9: Competitive Markets

Focus on interpretation.

Market Structure

  • Market power: the ability of a firm to influence the price of a product or the terms under which it is sold. (not dictate).

    • 0 market power: no ability to influence price or the terms.

    • 100% market power: the ability to influence both the price and the terms of sale.

    • It’s a scale — different levels. 

  • 0%: perfect competition. Zero market power.

  • 100%: monopoly.

    • Then we focus on monopolistic competition/oligopoly//duopoly.

Industrial organization: field that studies the strategic behaviour of firms in each market structure. Whichever market structure you’re in determines how you behave.

  • Perfect market structure: perfect competition. 0% market power.

  • Everything else is imperfect market structure.

Perfect Competition

  • all firms in an industry are price takers and which there is freedom of entry into and exit from the industry.

    • e.g. New Zealand’s Dairy Farmers. They have very little market power. We see a lot of this in agriculture.

Assumptions

  • Price taker: alter the rate of production and sales without affecting the market price. Must take the price that is given to them by the consumer. Apple seller example.

  • Homogeneous products: all firms in the industry sell identical products. There is a full knowledge of the product. (e.g. apples, milk, eggs). In the eyes of consumer.

  • Small output relative to industry output: an insignificant amount of production in relation to the total industry production.

  • Freedom of entry and exit: any firm can enter and exit the industry.

Demand Curve

  • The price remains the same regardless of the quantity.

    • Therefore, the demand curve is a flat, linear line.

  • Calculate total revenue and average revenue. Then, the demand curve becomes your average revenue line. And the marginal revenue is the same too.

    • D = AP = MR. Perfectly elastic.

  • Then, let’s superimpose the cost curves: AFC, AVC, ATC and MC.

    • At the capacity, the demand curve intersects. Each apple for as low as possible. 

    • The profit is zero. It’s at the break-even point.

      • TR = P0Q0

      • TC = ATCQ0

      • Profit = TR - TC, which equals zero.

Considerations in the Short-Run

  • To produce or not to produce? Produce as long as P > AVC.

  • Market Structure

    • If P = D = AR = MR, then you’re a price taker. The same price regardless of the quantities.

    • If P = D = AR =/= MR, then you’re a price setter.

  • How much to produce?

    • We will always produce where marginal revenue is equal to marginal cost.

    • If MR > MC, then increase quantity.

    • If MR < MC, decrease quantity.

    • Produce where MR = MC.

  • Profits? When the price is greater than your average total cost.

You as an individual firm face a perfectly elastic demand curve, you as an entire industry faces a downward sloping demand curve.

  • And that’s why the market demand curve shifts.

Long Run Decisions

  • Profit signals: if P > ATC, then you get profit. And you get an increase in firms. It then drives the price down.

  • When P < AVC, then a firm shuts down. There is an increase in firms.

  • As a firm in the long run, the best that you can do as a firm in perfect competition is break even. 0 economic profits.

  • How quickly a firm shuts down and becomes obsolete.

  • Obsolete rate: the rate of time that it takes for capital to become obsolete.

    • Sunk (unrecoverable costs): slow obsolete rate

    • Non-sunk (recoverable costs): fast obsolete rate.

  • e.g. ownership of buildings vs. computers. Computers will go obsolete quicker.

Calculating Costs