Perfect Competition

Perfect Competition • Many (small) firms, producing a homogeneous (identical) product, none of which having an impact on the price; each firm's product is non-distinguishable from other firms' product. • b. Many buyers none of whom having any effect on the price. • c. No barriers to entry and exit: in the long run firms can shut down and leave the industry or new firms can come into the industry freely. • d. No interference in the market process: No price control or restrictions on production • e. All firms have equal and complete access to the available inputs (input markets) and production technology; all firms have the same production and cost functions. • f. All sellers and buyers have perfect information about the market conditions. • g. Making above-normal profits by existing firms will result in new entries into the industry. Firms that have losses shut down and leave the industry in the long run.

How is the market price Determined? • Market Supply: The (horizontal) sum of individual supply curves • Market Demand: The (horizontal) sum of individual demand curves

P P Smo Sm1 S po Do p1 D1 Dm Q Q 0 0 q1 qo Market A typical firm

Perfect Competition:Profit Maximization in the Short Run • An individual firm takes the market price as given; the demand each individual firm faces is horizontal. • MR = P: Demand • Set the price equal to MC • In the short- run the firm could have an economic profit

Profit Maximization in the Short Run SMC $ SATC AVC c Pm Df , MR b a Q 0 Qe

Adjustments in the Long Run • If economic profits are present new firms will come into the industry • The Market price will fall • The profit shrinks • Input prices may go up • Firms try to stay profitable by taking advantage of economies of scale • Firms adopt an optimal size • Economic profits tend toward zero

$ Smo Sm1 Sm2 Sm3 Sm4 Pm1 Pm2 Pm3 Pm4 Dm o Qm Q4 Q3 Q2 Q1 Qo MARKET

A competitive firm’s long-run equilibrium LATC SAC1 SAC2 SAC4 SAC3 D Pm Q o Qe

Long-Run Equilibrium in a Perfectly Competitive Market $ $P LATC Sm SATC3 SATC1 MC2 SATC2 Pe Df Dm Q o o Qe A typical firm Market

Long-Run Equilibrium under Perfect Competition • Many “optimal-size” firms, each producing at the minimum long run average cost and charging the market price where: P = MR= MC = SATC = LATC • Allocative efficiency: MC = P • Productive efficiency: MC= SATC = LATC • Zero economic profit (normal profit) : P = ATC

Pure Monopoly • A single firm producing a homogenous or differentiated (unique) good and facing the market demand. • No substitutes • No new entries allowed • The monopoly is a price maker • P>MR • Possibility of a sustained economic profit

What circumstances lead to the formation of a monopoly? • Extensive economies of scale: natural monopolies • Exclusive patent rights • Copy rights to intellectual properties • Government franchises • Exclusive access to a essential resource (input) • Cartels A monopoly is a profit maximizer too!

Demand Faced by A Monopoly $ a -2b -b Dm MR Q 0 $ TR Q 0

$ SMC k SATC P c m n D Q o Qe Qc MR

The Dynamics of a Monopolistic Market • As a profit maximizer a monopoly may try to take advantage of economies of scale • A monopoly tends to try to protect its monopolistic position • A monopoly may take advantage of technological advances • A monopoly may face changes in demand • A monopoly may try to promote its product to maintain demand

$ ATC>MC, P>MR, P>MC, P>ATC SMC LATC k P SATC m n D Q o Qe MR L-R Positive Economic Profit

Monopolies and Profit Maximization • A monopoly faces the industry demand curve • To maximize profit: MR = MC P = 80 - .0008Q ; MR = 80 - .0016Q TC = 10,000 + .0092Q2 ; MC = .0184 Q Set MR = MC  Q = 4000; P = 76.8 Profit = 307,200 – 147,200 – 10,000 = 150,000 • Profit = (P- ATC). Q

Things Change • Demand may go down • Cost could increase • In an attempt to keep the potential competitors out, the monopolist may lower its price to near its average cost • Rent seeking: an attempt to maintain its monopolistic position by influencing the political processes-e.g., zoning laws • Closer substitutes may emerge

$ ATC>MC, P>MR, P>MC, P = ATC SMC LATC SATC P D Q o Qe MR L-R Zero Economic Profit

The Case of Natural Monopolies • A natural monopoly emerges out of competition among firms in an industry with extensive economies of scale; the downward-sloping segment of the LATC curve extends to or beyond the market capacity (or market demand). • Smaller firms are gradually driven out by the larger (more efficient) firms. • The surviving firm would become a (natural) monopoly. • If unchecked, a natural monopoly behaves like a monopoly; it under-produces and overcharges.

$ SAC1 Natural Monopolies SAC2 SAC3 LAC D o Q2 Q Q1 Q3

$ Natural Monopolies Monopoly Pricing LATC p Pm SMC SAC AC LMC D o Qm Qc Q MR

$ A Comparison Pm MC Pc D MR Q Qm Qc o

Price Discrimination • Segmenting the market into separate classifications or regions • Assuming that each class of consumers have different demand, a monopoly can charge different prices in each market segment To price-discriminate • The firm must identify consumer groups/classes with different downward-sloping demand curves • The firm must be able to prevent consumers of one class from reselling its product to the consumers of another class; no intermarket redistribution of the product is allowed

$ P` P MC, ATV D D` MR MR Q Q o Q Q Price Discrimination

Monopsony vs. Monopoly MCL SL Wu Wc Wm MRPL:DL MRL Eu Em Ec o

Cartels P,C P,C P,C ΣMC P MCB Dm ATCB MCA ATCA MR o o o Q QA QB Industry Firm B Firm A

Perfect Competition