Pure Perfectly Competitive market ◦ Large number of small sellers ◦ Sellers produce homogeneous products ◦ Both buyers and sellers have full information ◦ Firms have no price setting power (price taker) ◦ New firms can freely inter into or exit from the market ◦ Firms are independent in decision making ◦ There is no government intervention Pure Monopoly market ◦ A single seller and many buyers ◦ The seller produce unique product ◦ The firm set price of its product (Price maker) ◦ Strict barriers to entry (no entry for new firm) ◦ There is government intervention through tax Monopolistically competitive market ◦ Large number of sellers (but not as large as perfectly competitive) ◦ Small sellers (but not as small as in perfectly competitive) ◦ Sellers produce heterogeneous (differentiated) products ◦ Firms have some price setting power ◦ Easy entry and exit (but not free) ◦ There is some government regulation ◦ Firms decision is interdependent to some extent Oligopoly market ◦ Few sellers and many buyers (few enough to know each other) ◦ Relatively large sellers ◦ Sellers produce either homogeneous or heterogeneous pdt ◦ Firms have price setting power ◦ There is barriers to entry ◦ Firms decision is interdependent Barriers to entry ◦ Exclusive ownership of strategic input ◦ Exclusive knowledge of techniques of production ◦ Economies of scale ◦ Merger of firms ◦ Government franchise and license ◦ Copy right and patent right Profit Maximization in a Perfectly Competitive market Short run Profit is the difference between sale and cost TR is the monetary value of total sale TR P.Q TC is the monetary value of inputs TC C (Q )
TR TC P.Q AC.Q because AC TC / Q So profit depends on P and Q How much price a competitive firm charges and how
much Q it produces to maximize its profit (ᴨ)?
Equilibrium Price In a perfectly competitive market price is set where
market demand equals market supply
A firm cannot charge higher or lower than the price If it tries to increase its price no one buys its product If it can sell any quantity at the market price why try to
decrease price A firm takes the equilibrium price and sells its product
at the set price
A demand curve that faces a firm is constant @ P Total Revenue Total revenue (TR) TR P.Q TR P.Q Average Revenue (AR) AR P Q Q dTR d ( P.Q ) P.dQ Marginal Revenue (MR) MR P dQ dQ dQ
ly ar ne Q is li ith e w u d en te ev la r re tal To Q Since P is fixed, a firm can make decision only on Q
Total Cost Cost curves are as we have discussed in chapter 4 Profit Maximizing Q There are Total Approach and Marginal Approach
to determine the level of output that maximizes
profit. Total approach (ᴨ=TR-TC) ◦ Q that maximizes the positive gap between TR and TC ◦ At that point MR=MC ◦ Positive profit is also known as abnormal (surplus) profit TC Zero profit getting firm
TR TC TR ᴨ
Q Q*
ᴨ • At that point MR=MC • Zero profit is also known as normal profit TC Negative profit getting firm
TR TC TR ᴨ
Q Q*
ᴨ • At that point MR=MC • Negative profit is also known as loss Example:- If in perfectly competitive market equilibrium price is 100, and if the total cost of a firm is TC 1/ 3Q 3 20Q 2 400Q 400 then find A) Profit maximizing Q B) What is the maximum profit? Solution A) TR TC P.Q TC 100Q (1/ 3Q 3 20Q 2 400Q 400) 1 3 Q 20Q 2 300Q 400 3 d F .O.C 0 dQ d Q 40Q 300 0 2
dQ Q 10 and Q 30 d 2 S .O.C 2 0 dQ d 2 2 2Q 40 0 dQ 2(10) 40 0 2(30) 40 0 20 0 20 0 B) What is the maximum profit? 1 3 Q 20Q 2 300Q 400 3 1 (30)3 20(30) 2 300(30) 400 3 400 Marginal Approach Q where TR TC ◦ MC=MR and F .O.C ◦ MC increasing is profit maximizing d dTR dTC 0 dQ dQ dQ MC MC MR MR MC 0 MR MC MR=AR=P S .O.C d 2 dMR dMC 2 0 Q* Q dQ dQ dQ 0 slope of MC 0 Slope of MC 0 Based on the position of AC relative to P, a firm may get - positive profit (if P>AC) - Zero Profit (if P=AC) - negative profit (if P<AC) A firm getting positive profit Unit Profit =AR-AC
MC MC Unit profit =P-AC
MR
AC ∏=TR-TC P=10 MR=AR=P ∏=PQ-AC.Q AC=8 ∏=Q(P-AC) ∏=20(10-8) Q=20 Q ∏=40 If the Price line cuts the AC curve at two points the firm gets positive profit A firm getting zero profit
the firm gets negative profit Why a firm cannot decrease price below the mkt P? If a firm tries to decrease P from the mkt P, then its
profit decreases Let for a positive profit getting firm market price is
P=10, but it tries to charge only P=8 @ mkt P=10
MC MC ∏=Q(P-AC) MR ∏=20(10-8) AC ∏=40 P=10 MR=AR=P @firm P=10 P=AC=8 ∏=Q(P-AC) ∏=18(8-8) 18 20 Q ∏=0
So the firm does not decrease price from the
market given price Getting negative profit does a firm continue operating the business? Yes! It may continue supplying its product as long as P>AVC even if it is negative profit However if price of the product is less than the minimum of the AVC, it stops operating Shutdown: Shutdown is a short run (temporary) stopping of supplying (operating business) In the short run, because there is/are fixed inputs, a firm cannot exit from the market Exit: In the long run a firm can permanently leave the market In the long run all inputs are variable so it is possible to sell its whole capital and exit from the market MC MC MR=P AC AC AVC P=17
P=14
P=9 MR=AR=P
P=6
P=5
12 14 16 18 20 Q Mathematical Example: If for a perfectly competitive firm the total cost
function is, TC 0.6Q 3 6Q 2 240Q 400
Then, find the shut down price
Solution TVC 0.6Q 3 6Q 2 240Q AVC 0.6Q 2 6Q 240 slope of AVC 1.2Q 6 0 Q5 Minimum ( price AVC ) 0.6(5) 2 6(5) 240 225 The short run supply curve is the MC above the minimum of AVC
