Competitive firms and Markets

1
Competitive firms and Markets

• Perloff chapter 8

2
Competition

• Firms are price takers.
• Firms demand curve is horizontal.
• Reasons for a horizontal demand curve
• Identical products from different firms
• Freedom of entry and exit
• Perfect knowledge of prices
• Low transaction costs.
• Where all conditions are satisfied Perfect
  Competition.

3
Profit

• p R C
• Definition of R straightforward.
• Costs
• Business profit includes only explicit costs,
  e.g. workers wages and materials.
• Owner doesnt take a salary, what remains is
  profit.
• Economic profit uses opportunity cost.
• Suppose profit was 20000 but you could earn a
  salary of 25000, what should you do?

4
Profit maximisation
p
, Profit
p

Profit
D
p
lt 0
p
gt 0
D
1
1
0
q

Quantity,
q
, Units
per day
Source Perloff
5
Output decision

• Produce where profit is maximised.

6
Profit maximisation
p
, Profit
p

Profit
D
p
lt 0
p
gt 0
D
1
1
0
q

Quantity,
q
, Units
per day
Source Perloff
7
Output decision

• Produce where profit is maximised.
• Produce where marginal profit is zero.
• Marginal cost equals marginal revenue.
• p(q) R(q) C(q)
• Marginal Profit(q) MR(q) MC(q) 0
• MR(q) MC(q)

8
Shutdown rule

• Shutdown if it reduces its loss.
• In the short-run, shutting down means revenue and
  variable costs are zero.
• It must continue to cover fixed costs.
• pR-VC-F2000-1000-3000-2000
• pR-VC-F500-1000-3000-3500
• Shutdown if revenue is less than avoidable cost.
• This rule is applicable in the long and short run.

9
Short-run output decision
Cost, revenue,
Thousand
Cost,
C
Revenue
4,800
MR


8
1
2,272
p

1,846

• MCMR
• Rpq
• MCp

426
p
(
q
)
p
426,000
100
0
284
140

100
q
me per year
, Thousand metric tons of li
p
, per ton
10
MC
AC
e
8
p

MR
426,000
p
6.50
6
284
140
0
q
, Thousand metric tons of li
me per year
10
Short run shutdown decision

• Shutdown if revenue less than avoidable cost.
• In short run avoidable costs are variable costs.

11
Short run shutdown decision
p
, per ton
MC
AC
b
6.12
AVC
6.00
A



62,000
p
5.50
e
B


36,000
5.14
5.00
a
q
, Thousand metric tons of lime per year
100
50
140
0
12
Short run supply curve of the firm
p
, per ton
S
e
4
p
8
4
e
3
AC
p
7
3
AVC
e
2
p
6
2
e
1
p
5
1
MC
q
215
q
285
q
50
q

140
0
3
4
1
2
q
, Thousand metric tons of lime per year
13
Industry SR supply curve with 5 identical firms
(a) Firm
(b) Market
p
, per ton
p
, per ton
3
2
7
7
S
S
1
1
S
S
4
S
6.47
6.47
AVC
5
S
6
6
5
5
MC
140
50
175
0
150
50
250
700
0
200
100
q
, Thousand metric tons
Q
, Thousand metric tons
of lime per year
of lime per year
14
Industry SR supply curve with 2 different firms
p
, per ton
2
1
S
S
S
8
7
6
5
100
140
165
215
315
450
25
50
0
q
,
Q
, Thousand metric tons of lime per year
15
SR equilibrium in the market
(a) Firm
(b) Market
p
, per ton
p
, per ton
8
8
S
1
S
1
D
e
1
7
7
E
6.97
1
AC
A
B
2
D
6.20
6
6
AVC
C
5
5
E
e
2
2
q

215
q

50
Q
1,075
Q
250
0
0
1
2
1
2
q
, Thousand metric tons
Q
, Thousand metric tons
of lime per year
of lime per year
16
Supply curve of the firm in the long-run
p
, per unit
SR
S
LR
S
LRAC
SRAC
SRAVC
p
35
B
A
28
25
24
20
LRMC
SRMC
50
110
q
, Units per year
0
17
Long run adjustment of the industry

• All factors are variable.
• Entry and exit are possible.
• Entry occurs with positive long-run profits
• Exit occurs with long-run losses
• Identical firms
• All firms make a loss when Pltmin(LAC), industry
  supply is zero.
• All firms make a profit if Pgtmin(LAC), number of
  firms is indeterminate. Note that elasticity of
  the industry supply curve increases with the
  number of firms.

18
Long run industry supply curve
(a) Firm
(b) Market
p
, per unit
p
, per unit
S
1
LRAC
Long-run market supply
10
10
LRMC
0
150
0
Q
, Hundred metric tons of oil per year
q
, Hundred metric tons of oil per year
19
Upward sloping long run industry supply curve

• Limited entry
• New firms cannot enter because of legislative
  control.
• New firms only enter when profits exceed the
  costs of entry.
• Firms differ
• Minimum LAC is lower for some firms than others.
• Number of low LAC firms is limited.
• Input prices vary with output
• Increasing cost (firms in one industry account
  for much of the supply of a particular input).
• Decreasing cost (economies of scale in the input
  supplier)

20
Differing firms the LR supply curve for cotton
Price, per kg
Iran
S
1.71
United States
1.56
Nicaragua, Turkey
1.43
Brazil
1.27
Australia
1.15
Argentina
1.08
Pakistan
0.71
0
1
2
3
4
5
6
6.8
Cotton, billion kg per year
21
Increasing cost industry
(a) Firm
(b) Market
p
, per unit
p
, per unit
2
MC
1
MC
2
AC
S
1
AC
e
E
2
2
p
2
e
E
1
1
p
1
q
q
Q

n
q
Q

n
q
q
, Units per year
Q
, Units per year
1
2
1
1
1
2
2
2
22
Decreasing cost industry
(b) Market
(a) Firm
p
, per unit
p
, per unit
1
MC
2
MC
1
AC
2
AC
e
E
1
1
p
1
e
E
2
2
p
2
S
q
q
Q

n
q
Q

n
q
q
, Units per year
Q
, Units per year
1
2
1
1
1
2
2
2
23
Long run competitive equilibrium
(a) Firm
(b) Market
, per ton
p
, per ton
1
2
D
D
MC
AC
SR
S
f
F
AVC
2
2
11
E
11
LR
S
2
10
10
e
E
F
f
1
1
1
7
7
100
0
150
165
1,500
0
2,000
3,300
3,600
q
, Hundred metric tons
Q
, Hundred metric tons
of oil per year
of oil per year
24
Profit in the long run

• Free entry
• Entry occurs to the point where profits are zero
• No profit in long-run equilibrium
• Economic profit is revenue minus opportunity
  cost.
• Restricted entry
• Entry is often limited because of a limited
  quantity of an input eg. land.
• Profits become rent.

25
Economic Rent
p
, per bushel
MC
AC
(including rent)
AC
(excluding rent)
p

p

Rent
q

q
, Bushels of tomatoes per year