Studied by 0 people
Looks like no one added any tags here yet for you.
Four Market Models
Pure competition
Monopolistic competition
Oligopoly
Pure monopoly
Characteristics of Pure Competition
Very large number of firms
Standardized products
No control over price (Price takers)
Very easy entry and exit, no obstacles
No nonprice competition
Example: Agriculture
Characteristics of Monopolistic Competition
Many firms
Differentiated products
Some control over price, but within rather narrow limits
Relatively easy entry
Nonprice Competition has considerable emphasis on advertising, brand names, and trademarks
Examples: Retail trade, dresses, shoes
Characteristics of Oligopoly
Few firms
Standardized or differentiated products
Control over price is limited by mutual inter-dependence; considerable with collusion
Significant obstacles to entry
Nonprice competition is typically a great deal, particularly with product differentiation
Examples: Steel, auto, farm implements
Characteristics of Monopoly
One firm
Unique product; no close substitutes
Considerable control over price
Blocked entry
Nonprice competition is mostly public relations and advertising
Example: Local utilities
Purely Competitive Demand
Perfectly elastic demand
Firm produces as much or as little as they wish at the market price
Demand graphs as horizontal line
Average Revenue
Revenue per unit
Total Revenue (TR) =
P x Q
Marginal Revenue
Extra revenue from 1 more unit
Marginal Revenue (MR) =
Change in TR / Change in Q
Average Revenue (AR) =
TR / Q = P
Profit Maximization: TR - TC Approach
The competitive producer will wish to produce at the output level where total revenue exceeds total cost by the greatest amount
Break-Even Point
An output at which a firm makes a normal profit; Total Revenue = Total Costs
Profit Maximization: MR = MC Approach
For a price taker, Price = Marginal revenue
The firm considers three questions:
Should the firm produce?
If so, what amount?
What economic profit (Loss) will be realized?
MR = MC Rule
Principal that a firm will maximize its profit or minimize its losses by producing the output at which marginal revenue and marginal cost are equal, provided product price is equal to or greater than average variable cost
Loss Minimizing Case
Still produce because MR > Minimum AVC
Losses at a minimum where MR = MC
Producing adds more to revenue than to costs
Short Run Supply
Supply graph has upsloping line
Short Run Supply Curve
As long as P exceeds minimum AVC
Firm continues to produce using the MR (= P) = MC rule
A firm should produce if
Price is equal to, or greater than, minimum average variable cost. This means that the firm is profitable or that its losses are less than its fixed cost.
What quantity should this firm produce?
Produce where MR (= P) = MC; there, profit is maximized (TR exceeds TC by a maximum amount) or loss is minimized.
Production will result in economic profit if
Price exceeds average total cost (TR will exceed TC)
Production will NOT result in economic profit if
Average total cost exceeds price (TC will exceed TR)
Fixed Costs: Digging Out of a Hole
Shutting down in the short run does not mean shutting down forever
Low prices can be temporary
Some firms switch production on and off depending on the market price
In the long run
Firms can expand or contract capacity
Firms can enter or exit the industry
The Long Run in Pure Competition
Decisions are based on the incentives of profits or losses
Long Run Supply Curve
Defined as a curve showing the prices at which a purely competitive industry will make various quantities of the product available in the long run when all inputs are variable.
Profit Maximization in the Long Run
Easy entry and exit
Identical costs
All firms in the industry have identical costs
Constant-Cost Industry
Entry and exit of firms does not affect resource prices
Long Run Adjustment Process in Pure Competition
Firms seek profits and shun losses
Firms are free to enter or to exit
Production will occur at firm’s minimum average total cost
Price will equal minimum average total cost
Long Run Equilibrium - Entry
Entry eliminated profits
Firms enter
Supply increases
Price falls
Long Run Equilibrium - Exit
Exit eliminates losses
Firms leave
Supply decreases
Price rises
Constant-Cost Industry
Entry or exit does not affect Long Run ATC
Constant resource prices
Increasing-Cost Industry
Most Industries
Long Run ATC increases with expansion
Specialized resources
Input costs have positive relationship with Entry and exit of firms
Long run supply curve is upsloping
Decreasing-Cost Industry
Input costs have inverse relationship with Entry and exit of firms
Long run supply curve is down sloping
Productive Efficiency
Producing where P = Minimum ATC
Allocative Efficiency
Producing where P = MC
Triple Equality
P = MC = Minimum ATC
Pure Competition and Efficiency
In the long run, efficiency is achieved
Consumer Surplus and Producer Surplus are maximized
Purely competitive markets will automatically adjust to
Changes in consumer tastes
Resource supplies
Technology
Technological Advance and Competition
Entrepreneurs would like to increase profits beyond just a normal profit
Decrease costs by innovating
New product development
Creative Destruction
Competition and innovation may lead to “Creative Destruction”
Creation of new products and methods may destroy the old products and methods.
Patents
Give the inventor exclusive rights to market and sell their product for 20 years
