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Perfect competition

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Title: Perfect competition


1
Perfect competition
  • Everything you ever wanted to know ?

2
FOUR CONDITIONS FOR PERFECT COMPETITION
  • Many buyers and sellers participate in the market
  • Sellers offer identical products
  • Buyers and sellers are well informed about
    products
  • Sellers are able to enter and exit the market
    freely

3
1. Many buyers and sellers
  • No individual buyer or seller can influence the
    total market quantity or the market price
  • Supply and demand determines price without any
    influence from individual suppliers or consumers
  • Sellers MUST charge this price or they will sell
    NONE of their product

4
2. Identical products
  • All suppliers offer the same product or service
  • There are no differences consumers cant tell
    the difference
  • There is no way to differentiate
  • Commodity a product that is considered the same
    regardless of who makes or sells it
  • low-grade gasoline, notebook paper, milk
  • a buyer will not pay extra for one particular
    companys goods but will always choose the
    supplier with the lowest price

5
3. Informed buyers and sellers
  • Buyers and sellers know enough about the market
    to find the best deal they can get
  • You have full information about the product and
    its price

6
4. Free market entry and exit
  • What are barriers to entry?
  • How expensive or difficult it is to get into a
    certain business or to get out of it
  • Start-up costs the expenses that a new business
    must pay before the 1st product reaches the
    customer
  • High start-up costs or technological know-how
    keep many entrepreneurs from entering a market
  • Ex less expensive to start up a sandwich shop
    than a giant supermarket

7
Free market entry and exit, cont
  • In perfect competition
  • Firms can very easily enter a market when they
    can make money
  • Firms can very easily exit a market when they
    cant earn enough to stay in business

8
Price and output
  • So why do we care and why are we starting with
    perfect competition?
  • Because of all of the competing sellers
  • Perfectly competitive markets are the most
    efficient
  • Competition keeps prices and production costs low
  • Firms have no choice but to use land, labor,
    organizational skills, machinery, and equipment
    to their best advantage
  • Prices that consumers pay are very close to what
    it cost to produce the good
  • prices are the lowest possible
  • prices just cover the most efficient sellers
    costs of doing business

9
MONOPOLY
  • Everything you ever wanted to know ?

10
Monopolies
  • What is the point of the game Monopoly? How do
    you win?
  • What is the problem with monopolies?

11
Imperfect Competition and Market Power
  • Weve learned about perfectly competitive
    markets, so what does it mean when a market is
    imperfectly competitive?
  • Firms have some control over the price of their
    output
  • Having market power means that a firm is able to
    raise price without losing all of the quantity
    demanded for its product.

12
Characteristics of Pure Monopoly
  • Single firm in an industry
  • No close substitutes
  • Significant barriers to entry prevent other firms
    from entering
  • Not price-takers, but instead they are
    price-makers!

13
Barriers to Entry
  • In real life, a monopoly forms when barriers
    prevent firms from entering a market that has a
    single supplier.

14
  • Sometimes it just makes sense for a monopoly to
    form. Here are some reasons why

15
1. Economies of Scale
  • A producers average cost drops as production
    rises
  • High start-up costs can be spread out among more
    and more goods as production rises
  • Large, initial fixed costs like paying for a
    factory and machinery
  • Would you spend 1 million to build a huge bakery
    if you were only planning on selling a few dozen
    cookies each week?

16
Economies of Scale - example
  • A factory costs 1,000 to build and each unit of
    output costs 10 to make
  • Producing 1 unit will cost 1,010
  • Producing 2 units will cost 1,020 (or 510 each)
  • What happens to the costs as this business
    produces more?
  • It just makes sense for them to get really big!
  • Once they are big, it will be hard for others to
    enter the market and compete with them.

17
2. Natural Monopolies (mentioned later in
chapter)
  • A market that runs most efficiently when one
    large firm provides all of the output
  • Public water or electricity
  • Would it make sense for there to be more than one
    firm providing the water or electricity in an
    area?
  • Resources would be wasted
  • The government allows these types of monopolies.

