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Competitive Markets

Competitive Markets. Structure. Fragmented Undifferentiated Products : Homogeneous Perfect Information about Price Equal Access to Resources. Three Implication. Price Takers Law of one Price Free Entry & Free Exit. Profit Maximization. Profit Maximization Condition. TR. TR,TC. TC.

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Competitive Markets

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  1. Competitive Markets

  2. Structure • Fragmented • Undifferentiated Products : Homogeneous • Perfect Information about Price • Equal Access to Resources

  3. Three Implication • Price Takers • Law of one Price • Free Entry & Free Exit

  4. Profit Maximization Profit Maximization Condition

  5. TR TR,TC TC Profit 0 Q MC MR = P 0 Q MC > MR MC < MR MC = MR MC > MR

  6. Firm Industry Price Price AR = P = MR D Q Q

  7. Price MC AC A MR = P P1 Excess Profit AVC C B Q 0 Q

  8. Price AC MC A MR = P P1 AVC C Q 0 Q

  9. Price MC AC B AVC C Loss P1 A MR = P Q 0 Q

  10. Price MC AC B C AVC Loss A MR = P P1 Q 0 Q

  11. Price MC AC B C AVC Loss MR = P P1 A Q 0 Q

  12. Price MC AC P1 AVC P2 P3 P4 Shut Down Point Q 0

  13. Price MC AC P1 AVC P2 P3 P4 Shut Down Point Q 0 Firm’s Supply

  14. Example The Firm’s short run total cost curve is STC = 100 +20Q + Q2. The short run Marginal cost curve is SMC = 20 + 2Q If SFC = 100, while SVC = 20Q + Q2 Find AVC , Minimum level of average variable cost, supply curve

  15. Fixed Cost + Sunk Cost TFC = SFC + NSFC

  16. Price MC AC ANSC AVC B C P1 Minimum ANSC = P A Q 0 Q

  17. Example The Firm’s short run total cost curve is STC = 100 +20Q + Q2. The short run Marginal cost curve is SMC = 20 + 2Q If SFC = 36, while NSFC = 64 Find ANSC , Minimum level of average non sunk cost, supply curve

  18. Firms Market P P p Q Q Q1 Q2 Q1+Q2 Firm Supply and Market Supply

  19. P P S SAC P* D Q* Q D(P*) Q Short Run perfectly Competitive equilibrium

  20. The Market consists of 300 identical firms, and the market demand curve is given by D(P) = 60 – P. Each firm has a short run cost curve STC = 0.1 + 150Q2 , all fixed cost are sunk. The corresponding short run marginal cost curve SMC = 300Q. The corresponding average variable cost curve is AVC = 150Q. You should verify that the minimum level of AVC is 0. Thus, a firm will continue to produce as large as price is positive Find Short run equilibrium in market, at equilibrium, do the firm make positive profit?

  21. P P S SAC S’ P1 P2 D Q2f Q1f Q Q Q1 Q2 Comparative Statics in short run Increase in the number of firm

  22. Price MC2 SAC2 LMC MC1 P1 SAC1 LAC Quantity Q1 Q2 Long Run – Plant Adjustment

  23. Price LMC LAC P1 P2 P* Quantity Q* Q2 Q1 Long Run Supply Curve

  24. Price LMC LAC P1 P2 P* Quantity Q* Q2 Q1 Long Run Supply Curve

  25. Free Entry and Long Run 1. Long Run Profit is maximized with respect to output and plant size. P* = MC ( Q* ) 2. Economic profit is Zero. P* = AC ( Q* )

  26. P P LMC SMC S SAC LAC P* D D(P*) = n*Q* Q* Q Q Free Entry and Long Run 3. Demand equals Supply. D( P* ) = n Q*

  27. In this market, each firm and potential entrant has a long – run average cost AC( Q ) = 40 – Q – 0.01Q2. And a corresponding long run marginal cost curve MC( Q ) = 40 – 2Q + 0.03Q2. Where Q is thousand units per year. The Market demand curve is D( P ) = 25,000 – 1,000P, Where D(P) is also measured in thousand units. Find the long run equilibrium price, quantity per firm, and number of firms.

  28. P P LMC S SAC S’ LAC A P2 B P1 D’ D Q Q Q1f Q2f Q1 Q2 Long Run Market Supply Curve

  29. P P LMC S S’ LAC A P2 SL B P1 D’ D Q Q Q1f Q2f Q1 Q2 Industry Long Run Supply Curve Constant Cost

  30. Increasing Cost P P LMC2 S LMC1 LAC2 S’ LAC1 P2 P3 SL P1 D’ D Q2 Q Q Q1f Q2f Q1 Industry Long Run Supply Curve

  31. Problem 1 The bolt industry currently consists of 20 producers, all of whom operate with identical short run total cost function STC ( Q ) = 16 + Q2 Where Q is the annual output. The corresponding short run marginal cost curve is SMC ( Q ) = 2Q The market demand for the bolts is D ( P ) = 110 – P Where P is the market price

  32. a ) Assuming that all of the firm fixed cost is sunk, what is the firm’s short run supply curve? b ) What is the short run market supply curve? c ) Determine the short run equilibrium price and quantity in the industry.

  33. Problem 2 Propylene is used to make plastic. The propylene industry is perfectly competitive, and each producer has a long run marginal cost function given by MC ( Q ) = 40 – 12Q + Q2 The corresponding long run average cost function is AC ( Q ) = 40 – 6Q + (1/3)Q2 The market demand curve for propylene is D ( P ) = 2200 – 100P

  34. a ) What is long run equilibrium price in the industry? b ) At this price, how much would an individual firm produce? c ) How many firms are in the propylene market in long run competitive equilibrium. d ) Suppose the demand curve shifted so that it is now D ( P ) = A – 100P. How large would A have to be so that in the new long run competitive equilibrium, the number of propylene firms was twice what it was in the initial long run equilibrium?.

  35. Problem 3 The long run total cost function for producers of mineral water is TC ( Q ) = cQ Where Q is the output of individual firm expressed as thousand liters per year. The market demand curve is D ( P ) = a – bP Find the long run equilibrium price and quantity in term of a, b, c, . Can you determine the equilibrium number of firms? If so, what is it? Why not?

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