1. Many buyers and sellers in the market

2. Buying and selling nearly identical goodsand services

3. Firms can freely enter and exit the market

wheat

dowels direct cremations

Competitive Markets

memory

Characteristics of Perfectly Competitive Markets

modules

D

Pe=75

S

PMM

QMM (thou. per year)

Qe

DWDP=75

PMM

QMM

Market for Memory Modules

Demand for Western Digital

Memory Modules

Individual firms are price-takers

Too small to ΔS

quickly switch if P Consumers would

(millions per year)

Western Digital Memory Modules

Total Revenue (TR) = Price (P) * Quantity (Q)

Being a price-taker, WD can’t change

Hence, ΔTR = P * ΔQ

Dividing both sides by ΔQ yields

ΔTR

ΔQ= P

Marginal revenue (MR)—the additional revenue from selling one additional unit

For perfectly competitive firms, MR equals price (not true for firms in less than competitive markets).

Cost Curves of Parsons’ Mill

ATC

AVC

MC

Cost($ per bundle)

Quantity (bundles of dowels per day)

ATC reaches its minimum

where MC=ATC

Dist=AFC, which is larger at lower Q

2.80

1.25

125 142

ATC

AVC

MC

Cost($ per bundle)

Quantity (bundles of dowels per day)

2.80

1.25

125142

D$4

SPD

QD

If , what is QπMax ?

4.00

Q’

MR=P>MC(Q’)

QπMax

Δπ from Q from Q=142 to QπMax

Hence, the profit maximizing output level (QπMax) occurs where MR=MC.

If MR > MC then firms can econ π by Q

(=P for perfectly competitive firms)

If MR < MC then firms can econ π by Q

(=P for perfectly competitive firms)

For perfectly competitive firms, QπMax occurs where MR=P=MC.

ATC

AVC

MC

Cost($ per bundle)

Quantity (bundles of dowels per day)

2.80

1.25

125 142

PMKT=4.00

To find QπMax for perfectly competitive firms, go from PMKT over to the MC curve and down.

QπMax≈ 155

ATC

AVC

MC

Cost($ per bundle)

Quantity (bundles of dowels per day)

QπMax≈ 155

PMKT=4.00

To find average total cost, go from QπMax up to the ATC curve and over to the vertical axis

ATC(Q=155)

ATC

AVC

Cost($ per bundle)

Quantity (bundles of dowels per day)

QπMax≈ 155

PMKT=4.00

ATC(Q=155)

A

B

Total Revenue = PMKT* QπMax

Height of rectangle A+BBase of rectangle A+B

= area A+B

Total Cost = ATC(Q=155) * QπMax

MCEcon π = TR − TC = area A

= area B

ATC

AVC

Cost($ per bundle)

Quantity (bundles of dowels per day)

Suppose PMKT=$2

QπMax

PMKT=2

ATC(QπMax)

MC

AVC(QπMax)

A

B

C

TR=B+CTC=A+B+CEcon Losses= A

Because TR=B+C > TVC=C by B, which can be applied against the TFC of A+B. Shutting down would produce econ losses = TFC

If Parsons’ Mill is suffering econ losses, why does it produce in the short-run?

AFC(QπMax)

MC

Cost($ per bundle)

Quantity (bundles of dowels per day)

PSD=1.25

125

P<PSD

shutdown

P>PSD

Produce where P=MC

TR<TVC at all Q>0

ATC

AVC

SShort-run

Supply curve of a perfectly competitive firm equals the MC curve above the shutdown price.

“A year after Lewontin was fired, Parsons closed the mill.”

D

Pe

S1

PD

QDQe

Market for Wooden Dowels

Saunders with dowelsJosh

North Waterford, Maine

Parsons’ Mill

QD(millions…) (thous…)

1

1 QπMax

ATC

AVC

MCShort-run produce b/c P > min AVCLong-run exit b/c econ losses

S2

Pe2

Qe2

D

PD

QD

Market for Wooden Dowels

QD(millions…) (thous…)

QπMax

ATC

AVC

MCS2

Pe2

Qe2

Reaching Long-Run Equilibrium

Typical Mill: Econ π < 0

Some Mills Exit in LR

Supply P until Typical Mill’s econ π = 0

Pe2

= min ATC

SLong-Run

SUPPLY CURVE IN A COMPETITIVE MARKET

The Supply Curve of an Individual Firm

Short-run: the MC curve above AVC

Market Supply = ∑Individual Supply Curves

PD

QD

Parsons’ Mill

SP’

QPM

PD

QD

Saunders’ Brothers

SP’

QSB

• • •

PD

QD

Market

SP’

(QPM+QSB+ • • •)

Let’s call it a Premium Club (PC)

Known within the health club industry as a (no-frills) keycard club (KC)

“You typically won't see space-intensive amenities such as pools, racquetball courts or steam rooms at [keycard clubs]. Some don't even have locker rooms. Instead what you'll find is a surplus of cardio machines in a small space and 24-hour access.”

Smaller Gyms Show MuscleLower-cost chains may be financially fitter for expansion

The “popularity” of the keycard clubs “is soaring as the recession drives people to spend less. And the newer gyms have emerged against a backdrop of shifts within the industry, including bankruptcy filings by some of the [premium gyms].

Average Total Cost($ per month)

ATC

PCATC

KC

Pennsylvania Hospital University of Pennsylvania Hospital

Point-to-Point Carrier Hub Carrier

Hubs

Suppose the markets for keycard clubs (KC) and premium clubs (PC) were in equilibrium prior to the recent recession. Illustrate the effect of the recession on these markets and describe the long-run adjustment process.