18
3. Government Monopolies
  • A monopoly created by the government
  • There are technological, franchise, license, and
    industrial organizations

19
Government Monopolies
  • Technological monopolies
  • Patent gives a company exclusive rights to sell
    a new good or service
  • Why does the government want to provide patents
    to pharmaceutical companies or other inventors?

20
Government Monopolies
  • Franchise contract issued by a local authority
    that gives a single firm the right to sell its
    goods within an exclusive market
  • Shaler Area has this deal with a soft drink
    company. Which one?
  • Not that you would know about this, BUTin
    Pennsylvania, what is the only store that is
    permitted to sell liquor? Why do you think this
    is?

21
Government Monopolies
  • License grants firms the right to operate a
    business
  • Radio and tv broadcast frequencies

22
Government Monopolies
  • Industrial Organizations
  • Government allows companies in an industry to
    restrict the number of firms in a market
  • Major League Baseball and other sports leagues
    can restrict the number and location of their
    teams

23
Monopoly Demand
  • A perfect competitor faced a perfectly elastic
    demand curve that came from the industry.
  • There is no distinction between the firm and the
    industry for a monopolist (they ARE the
    industry!)
  • Their demand curve is downward sloping, then.
  • The monopolist will then choose the point on
    their demand curve where it wants to be.

24
Price and Output Decision
  • Will demand MR (marginal revenue) for a
    monopolist?
  • NO!!!

25
OUTPUT DECISIONS FOR A MONOPOLIST
  • What do you think? Can a monopolist literally
    charge the highest price possible?
  • We know that monopolists can obviously charge a
    higher price than a perfect competitor, but they
    face a dilemma

26
The Monopolists Dilemma
  • Even a monopolist faces the law of demand!!!
  • They can charge a high price, but then they cant
    sell all they want (at a higher price, people
    will not buy as much)
  • If Duquesne Light quadrupled the price of
    electricity, what kinds of things would people do?

27
Dilemmaanother example
  • BreatheDeep (asthma medication) people with
    severe asthma might pay very high prices for the
    drug, but people with milder cases may choose a
    cheaper, weaker medicine if the price rises too
    high
  • BreatheDeep will try to figure out the best
    combination of price and output to maximize their
    profit.
  • Higher price less output
  • Higher output lower price

28
Example
  • Can they charge the people with severe asthma a
    high price and people with mild asthma a lower
    price to entice them to still buy BreatheDeep?
  • Mostly, the answer is NO. You have to charge
    every customer the same price.
  • When a monopolist wants to sell more, they
    must lower the price for all customers.

29
Sowhere IS marginal revenue, then?
  • MR will lie below price b/c
  • When they sell more (by lowering price for ALL
    customers), this will bring in more revenue for
    the business, but this increase is offset
    somewhat by the lower price charged for all
    previous units that could have been sold at a
    higher price.
  • Therefore, the increase in revenue from
    increasing output by one more (MR) is less than
    the price

30
Price and Output Decisions in Pure Monopoly
Markets
Demand in Monopoly Markets
Marginal Revenue and Market Demand
TABLE 13.1 Marginal Revenue Facing a Monopolist TABLE 13.1 Marginal Revenue Facing a Monopolist TABLE 13.1 Marginal Revenue Facing a Monopolist TABLE 13.1 Marginal Revenue Facing a Monopolist TABLE 13.1 Marginal Revenue Facing a Monopolist TABLE 13.1 Marginal Revenue Facing a Monopolist TABLE 13.1 Marginal Revenue Facing a Monopolist TABLE 13.1 Marginal Revenue Facing a Monopolist
(1)Quantity (1)Quantity (2)Price (2)Price (3)Total Revenue (3)Total Revenue (4)Marginal Revenue (4)Marginal Revenue
0 11 0 -
1 10 10 10
2 9 18 8
3 8 24 6
4 7 28 4
5 6 30 2
6 5 30 0
7 4 28 -2
8 3 24 -4
9 2 18 -6
10 1 10 -8

