Transcript Perfectly Competitive Markets
Lecture 2: Perfectly Competitive Markets Required Text: Chapter 2
Market Models
Market Structures
Four different types of market structure make up the basis of most economic modeling: Perfect Competition Monopoly Monopolistic Competition, and Oligopoly The last three types of markets are said to be imperfectly competitive markets .
Perfect Competition
A market is said to be perfectly competitive if There are many buyers and sellers, each with roughly the same market share. Thus, all buyers are sellers are price takers in the market All sellers sell identical ( homogenous ) goods Information freely about how to produce and use the good is available – all firms have access to technology One can become the seller or buyer with relative ease ( free entry and exit ) In a perfectly competitive market, firms compete with each other on production/procurement costs. In a perfectly competitive market, a firm’s marketing strategy focuses on the level and timing of sales
Perfect Competition
A perfectly competitive faces a horizontal demand curve, because as a price taker, it faces “a going price” for whatever amount it sells.
The going price is determined by levels of market demand and supply. A perfectly competitive firm has U-shaped average cost (
AC
) and marginal cost (
MC
) curves in the short-run Short run is the time period within which the fixed factor of production (i.e., plant size) cannot be adjusted. There is no fixed factor in the long run As a profit-making firm, it adjusts its output to equate its marginal cost (MC) to the going price Equilibrium condition:
MC = P = MR
Revenue of a Perfectly Competitive Firm
Total Revenue:
The amount of money received when the firm sells the product, i.e., Total Revenue = Price of the product
×
Quantity of the product sold
TR = P × Q
Since the firm is a price taker under perfect competition, it sells each additional unit of the product for the same price.
Average Revenue
= Total Revenue
/
Quantity sold
AR = TR/Q = P Marginal Revenue
= Additional revenue earned from selling an additional unit of the product.
MR = ∂TR/∂Q = P
Thus, for a competitive firm
AR = P = MR
Total Revenue: P×Q
TP = Q 0 10 25 50 70 85 95 100 101 95 85 P 3 3 3 3 3 3 3 3 3 3 3 210 255 285 300 303 285 255 TR 0 30 75 150 AR 0 3 3 3 3 3 3 3 3 3 3 MR 0 3 3 3 3 3 3 3 3 3 3 Total Revenue
350.00
300.00
250.00
200.00
150.00
100.00
50.00
0.00
0.00
20.00
40.00
60.00
Output
80.00
TR 100.00
120.00
Average Revenue: TR/
Q = P
TP = Q 0 10 25 50 70 85 95 100 101 95 85 P 3 3 3 3 3 3 3 3 3 3 3 210 255 285 300 303 285 255 TR 0 30 75 150 AR 0 3 3 3 3 3 3 3 3 3 3 MR 0 3 3 3 3 3 3 3 3 3 3
AR 3.50
3.00
2.50
2.00
1.50
1.00
0.50
0.00
0.00
20.00
40.00
60.00
Output
AR 80.00
100.00
120.00
TP = Q 0 10 25 50 70 85 95 100 101 95 85 P 3 3 3 3 3 3 3 3 3 3 3
Marginal Revenue: ∂TR/∂
Q = P
210 255 285 300 303 285 255 TR 0 30 75 150 AR 0 3 3 3 3 3 3 3 3 3 3 MR 0 3 3 3 3 3 3 3 3 3 3 MR
3.50
3.00
2.50
2.00
1.50
1.00
0.50
0.00
0.00
20.00
40.00
60.00
80.00
100.00
Output
120.00
MR
Profit Maximization by the Competitive Firm:
Approach I: Total Profit = TR – TC L 0 1 2 3 4 5 6 7 8 9 10 TP = Q 0 10 25 50 70 85 95 100 101 95 85 TR 0 30 75 150 210 255 285 300 303 285 255 TC 80 105 130 155 180 205 235 255 280 305 330 Profit
-
80 -75 -55 -5 30 50 50 45 23 -20 -75
350.00
300.00
250.00
200.00
150.00
100.00
50.00
0.00
0.00
20.00
TC, TR, & Profit
40.00
60.00
Output
TC TR 80.00
100.00
On the Diagram, the profit maximizing level of output is the level where the vertical difference between the TR and TC is the largest.
With P = $3/unit, profits are maximized by producing 95 units of output.
120.00
Profit Maximization by the Competitive Firm:
Approach I: Total Profit = TR – TC Input (L) 0 1 2 3 4 5 6 7 8 9 10 TP (Q) 70 85 95 100 101 0 10 25 50 95 AP (Q/L) 0.00
10.00
12.50
16.67
17.50
17.00
15.83
14.29
12.63
10.55
85 8.50
MP 10 15 25 20 15 10 5 1 -6 -10 TC 80 105 130 155 180 205 235 255 280 305 330 TR 0 30 75 150 210 255 285 300 303 285 255 Profit -80 -75 -55 -5 30 50 50 45 23 -20 -75
Max Profit Max Output
Profit Maximization by the Competitive Firm:
Approach II: MR = MC
Most managers do not make decisions looking at TR and TC. Most decisions are made at the “margin.” The output level that will maximize profit is determined by comparing the amount that each additional unit of output adds to TR and TC.
