Market Structure: Perfect Competition. ï‚ Many buyers and sellers ï‚...
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Market Structure: Perfect Competition
Many buyers and sellersBuyers and sellers are price takersProduct is homogeneousPerfect mobility of resourcesEconomic agents have perfect knowledge
Diagrammatic representationCost/RevenueOutput/SalesThe industry price is determined by the demand and supply of the industry as a whole. The firm is a very small supplier within the industry and has no control over price. They will sell each extra unit for the same price. Price therefore = MR and ARP = MR = ARMCThe MC is the cost of producing additional (marginal) units of output. It falls at first (due to the law of diminishing returns) then rises as output rises.ACThe average cost curve is the standard U shaped curve. MC cuts the AC curve at its lowest point because of the mathematical relationship between marginal and average values.Q1Given the assumption of profit maximisation, the firm produces at an output where MC = MR (Q1). This output level is a fraction of the total industry supply. At this output the firm is making normal profit. This is a long run equilibrium position.
Perfect CompetitionDiagrammatic representationCost/RevenueOutput/SalesP = MR = ARMCACQ1Now assume a firm makes some form of modification to its product or gains some form of cost advantage (say a new production method). What would happen?AC1MC1AC1Abnormal profitQ2Because the model assumes perfect knowledge, the firm gains the advantage for only a short time before others copy the idea or are attracted to the industry by the existence of abnormal profit. If new firms enter the industry, supply will increase, price will fall and the firm will be left making normal profit once again.P1 = MR1 = AR1The lower AC and MC would imply that the firm is now earning abnormal profit (AR>AC) represented by the grey area.Average and Marginal costs could be expected to be lower but price, in the short run, remains the same.
Firms Demand Curve = Market Price= Marginal RevenueFirms Supply Curve = Marginal Costwhere Marginal Cost > Average Variable Cost
Total Profits = TR -TCd = d(TR) - d(TC) = 0 dQ dQ dQ MR - MC = 0MR = MCd(TR) = d(PQ) = P = MRdQ dQ
Losses and Shutdown Decision
Losses and Shutdown Decision
024681012012345678910MCATCAVC53.35Quantity per periodPrice, costper unitLosses and Shutdown DecisionC
024681012012345678910MCATCAVC53.35Quantity per periodPrice, costper unitLosses and Shutdown DecisionBC
MCATCAVC53.35Quantity per periodPrice, costper unitLosses and Shutdown DecisionABC
SPeCDP1QeQuantity per periodPrice per unitConsumer Surplus
P = 45 - 0.5QTC = Q3 - 8Q2 + 57Q + 2PROFIT MAXIMISATION
High degree of competition helps allocate resources to most efficient usePrice = marginal costsNormal profit made in the long runFirms operate at maximum efficiencyConsumers benefit
Single seller and many buyersNo close substitutes for productSignificant barriers to resource mobilityControl of an essential input (OPEC)Patents or copyrights (Medicines/drugs)Economies of scale at large output (China)Government franchiseAbnormal profits in long runPossibility of price discriminationPrices in excess of MC
Demand curve for the firm is the market demand curve
Firm produces a quantity (Q*) where marginal revenue (MR) is equal to marginal cost (MC)
P = a - bQ
TR = PQ = (a - bQ)Q = aQ - bQ2
MR = d(TR) = a - 2bQ dQ
MRDOQPMonopoly Short-Run Equilibrium
MCACMRDPmQmOQPMonopoly Short-Run Equilibrium
Q* = 500P* = $11
Q* = 700P* = $9
Encourages R&DEncourages innovationEconomies of scale can be gained consumer may benefit
Exploitation of consumer higher pricesPotential for supply to be limited - less choicePotential for inefficiency
Many sellers of differentiated (similar but not identical) productsLimited monopoly power (based on the uniqueness of their product)Dominoes : quick deliveryMaggi : 2 minutesDettol : HygienePerfect mobility of resourcesDownward-sloping demand curveIncrease in market share by competitors causes decrease in demand Easy entry and exitDifferentiated products : Advertising costs
Profit = 0
Cost without selling expensesCost with selling expenses
In Mumbai, the movie market is monopolistically competitive. The long run demand equation & AC is given P = 5 0.002Q AC = 6 0.004Q + 0.000001Q2
To maximize profits, what should be the price & Q. (Q = 1000 & P = 3)How much profit will the firm earn? (0)
Hyundai has taken Mahindra Renault to High Court objecting to Mahindras plan to launch a compact car with the name 'Sandero' alleging that Mahindra is trying to cash on its popular brand Santro.
Asian Paints (label "Utsav) vs Jaikishan Paints & Allied Products (label Utkarsh) with similar name, color, layout.
Few sellers of a productDuopoly - Two sellersPure oligopoly - Homogeneous productDifferentiated oligopoly - Differentiated productNon-price competitionBarriers to entryHigh degree of interdependence between firmsAbnormal profitsPotential for collusion?
Economies of scale (Exide: distribution, Walmart)Large capital investment required (Steel)Patented production processes (Drugs)Brand loyalty (Tata Salt) Control of a raw material or resource (Cement)Government franchise (Licenses)
CollusionCooperation among firms to restrict competition in order to increase profitsMarket-Sharing CartelCollusion to divide up marketsCentralized CartelFormal agreement among member firms to set a monopoly price and restrict outputExamples: OPECDe Beers
Firms can ask for an equitable distribution of profits.
Cartel members have a strong incentive to cheat by selling more.
Monopoly profits may attract other firms.