At every level of output except 1 unit, a
monopolists marginal revenue (MR) is below
price. This is so because (1) we assume that the
monopolist must sell all its product at a single
price (no price discrimination) and (2) to raise
output and sell it, the firm must lower the price
it charges. Selling the additional output will
raise revenue, but this increase is offset
somewhat by the lower price charged for all units
sold. Therefore, the increase in revenue from
increasing output by 1 (the marginal revenue) is
less than the price.
? FIGURE 13.3 Marginal Revenue Curve Facing a
Monopolist
31
Profit-Maximization
  • The profit-maximization rule still holds here!
  • So the monopolist will set output by producing up
    to where MC MR
  • However, once they choose that level of output,
    they can charge price by looking at their demand
    curve!

32
Price and Output Decisions in Pure Monopoly
Markets
The Monopolists Profit-Maximizing Price and
Output
A profit-maximizing monopolist will raise output
as long as marginal revenue exceeds marginal
cost. Maximum profit is at an output of 4,000
units per period and a price of 4. Above 4,000
units of output, marginal cost is greater than
marginal revenue increasing output beyond 4,000
units would reduce profit. At 4,000 units, TR
PmAQm0, TC CBQm0, and profit PmABC.
? FIGURE 13.5 Price and Output Choice for a
Profit-Maximizing Monopolist
33
Price and Output Decisions in Pure Monopoly
Markets
Perfect Competition And Monopoly Compared
? FIGURE 13.7 Comparison of Monopoly and
Perfectly Competitive Outcomes for a Firm with
Constant Returns to Scale
In the newly organized monopoly, the marginal
cost curve is the same as the supply curve that
represented the behavior of all the independent
firms when the industry was organized
competitively. Quantity produced by the monopoly
will be less than the perfectly competitive level
of output, and the monopoly price will be higher
than the price under perfect competition. Under
monopoly, P Pm 4 and Q Qm 2,500. Under
perfect competition, P Pc 3 and Q Qc
4,000.
34
Monopoly and Profit
  • Obviously, this is going to generate profit for a
    monopolist (price will be set far above ATC)
  • If they were perfect competitors, what would
    happen in the long run?
  • Will the same thing happen for the monopolist?

35
The Social Costs of Monopoly
Inefficiency And Consumer Loss
? FIGURE 13.9 Welfare Loss from Monopoly
The triangle ABC roughly measures the net social
gain of moving from 2,000 units to 4,000 units
(or the loss that results when monopoly decreases
output from 4,000 units to 2,000 units).
36
  • Regulating Monopoly
  • Two ideas
  • Socially Optimal (where S D or for a monopolist
    where MC p)
  • or
  • Fair price (where p ATC) so they can at least
    break-even like a perfect competitor

37
PRICE DISCRIMINATION
  • Can you think of a time when you paid more or
    less for something than someone else?
  • It happens all the time! Price discrimination is
    the ability to divide consumers into two or more
    groups and charge a different price to each
    group.

38
PRICE DISCRIMINATION
  • This gives the monopolist the best of both
    worlds!
  • They can charge the people willing to pay a lot a
    very high price
  • But they can also sell more by charging those
    willing to pay less a lower price

39
CHARACTERISTICS OF PRICE DISCRIMINATION
  • Market power - firms must have some control over
    prices
  • Distinct customer groups must be able to
    identify consumers willing to pay more / less and
    separate them
  • Difficult resale
  • Could you charge lower food prices for children
    at Heinz Field?
  • What would people do?

40
CAN YOU THINK OF EXAMPLES?
  • Airline fares
  • Coupons / rebates
  • Senior citizen / student discounts
  • Early bird special
  • Children fly or stay free promotions

41
Monopolistic Competition
  • And Oligopolythe other 2 types of competition!

42
What are most businesses?
  • Most businesses in the world are NOT either of
    the extremes that we have learned about so
    farthey are somewhere in between PERFECT
    COMPETITION and MONOPOLY.

