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Econ 1900 Laura Lamb
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1. Perfect competition
2. Monopolistic competition
3. Oligopoly
4. Pure Monopoly
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What are the major characteristics of each market model?
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Large number of firms
Standardized products
Price takers
Easy entry & exit of firms
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Then why do we study it?
◦ helps analyze industries with characteristics similar to perfect competition.
◦ provides a context in which to apply revenue and cost concepts developed in previous chapters.
◦ provides a norm or standard against which to compare and evaluate the efficiency of the real world.
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Demand is perfectly elastic for each firm◦ Not for the industry◦ Individual firms can sell as much as they want at
the market price
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Average Revenue
Total Revenue
Marginal Revenue
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Product price Quantity Demanded
Total Revenue Marginal Revenue
8888888
0123456
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1. Compare total revenue & total cost
2. Compare marginal revenue & marginal cost
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Consider the Maple Syrup Market: The North American maple syrup market
produces nearly 30 million litres/year. More than 80% is produced in Canada. The number of firms can only be estimate because some are very small and sell their output in a small local market. There are about 9,500 producers in Canada & about 2,000 in the US.
Maple syrup is not quite a standardized good,
but is close. At the wholesale level, the market is highly competitive and a good example for perfect competition.
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Total Revenue & Total Cost Schedule for Dave’s Maple Syrup
Quantity (cans/day)
Total Revenue ($/day)
Total cost ($/day)
Economic profit($/day)
01234567891011121314
081624324048566472808896
104112
15222730323334363944516076
104144
-15-14-11-607142025282928200
-3211
Where is the break-even point?
How do we describe the profit at this point?
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MR = MC rule: in the short run, a firm will maximize profit by producing at the output level where MR = MC.
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Quantity (cans/day)
Total Revenue$/day
MR$/day
Total Cost$/day
MC$/day
Economic Profit
8
9
10
11
12
64
72
80
88
96
8
8
8
8
39
44
51
60
76
5
7
9
16
25
28
29
28
20
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***The MR=MC rule is applicable to all market models***
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Note: for perfectly competitive firms: MR = MC is equivalent to P= MC
Why?
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1. If average cost is $8/can, what is the economic profit?
2. Suppose the price dropped from $8/can to $6/can, how would the profit maximizing level of output change?
3. Now suppose, the price drops to $4/can. How much should Dave produce?
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Quantity (cans/day)
Total revenue
($/day)
MR ($/day) Total cost
($/day)
MC ($/day) Economic profit
(TR-TC)
7
8
9
10
11
12
28
32
35
40
44
48
4
4
4
4
4
36
39
44
51
60
76
3
5
7
9
16
-8
-7
-8
-11
-16
-28
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If a loss is incurred, the firm should continue to produce as long as the price is greater than average variable cost (AVC).
Modified rule: MR = MC if P>minimum AVC
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In the example of Dave’s Maple Syrup: when P=$8, quantity supplied = 10 when P=$4, quantity supplied = 8
◦ appears rational in light of the law of supply!
◦ The short-run supply curve is the section of the MC curve starting at minimum AVC (and above).
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In what situations would the supply curve for the firm shift?
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Quantity supplied by 1 firm
Total quantity supplied by 1000 firms
Product price Total quantity demanded
10865
10,0008,0006,0005,000
8421
3,0005,0006,00010,000
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Is the industry profitable at the equilibrium?
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1. The firm should produce is P≥minimum AVC
2. The firm should produce the quantity at MR=MC
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Individual firms must take price as given, but the supply plans of all competitive producers as a group are a major determinant of product price.
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Assumptions:1.Entry and exit of firms are the only long‑run
adjustments 2.Firms in the industry have identical cost
curves.3.The industry is a constant‑cost industry
the entry and exit of firms will not affect resource prices or location of unit‑cost schedules for individual firms.
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**In the long run, product price = minimum ATC
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If P>minimum ATC →economic profits will attract new firms to the industry →increased supply of the product →price is driven down to minimum ATC.
If P<minimum ATC →economic losses will cause some firms to leave the industry →decreased supply of the product →price is driven up to minimum ATC.
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A change in consumer tastes increases the demand for product
trace the steps to a new long-run equilibrium
Illustrate with two graphs, one for the firm and one for the industry.
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Household income decreases causing a fall in demand for the product.
trace the steps to a new long-run equilibrium
Illustrate with two graphs, one for the firm and one for the industry.
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**In the long run, equilibrium price & quantity always occur where ATC is at a minimum for a perfectly competitive firm.
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The product price will be exactly equal to each firm’s point of minimum average total cost.
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Perfectly elastic ◦ Level of output does not affect price in the long-
run.
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Upward sloping as industry expands output.
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Downward sloping as the industry expands output.
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In the long run:◦ Productive efficiency occurs where P = minimum
ATC
◦ Allocative efficiency occurs where P = MC allocative efficiency implies maximum consumer and
producer surplus.
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When a pharmaceutical company introduces a new drug, it typically owns the patent and can price and produce as a monopolist, earning economic profits.
When patent rights expire, firms pursuing economic profits enter the market for that drug.
Prices of these drugs typically drop 30-40 percent. ◦ Those lower prices increase efficiency and consumer
surplus.
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