chapter 09 posted

7/30/2019 Chapter 09 Posted

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Chapter 9

Competitive Markets

Copyright 2011 Pearson Canada Inc.


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The Significance of Market Structure

1. Understand behaviour of an individual firm

2. Evaluate overall efficiency of market outcomes

In this chapter we focus on competitive market structures.

!

Firms: maxProfits = TR TC

Individual firm demand curve industry demand curve From the industry demand curve we can infer firms

demand curve

9.1 Market Structure and Firm Behaviour


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Copyright 2011 Pearson Canada Inc..

Different market structures


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Competitive Market Structure

The competitiveness of the market the influence thatindividual firms have on market prices.

The less power an individual firm has to influence the market

price, the more competitive is that markets structure.

Zero market power:

! Extreme form of competitive market: perfectly

competitive market

! Firms able to sell as much as they want at theprevailing price.


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Competitive Behaviour

The term competitive behaviour refers to the degree to whichindividual firms actively vie with one another for business.

Examples:

1. GM and Toyota engage in competitive behaviour but theirmarket is not competitive.

2. Two wheat farmers do not engage in competitive behaviourbut they both exist in a very competitive market.


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9.2 The Theory of Perfect Competition

The Assumptions of Perfect Competition

1. All firms sell a homogeneous product.

2. Customers know the product and each firms price.

3. Each firm reaches its minimum LRAC at a level of outputthat is small relative to the industrys total output.

4. Firms are free to exit and enter the industry.

1, 2 and 3 imply that the firm is price taker.


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The Demand Curve for a Perfectly Competitive Firm

Quantity (Millions of Tonnes)

Pr

ice

D

S

D (Firm)

Quantity (Thousands of Tonnes)

Pr

ice

Each firm in a perfectly competitive market faces a horizontaldemand curve even though the industry demand curve isdownward sloping.


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This does not mean the firm could actually sell an infiniteamount at the market price.

" Normal variations in the firms level of output have a

negligible effect on total industry output.


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Why Small Firms Are Price Takers

Consider an individual wheat farmer and the world market for wheat:

1. Market elasticity of demand for wheat = 0.25. If price decreases10%, quantity demanded increases 2.5%

2. 2009: total world production wheat = 650 millions tonnes

3. Canada: 20 000 wheat farms. Each 1200 tonnes. Each farmproduces 0.0002% world wheat crop.

4. If a farmer increases production by 200%. The percentage increasein world output (2400/650 million) X 100 = 0.0004%! worlds price

decreases by 0.0016%

5. Farms own demand curve has an elasticity of 200/0.0016= 125 000,enormous!


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1. Explain what would happen if the individual firm tried to charge ahigher price for its product.

2. Explain why the individual firm has no incentive to charge a lowerprice for its product.

3. Explain why the demand curve for an individual firm is horizontal atthe current market price.

Review the following figure and answer the following questions:

Quantity (Millions of Tonnes)

Pr

ice

D

S

D (Firm)

Quantity (Thousands of Tonnes)

Pr

ice


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Total, Average, and Marginal Revenue

Total revenue (TR):

TR = p x q

Average revenue (AR):AR = (p x q)/q = p

Marginal revenue (MR):

MR = !TR/!q = p

Note: For a perfectly competitive firm,AR= MR=p.


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Price Quantity TR=p x q AR= TR/q MR=!

TR/!

q3333

10111213

30333639

3333

333

3

Dolla

rsperUnit

Output

AR = MR = p

TR

Output

Dollars

10 13

3039

10


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9.3 Short-Run Decisions

Should the Firm Produce at All?

The firm will not produce if:TVC of producing that output > TR of selling the outcome

If produces something! fixed costs + variable costs

If produces nothing! fixed costs


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Should the Firm Produce at All? Table 9.1

-80500-380200580200380100

-70450-34018052020032090

-60400-30016046020026080

-50350-26014040020020070

-60300-24012036020016060

-80250-23010033020013050

-110200-2308031020011040

-150150-2406030020010030

-180100-240402802008020

-20050-230202502005010

-2000-200020020000

ProfitTRProfitTRTCTFCTVCQHigh price $5Low price $2


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Suppose p > AVC" firm does not shut down

When firm decides to increase production in 1 unit, then

for each extra unit the firms has to contemplate:

If MR>MC! produce more q

If MR=MC!

no incentive to change qIf MR


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Profits= TR TC

= (p x Q) (ATC x Q)

= (p - ATC) x Q

! Profit per unit = p ATC

But how large are each firms profits in this SR equilibrium?

! There are three possibilities: positive, negative or zero

Short-Run Equilibrium in a Competitive Market


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MC

q*

Output

DollarsperUnit

p

ATC

Case 1: Zero Economic Profits

The typical firm isjust covering its

costs,p = ATC.

There is zeroeconomic profit.


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Case 2: Positive Economic Profits

Typical firm maximizesprofit at q*.

Sincep > ATC, the firmmakes positiveeconomic profits equalto the blue area.

Positive profits means that this firm is earning more than itcould in its next best alternative venture.

MC

q* Output

p

ATC


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LRAC

SRATC

MC

DollarsperU

nit

p0

q0 qM

Price

Output

In LR equilibrium,competitive firmsproduce at theminimum point ontheir LRAC curves.

At q0, the firm ismaximizing short-run profits but notits long-run profits.

Short-Run versus Long-Run Profit Maximization for a

Competitive Firm

9.4 Long-Run Decisions


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How about negative profits, and exit?


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Long-Run Equilibrium

The LR industry equilibrium occurs when there is no longerany incentive for entry or exit (or expansion).

In long-run equilibrium, all existing firms:

must be maximizing their profits.

are earning zero economic profits.

are at the minimum point of its LRAC: are not ableto increase their profits by changing the size oftheir production facilities.


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Consider a competitive industry that is in long-run equilibrium.Now suppose that the market demand for the industrysproduct increases

The price will rise, and profits will rise. Entry will then occur,and price will eventually fall.

But what will happen to the LRAC? What will the new long-runequilibrium look like?

The Long-Run Industry Supply Curve


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