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Ch.7 Price-Taking Market

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  1. Ch.7 Price-Taking Market

  2. 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

  3. 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

  4. 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)

  5. 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

  6. 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)

  7. 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

  8. Short Run Model of a Price-taker 受價者市場

  9. 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

  10. 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)

  11. 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.

  12. 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.

  13. Marginal revenue (MR)&Average revenue(AR)of a Price-taking firm

  14. (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)

  15. Fill in the table = P x Q $50 $5 $5 $75 $5 $5 $5 $100 $5 $125 $5 $5 $150 $5 $5

  16. 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

  17. 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

  18. HKALE MC98.29 • Answer: C

  19. 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.

  20. Is there any market can fulfill ALL the condition of P-taker model in our economy? • No

  21. 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.

  22. (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)

  23. (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

  24. Determination of a wealth maximizing output

  25. 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*

  26. 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?

  27. 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.

  28. 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

  29. SHORT-RUN OUTPUT DETERMINATION OF A PRICE-TAKER

  30. 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

  31. 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

  32. 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

  33. 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

  34. Short Run Supply Curve of a P-taker

  35. 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

  36. 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

  37. Long Run Model of a P-taker

  38. 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

  39. 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

  40. 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

  41. P Long 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.

  42. 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

  43. 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)

  44. 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

  45. 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

  46. 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

  47. Distinguish between three types of firm • Marginal firm or fringe firm • Intra-marginal firm • Extra-marginal firm

  48. 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

  49. 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*

  50. 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