Recall, Marginal Cost (MC) represents additional cost from producing an additional unit of output; and Marginal Revenue (MR) represents addition to TR from selling (producing) an additional (one more) unit of output, which is equal to the price of that output.
Thus, MC and MR can be used to determine profit maximizing level of output.
Profit maximizing Condition: MR = MC
Profit Maximization by the Competitive Firm:
Approach II: MR = MC L 0 1 2 3 4 5 6 7 8 9 10 Q 0 10 25 50 70 85 95 100 101 95 85 TR 0 30 75 150 210 255 285 300 303 285 255 MR 3 3 3 3 3 3 3 3 3 3 TC 80 105 130 155 180 205 235 255 280 305 330 MC 2.50
1.67
1.00
1.25
1.67
3.00
5.00
25.0
-4.17
-2.50
Profit
-
80 -75 -55 -5 30 50 55 45 23 -20 -75
8.00
7.00
6.00
5.00
4.00
3.00
2.00
1.00
0.00
0.00
20.00
MR, MC, & Profit
40.00
60.00
Output
MR MC 80.00
100.00
120.00
The firm will continue to expand production until MR is equal to MC, i.e., profit is maximized when MR = MC.
With
P
being $3/unit, profits are maximized by producing 95 units of output.
Profit Maximization by the Competitive Firm:
Approach II: MR = MC Input (L) 0 1 2 3 4 5 6 7 8 9 10 TP (Q) 70 85 95 100 101 0 10 25 50 95 AP (Q/L) 0.00
10.00
12.50
16.67
17.50
17.00
15.83
14.29
12.63
10.55
85 8.50
MP 10 15 25 20 15 10 5 1 -6 -10 MC 2.50
1.67
1.00
1.25
1.67
3.00
5.00
25.0
-4.17
-2.50
MR 0 3 3 3 3 3 3 3 3 3 3 Profit -80 -75 -55 -5 30 50 50 45 23 -20 -75
Max Profit Max Output
P E D 0
When the Firm Should Produce?
AR = MR A Q B C Given price “
P
”, the
AR
and MR are given by the horizontal line at P.
Profit is maximized by producing
Q
level of output, where
MR = MC
.
TR is given by the area
PAQ0 TFC
is given by the area
EBCD TVC
is given by the area
DCQ0 TC
is given by the area
EBQ0
Profit is given by the area PABE
When the Firm Should Produce?
P 1 P 2 P 3 P 4 P 5 At P 1 , the firm is making profit At P2, the firm is at the break-even point At P3, the firm continues to produce to minimize loss At P4, the firm may continue to produce At P5, the firm will close down 0 Q 5 Q 4 Q 3 Q 2 Q 1 Thus, a profit maximizing firm will continue to produce as long as the price of the product is above the AVC.
Supply
Supply is a direct price and quantity relationship indicating how suppliers (producers, sellers, & mgrs) of a product respond to differing price levels.
It states what suppliers are WILLING and ABLE to supply at a given price.
Derivation of Supply Curves
Supply curve for the individual firm is based on the cost structure of the firm & how managers respond to alternative product prices as they attempt to maximize profits.
We discussed earlier that profit maximizing firms will shut down if the price of the product falls below the AVC.
This implies that the MC curve above AVC represents the firm’s supply curve.
P 1 Q 1
The Competitive Firm’s Supply Responses
The Competitive Firm’s Short-Run Supply Curve
Law of Supply
Price The Law of Supply says that the quantity of goods &/or services offered will vary DIRECTLY with the price.
P 3 P 2 Price increase will result in an increase in quantity supplied.
Price decrease will result in a decrease in quantity supplied.
P 1 The amount of increase or decrease, however, depends on the Elasticity of Supply.
Q 1 Q 2 Q 3 S Output
Firms and the Industry
A market always involves both buyers and sellers of a product or commodity.
It may involve only firms, as when farmers sell grains to elevators A firm is an individual business. The industry is made up of a set of firms competing in a particular market. Firm 1 + Firm 2 + … + Firm n = Industry
The Competitive Industry Supply Curve
The Competitive Industry and the Firm
A Rise in Marginal Costs
Why is the competitive environment important in marketing?
Marketing managers operate in REAL MARKETS. Competition is not the same in all markets Recognize opportunities and constraints of the environment Begin to understand firm choices Begin to understand competitive reaction