Market Structure Competition

1
Market StructureCompetition
2
Competitive Firm
P
P
Industry
Firm
P0
P0
P0
d
D
10,000,000
50,000,000
30
10
3
Competitive Firm

• A competitive firm can sell any quantity at the
  market price. The firm decides how much to
  produce but not the price. Competitive firms are
  price takers.
• A competitive firm (not the industry) faces an
  horizontal demand function.
• A competitive firm usually represents a small
  share of the entire industry.

4
Marginal Revenue-Competitive FirmPrice 50
Marginal revenue is constant at the level of the
market price
5
Production Decision-The Firm

• The general rule to maximize profits was to
  produce up to the point in which marginal revenue
  equals marginal cost (conditional on profitsgt0).
• Marginal revenue is equal to price for a
  competitive firm. Therefore, a competitive firm
  produces a quantity at which price equals
  marginal cost.

6
The supply curve (firm) is equal to the marginal
cost curve but
7
The supply curve-The Firm
per bicycle
per bicycle
S
d
d
d
MC
Q
Q
8

• The rule for a competitive firm is to produce up
  to the point where the marginal cost equals the
  price.
• Which marginal costs? Long run marginal cost or
  short run marginal costs?
• The firm has a short run supply function and a
  long run supply function.

9
U-Shaped Marginal Cost
S
Only the upward slopping part of the marginal
cost is relevant for the production decision.
MC
50
MR
Q
Q1
Q2
10
Shutdown Decision

• ProfitTR-TCTR-FC-VC (TCFCVC)
• If the firm shuts down it still pays the FC
• Therefore, the firm will operate if
• TR-VCgt0 or TRgtVC
• TRPQ then TRgtVC?PgtAVCVC/Q
• The fix costs are irrelevant in the short run
  because the firm pays them even if it shuts down.
  Sunk cost are irrelevant even in the long run.
  What is considered fix cost will depend on the
  length of period the firm is considering.

11
Putting Everything Together-The Short Run Supply
Function (the FIRM)
S
MC
AC
AVC
Q
Q2
12
Elasticity

• Elasticity of SupplyPercentage change in
  quantity/Percentage change in price
• Elasticity of Supply(?Q/Q)/(?P/P)
  (?Q/?P)/(Q/P) (?Q/?P)(P/Q)

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The Supply of the Industry
P
Sc
Sb
Sa
Industry Supply
P0
Q
Q1
Q2
Q1Q2
14
The Supply of the Industry
P
Sc
Sb
Sa
Industry Supply
P0
P1
Q
15
The Competitive Industry in the Short Run
The Industry
The Firm
P
P
s
S
P0
d
D
q
Q0
q0
Q
16

• A Change in fixed costs
• What is the effect in the short run?

17
The Competitive Industry in the Short Run- A
Change in Variable Costs
The Industry
The Firm
S
P
s
P
s
s
S
P2
d
P0
d
D
q
Q0
q0
Q2
q2
q2
Q
18
The Competitive Industry in the Short Run- A
Change in Demand
P
P
s
S
P3
d
P0
d
D
D
q
Q0
q0
Q3
q3
Q
19
The Planners Problem

• Suppose a country wants to produce 1 million
  units of a good at the minimum possible cost. You
  are told to tell each firm in the industry how
  much to produce to reach this goal.
• How would you do this?
• Suppose a firm is producing the last unit at a
  marginal cost of 5 and another firm is producing
  the last unit at a marginal cost of 3. You can
  tell the firm which is producing at a higher cost
  to produce one less unit and the firm producing
  at a lower cost to produce an additional unit.
  The level of output is maintained and you save 2
  of cost. When every firm produces the last unit
  at the same marginal cost the total costs are at
  the minimum possible.
• In a competitive equilibrium every firm produces
  at a point where marginal costs are equal to the
  price (and the price is equal for all of the
  firms). Hence, the market automatically produces
  at the lowest possible cost.

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The Firm in the Long Run

• The long run supply function (firm) is equal to
  the long run marginal cost when the marginal cost
  is above the average costs.
• Firms may exit the industry in the long run. They
  exit if profits are negative. Profits is Revenues
  minus OPORTUNITY costs.
• TR-TCPQ-TCgt0 ?PgtTC/QAC
• The firm breaks even when the price is equal to
  the average cost

21
Break Even Price-The Firm
S
AC
MC
P
Break Even Price
P
Q
Q
Q
22
Long Run and Short Run Supply Responses to a
Change in PriceThe Firm
P
S
S
LRS
P1
P0
Q0
Q1
Q1
Q
23
Constant Cost Industries

• 1-All firms have equal technology they are
  identical.
• 2-Cost curves do not change when the industry
  expands or contracts.
• All firms have the same break even price. Zero
  Profit in LR equilibrium. Entry makes the
  industry long run supply curve (industry) flat.

P
LRS
Q
24

• The industry supply is usually upward slopping
  because less efficient firms are profitable at
  higher prices and enter the market.
• The price of factors increases when production
  increases.

25
Change in Fixed CostsLong Run
Each firm increases production but some firms
exit the market
P
P
MC
AC
d
P1
LRS
AC
P0
d
LRS
D
q
Q0
q0
Q1
q1
Q
26
Change in Variable CostsLong Run
P
MC
P
MC
AC
P1
LRS
AC
P0
d
LRS
D
q
Q0
q1
Q1
q0
Q
27
A Change in DemandShort and Long Run Responses
P
P
MC
S
S
P1
d
P0
d
D
D
q
Q0
q0
Q1
q1
Q2
q2
Q
28
Long Run and Short Run ResponsesRent Control
P
S
S
LRS
P2
P0P3
P1
D
Q1
Q2
Q0Q3
Q
Q0
29
Questions

• ____ When the efficiency criterion is used to
  choose between different policies, any
  recommendation requires unanimous agreement.
• ____ A competitive firm faces a downward-sloping
  demand for its product.
• ____ A firm will shut down in the short run if
  its revenues fail to cover its
• a. fixed costs.
• b. variable costs.
• c. total costs.
• d. sunk costs.
• ____ A firm will exit in the long run if its
  revenues fail to cover its
• a. fixed costs.
• b. variable costs.
• c. total costs.
• d. total costs plus sunk costs.
• Are sunk costs part of opportunity costs?
• The number of firms in an industry is fixed in
  the short run
• A competitive firm's exit price is equal to the
  minimum value of the firm's
• a. marginal cost b. average cost
• c. average variable cost d. fixed and sunk costs.