Transcript Term 2 Chapter 6 Dynamics of Markets: Perfect Markets

Examination of the dynamics of perfect markets
with the aid of cost and revenue curves.
• Perfect competition
• Individual business and industry
• Market structure
• Output
• Profits
• Losses and supply
• Competition policies
Producer’s behaviour dependant on market structure.
Markets can be described as:
• Perfect competition
• Monopolistic competition
• Monopoly
• Oligopoly
Perfect competition: occurs when none of the
individual market participants are able to
influence the market price of a product.
a) Many buyers and sellers





Neither have market power
Both are tiny parts of the overall market
Sellers are price takers
Perfectly elastic demand
Excess supply/demand cleared
by price mechanism.
b) Complete freedom of entry and exit





Freedom to enter into and exit from market
No legal, financial or technological barriers
New firms enter when profits are high
Ensures efficient use of resources
No sunk costs
Sunk costs: a cost of production that the firm
cannot recover should they leave the industry. E.g.
advertising, product research, speciality equipment
etc.
g) Products are homogeneous
Homogeneous product: a similar or identical
product.
Buyers cannot distinguish between the products
Makes no difference where buyers buy from
At higher prices, buyers will go elsewhere
Lower prices – not maximising profits
g) Perfect information
 Buyers/sellers have full knowledge of current
market conditions & can buy from anywhere
without incurring additional transport costs.
g) No government intervention
 Markets are unregulated
h) No collusion between sellers
Each seller acts independently
Assumptions of perfect competition do not apply to
virtually all real-world markets.
• Some suppliers exploit
• Some businesses may have
eg.
major supermarkets
• Most markets full of
due to
as choices influenced by
where seller knows more
than buyer eg. market for second-hand cars!
Indicate whether the following statements are true or false:
a) For perfect competition to exist there must be many
sellers and a few large buyers. (1)
b) Being a price-taker implies that a producer has no market
power over the market price of the product. (1)
c) Under perfect competition, it is possible for the
individual producer to decide what the price of a product
must be. (1)
d) Under perfect competition, producers collude with one
another to influence the market price. (1)
e) It is easy for new firms to enter a perfectly competitive
market. (1)
Individual firm is a price taker
Demand curve also = to average revenue
Each
of outputrevenue
sold at(MR)
same
price.
(AR)unit
and marginal
curves.
Did you remember…
Quantity of fixed factors (eg capital) does not change as
output change, therefore, fixed costs do not change as
output changes.
No fixed costs in long run, as all the factors of production
are variable.
Quantity of the variable factors (labour) does change as
output changes, therefore, variable costs changes as
output changes.
• Short run: time period for which quantity of at
least one FOP is fixed
• Long run: time period when no quantities FOP
is fixed
• Total costs (TC) = Variable costs (VC) + Fixed
costs (FC)
• Fixed costs: do not change as output changes
• Variable costs: change as output changes
ATC = TC
Q
MC = ∆TC
∆Q
AFC = FC
Q
ATC = TC
Q
AVC = VC
Q
TR = P X Q
AR = TR
Q
MR = ∆TC
∆Q
2 units : TC = TR = R20.
TC >even
TR except
0-2 units.
Breaks
& makeatnormal
profit.
Because individual firms too small to influence
price – based on market price taken, they must
decide…
• should they continue production?
• how much should they produce to maximise
its profits?
Firms maximise profits when MR = MC
When MR > MC → profits increase
When MR < MC → profits decline
Profit-maximising
Average
Therefore
cost
at of
2 units:
output,
2 unitsTR=P=R10.
=TC
R10.
AtBreakeven
2 units,
MC
MR
AR
=AC
TR
TC = 2&units
normal
×= R10
profits
==R20.
made.
Normal profits: occur when total costs = total
revenue.
Minimum earnings required to prevent
entrepreneur leaving and applying factors of
production elsewhere.
Normal profit earned, Since
since all its costs, including
Profit
isEAt
maximised
where
MR
= P2
Q
This
2, break
AR
occurs
=not
Peven
2earn
=are
atAC
Q
(C
2 =
2) MC profit.
2 aka
point
As
AR
= AC,
the
firm
does
an
economic
self-employed
resources,
fully
covered.
0CTR
2also
E2Q=2 (TC)
2by
E22EQTR
2 (TR)
P
2 Xfound
Q=2 =0P0P
2Q
2 - TC
Can
TC
Cbe
0C
Economic profits: profit that a business makes
that is more than the normal profit.
Economic profit occurs when total revenue >
total costs.
AKA excess profit, abnormal profit, supernormal
profit or pure profit.
Economic profit earned – above breakeven
Profit isAtmaximised
MR
= P3
AtQ3This
Q, AR
3, AR
(P
) >atAC
)CMC
occurs
=point.
Pwhere
3 3and
AC
Q(C
3 =1=
1
0P3E3Q3 (TR) > 0C1MQ3 (TC)
===CP
13 X
Q
0C
TR
Xfound
Q33 == Profit
0P
ETR
3=
QC331-P1TC
Can TC
also
be
by13MQ
Difference
Economic
E3M
Economic loss: occurs when a firm makes less
than normal profit.
• I.e. price (AR) < AC
Profit isAtEconomic
maximised
where
MR
= P3
3, 3AR
occurs
= (P
Ploss
33)
and
=AC
CAC
Q
3 3(C
– =P3=)3CMC
3
AtQThis
Q
, AR
<at
0P3E3Q3 (TR) < 0C1MQ3 (TC)
TR
===CP
33 X
Xfound
Q
Q33 == 0C
0P
E=TR
3Q
Can TC
also
be
by33MQ
TC3
Difference
Economic
Loss
P333C-3ME
If a firm is making an economic loss,
should they leave the market?
Depends on average revenue (P)
relative to average VARIABLE costs.
If P < AVC, best to leave the industry.
Shut-down point: the point at which
P = AVC.
• Under perfect competition, there is freedom
of entry and exit.
• When firms make economic profit, more
producers enter market.
• Economic profits decrease until they become
normal profits.
• Now there’s no incentive to either enter/exit
the market.