Lecture 4(a) Competition and Monopoly

1
Lecture 4(a) Competition and Monopoly
2
Why Bother?

• The first part of this course looked at the
  motivation and calculation of individual
  consumers and producers. Now we need to examine
  how these groups interact in a marketplace.
• The actual models are so unrealistic as to border
  on the absurd, but they provide a kind of a
  benchmark against which we can judge markets in
  the real world.

3
What Would a Perfectly Competitive Market Look
Like?

• Many Buyers and Sellers, of more or less the same
  size.
• No Walmarts or Dept. of Defense
• Homogenous Product
• Meaning the output of one firm is
  indistinguishable from that of another (i.e., a
  commodity)
• Perfect Information (about prices and costs)
• No Entry Barriers (well have to think more
  carefully about exactly what this means later).

4
Firm Demand is Perfectly Elastic (that is, firms
are price takers)
5
All This Really Means Is That MRP

• This makes perfect sense the firm doesnt have
  to cut price in order to sell more. Thus, every
  added unit sold increases revenue by the price of
  the good.
• Of course if you like calculus
• R Pq and so
• MR dR/dq P

6
The Next Step is Describe What an Equilibrium
Will Look Like in a Competitive Market

• An equilibrium is defined in economics (and
  most other sciences) as a state of the world in
  which none of the relevant variables will have a
  tendency to change.
• In analyzing markets it is useful to distinguish
  between short run equilibrium and long run
  equilibrium.
• The short run describes a period of time that is
  too short for new firms to enter the market or
  for existing firms to make significant
  adjustments to their productive capacity. (Think
  about how that fits in with the discussion of
  fixed costs and time from the previous lecture.)
• The long run refers to a time period sufficiently
  long to permit new entry (or exit) and maybe
  capacity adjustment.

7
Short Run Equilibrium Part I How Much Does a
Typical Firm Produce?(Obvious Answer The q
such that MCMRP
MC
P
q
8
Short Run Equilibrium Part II Short Run Supply
The supply curve is really just a reflection of
MC
qo
9
Short Run Equilibrium Part III Putting It All
Together
Supply
Think About Why This is Equilibrium
MC
Demand
qo
10
Short Run Equilibrium IV Summing Up

• A Short Run Equilibrium is Characterized by
• PMRMC
• Market Clearing Prices (i.e., Quantity Demanded
  Quantity Supplied

11
Long Run Equilibrium I What Does it Mean

• Since the defining characteristic of the short
  run was the assumption of no entry, the long
  run will be defined as the period of time long
  enough for firms to enter (or change scale).
• This means we need to ask about profits.

12
This Cant Happen in the Long Run
Supply
Positive Profits
AC
MC
Demand
qo
13
So What Would Happen in the Long Run With
Positive Profits?
Supply
Positive Profits
AC
Entry and Lower Price
MC
Demand
qo
14
What Would Happen in the Long Run If There Were
Negative Profits?
Market Supply With N Firms
Loss
Exit and Higher Price
Supply
AC
MC
Po
Demand
qo
Nqo
15
The Long Run Equilibrium
Market Supply With N Firms
No (economic) profit or loss
Supply
AC
MC
Po
Demand
qo
Nqo
16
Long Run Equilibrium Summing Up

• A Short Run Equilibrium is Characterized by
• PMRMC
• Market Clearing Prices (i.e., Quantity Demanded
  Quantity Supplied)
• No (economic) profits or loss (PACmin)

17
Issue Can You Make Money (i.e., earn positive
economic profits) In a Competitive Market

• The model says no but.

18
A note on stability and competitive equilibrium

• An equilibrium may exist but not be stable
• Think about the cattle cycle or bubbles.

19
Applying the Model SR Equilibrium and the
Burden of a Tax

• Consider a per unit tax on some good (like the
  tax on a pack of cigarettes).
• Does it matter whether the tax is imposed on the
  buyer or seller?

20
Suppose the Producer Must Pay 5 Tax

• Ptax

Supply (tax)
Supply (no tax)
Tax shifts the Supply by 5
Ptax
Pno tax
Pnet
Demand
21
Suppose the Consumer Must Pay 5 Tax

• Ptax

Supply
Pnet
Pno tax
Tax shifts the demand by 5
Ptax
Demand (tax)
Demand (no tax)