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Lecture 4(a) Competition and Monopoly

Lecture 4(a) Competition and Monopoly. 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.

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Lecture 4(a) Competition and Monopoly

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  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 (we’ll have to think more carefully about exactly what this means later).

  4. Firm Demand Market Demand P Q Firm Demand is Perfectly Elastic (that is, firms are price takers)

  5. All This Really Means Is That MR=P • This makes perfect sense: the firm doesn’t 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. Firm Demand Short Run Equilibrium Part I: How Much Does a Typical Firm Produce?(Obvious Answer: The q such that MC=MR=P MC P q

  8. Market Supply With N Firms Firm Demand MC Po P1 q1 Nq1 Nqo Short Run Equilibrium Part II: Short Run Supply The “supply curve” is really just areflection of MC qo

  9. Market Supply With N Firms Firm Demand Po Nqo 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 • P=MR=MC • “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. Market Supply With N Firms Firm Demand Po Nqo This Can’t Happen in the Long Run Supply Positive Profits AC MC Demand qo

  13. Market Supply With N Firms Firm Demand Po Nqo So What Would Happen in the Long Run With Positive Profits? Supply Positive Profits AC Entry and Lower Price MC Demand qo

  14. Firm Demand 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. Firm Demand 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 • P=MR=MC • “Market Clearing Prices” (i.e., Quantity Demanded = Quantity Supplied) • No (economic) profits or loss (P=ACmin)

  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)

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