43
Monopolistic Competition
  • Different from perfect competition in one major
    way
  • You can differentiate your product now!
  • Examples fast food industry, clothing stores

44
Four Conditions of Monopolistic Competition
  • Many firms (more than 10!)
  • Few barriers to entry
  • Slight control over price
  • You have to keep price similar, but you can
    charge a slightly different price
  • Differentiated products
  • Products are very similar, but you can tell the
    difference

45
Nonprice Competition
  • Competition through other ways than lowering
    prices
  • Can take different forms
  • Physical characteristics
  • Location
  • Service level
  • Advertising, image, status

46
San Francisco Restaurants
  • How can some charge such high prices and others
    have to charge similar prices to competition?

47
Other examples of monopolistic competition?
48
Advertising good or bad thing?
  • What are the arguments for?
  • Arguments against?

49
Price and Output
  • Demand curve for a monopolistic competitor will
    be slightly less elastic than a perfect
    competitor (b/c they will have some control over
    price)
  • It will definitely be more elastic less than a
    monopolist, though (a lot more competition than a
    monopolist)

50
Price and Output
  • To maximize profits, they will set output by
    producing up to where MC MR (any surprise?)
  • They will charge price off of the demand curve
  • NOTHING IS NEW HERE!!!!!

51
Profit
  • Monopolistically competitive firms do NOT earn
    huge profits
  • If they started earning profits well above their
    costs
  • 1strivals would think of new ways to
    differentiate and lure customers
  • 2ndnew firms will enter the market (offering
    cheap imitations)

52
Loss
  • If firms were losing money, some would definitely
    exit the industry (just as in perfect competition)

53
Price, Output, and Profits
  • Prices under monopolistic competition will be
    higher than in perfect competition.
  • However, prices will be lower than in a monopoly.
  • Why?

54
Output
  • Compared to perfect competition and monopolies,
    output will be less than that of a perfect
    competitor but much greater than that of a
    monopolist
  • So its somewhere in the middle!

55
Oligopoly! (The word no one can ever pronounce)
  • An oligopoly is a market structure that is
    dominated by a few, large firms
  • Price will be closer to that of a monopolist
    (higher than PC and MC) and output will be lower.
  • Example Pepsi and Coke

56
Barriers to Entry
  • Barriers for an oligopolist are pretty high

57
Cooperation and Collusion
  • Oligopolies often seem to work together to form a
    monopoly
  • Price war when competitors cut their prices
    very low to win business (good for us!)
  • Collusion an agreement among firms to set
    prices and production levels
  • Price fixing an agreement among firms to sell
    at the same or very similar prices

58
Cooperation and Collusion
  • Why would companies want to do this?
  • They can act as a monopoly and earn monopoly
    profits!

59
Cartels
  • These are even stronger than collusion.
  • They are agreements by a formal organization of
    producers to coordinate prices and production
  • They are illegal in the U.S.
  • Why might these not work very well all the
    time???? Well, lets see

60
GAME THEORY AN INTRO
  • In this game, you have two options You can play
    an A or you can play a B.

61
What will you do? Play A or B???
  • If both groups in the class play a B, then you
    both gain 5. If one group plays an A and the
    other group plays a B, the group who played A
    gains 10, while the group who played the B loses
    10. If you both play A, then you both lose 1.

62
PAY-OFF MATRIX
Group 1 Group 1 Group 1 Group 1
Group 2 Play A Play B
Group 2 Play A -1, -1 -10, 10
Group 2 Play B 10, -10 5, 5
63
Results!
Group 1 Group 2
Round 1 -1 -1
Round 2 -1 -1
Round 3 10 -10
Round 4 -1 -1
Round 5
Round 6
Round 7
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