry & Free Exit


Profit maximization

Profit Maximization

Profit Maximization Condition


Competitive markets

TR

TR,TC

TC

Profit

0

Q

MC

MR = P

0

Q

MC > MR

MC < MR

MC = MR

MC > MR


Competitive markets

Firm

Industry

Price

Price

AR = P = MR

D

Q

Q


Competitive markets

Price

MC

AC

A

MR = P

P1

Excess Profit

AVC

C

B

Q

0

Q


Competitive markets

Price

AC

MC

A

MR = P

P1

AVC

C

Q

0

Q


Competitive markets

Price

MC

AC

B

AVC

C

Loss

P1

A

MR = P

Q

0

Q


Competitive markets

Price

MC

AC

B

C

AVC

Loss

A

MR = P

P1

Q

0

Q


Competitive markets

Price

MC

AC

B

C

AVC

Loss

MR = P

P1

A

Q

0

Q


Competitive markets

Price

MC

AC

P1

AVC

P2

P3

P4

Shut Down Point

Q

0


Competitive markets

Price

MC

AC

P1

AVC

P2

P3

P4

Shut Down Point

Q

0

Firm’s Supply


Competitive markets

Example

The Firm’s short run total cost curve is

STC = 100 +20Q + Q2.

The short run Marginal cost curve is

SMC = 20 + 2Q

If SFC = 100, while SVC = 20Q + Q2

Find AVC , Minimum level of average variable cost, supply curve


Fixed cost sunk cost

Fixed Cost + Sunk Cost

TFC = SFC + NSFC


Competitive markets

Price

MC

AC

ANSC

AVC

B

C

P1

Minimum ANSC = P

A

Q

0

Q


Competitive markets

Example

The Firm’s short run total cost curve is

STC = 100 +20Q + Q2.

The short run Marginal cost curve is

SMC = 20 + 2Q

If SFC = 36, while NSFC = 64

Find ANSC , Minimum level of average non sunk cost, supply curve


Competitive markets

Firms

Market

P

P

p

Q

Q

Q1

Q2

Q1+Q2

Firm Supply and Market Supply


Short run perfectly competitive equilibrium

P

P

S

SAC

P*

D

Q*

Q

D(P*)

Q

Short Run perfectly Competitive equilibrium


Competitive markets

The Market consists of 300 identical firms, and the market demand curve is given by

D(P) = 60 – P.

Each firm has a short run cost curve

STC = 0.1 + 150Q2 , all fixed cost are sunk.

The corresponding short run marginal cost curve

SMC = 300Q.

The corresponding average variable cost curve is

AVC = 150Q.

You should verify that the minimum level of AVC is 0. Thus, a firm will continue to produce as large as price is positive

Find Short run equilibrium in market, at equilibrium, do the firm make positive profit?


Comparative statics in short run

P

P

S

SAC

S’

P1

P2

D

Q2f

Q1f

Q

Q

Q1

Q2

Comparative Statics in short run

Increase in the number of firm


Long run plant adjustment

Price

MC2

SAC2

LMC

MC1

P1

SAC1

LAC

Quantity

Q1

Q2

Long Run – Plant Adjustment


Long run supply curve

Price

LMC

LAC

P1

P2

P*

Quantity

Q*

Q2

Q1

Long Run Supply Curve


Long run supply curve1

Price

LMC

LAC

P1

P2

P*

Quantity

Q*

Q2

Q1

Long Run Supply Curve


Free entry and long run

Free Entry and Long Run

1. Long Run Profit is maximized with respect to output and plant size.

P* = MC ( Q* )

2. Economic profit is Zero.

P* = AC ( Q* )


Free entry and long run1

P

P

LMC

SMC

S

SAC

LAC

P*

D

D(P*) = n*Q*

Q*

Q

Q

Free Entry and Long Run

3. Demand equals Supply.

D( P* ) = n Q*


Competitive markets

In this market, each firm and potential entrant has a long – run average cost

AC( Q ) = 40 – Q – 0.01Q2.

And a corresponding long run marginal cost curve

MC( Q ) = 40 – 2Q + 0.03Q2.

Where Q is thousand units per year. The Market demand curve is

D( P ) = 25,000 – 1,000P,

Where D(P) is also measured in thousand units. Find the long run equilibrium price, quantity per firm, and number of firms.


Long run market supply curve

P

P

LMC

S

SAC

S’

LAC

A

P2

B

P1

D’

D

Q

Q

Q1f

Q2f

Q1

Q2

Long Run Market Supply Curve


Industry long run supply curve

P

P

LMC

S

S’

LAC

A

P2

SL

B

P1

D’

D

Q

Q

Q1f

Q2f

Q1

Q2

Industry Long Run Supply Curve

Constant Cost


Industry long run supply curve1

Increasing Cost

P

P

LMC2

S

LMC1

LAC2

S’

LAC1

P2

P3

SL

P1

D’

D

Q2

Q

Q

Q1f

Q2f

Q1

Industry Long Run Supply Curve


Competitive markets

Problem 1

The bolt industry currently consists of 20 producers, all of whom operate with identical short run total cost function

STC ( Q ) = 16 + Q2

Where Q is the annual output. The corresponding short run marginal cost curve is

SMC ( Q ) = 2Q

The market demand for the bolts is

D ( P ) = 110 – P

Where P is the market price


Competitive markets

a ) Assuming that all of the firm fixed cost is sunk, what is the firm’s short run supply curve?

b ) What is the short run market supply curve?

c ) Determine the short run equilibrium price and quantity in the industry.


Competitive markets

Problem 2

Propylene is used to make plastic. The propylene industry is perfectly competitive, and each producer has a long run marginal cost function given by

MC ( Q ) = 40 – 12Q + Q2

The corresponding long run average cost function is

AC ( Q ) = 40 – 6Q + (1/3)Q2

The market demand curve for propylene is

D ( P ) = 2200 – 100P


Competitive markets

a ) What is long run equilibrium price in the industry?

b ) At this price, how much would an individual firm produce?

c ) How many firms are in the propylene market in long run competitive equilibrium.

d ) Suppose the demand curve shifted so that it is now D ( P ) = A – 100P. How large would A have to be so that in the new long run competitive equilibrium, the number of propylene firms was twice what it was in the initial long run equilibrium?.


Competitive markets

Problem 3

The long run total cost function for producers of mineral water is

TC ( Q ) = cQ

Where Q is the output of individual firm expressed as thousand liters per year. The market demand curve is

D ( P ) = a – bP

Find the long run equilibrium price and quantity in term of a, b, c, . Can you determine the equilibrium number of firms? If so, what is it? Why not?


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