market types

8/14/2019 market types

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Firm Supply:

Market Structure & PerfectCompetition


2/40

Firm Supply

x How does a firm decide how much to

supply at a given price? This

depends upon the firms goals;

technology;

market environment; and

competitors behaviors.


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Market Environment

x Are there many other firms?

x How do other firms decisions effect

the firms payoffs?


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Market Environment

x Monopoly: Just one seller that

determines the quantity supplied/the

market-clearing price.x Oligopoly: A very small number of

firms, the decision of each

influencing the payoffs of the other

firms.


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Market Environment

x Dominant Firm: Many firms, but one

much larger than the rest. The large

firms decisions affect the payoffs ofeach small firm. Decisions by any

one small firm do not noticeably

effect the payoffs of any other firm.


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Market Environment

x Monopolistic Competition: Many

firms each making a slightly different

product. Each firms output level issmall relative to the total.

x Perfect Competition: Many firms, all

making the same product. Each

firms output level is very small

relative to the total output level.


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Perfect Competition

Assumptions

x There are many buyers and sellers,

each firm is a price-taker

x Homogeneous productx Freedom of entry and exit

x Perfect information


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Perfect Competition

x What is the demand curve faced by

the firm?


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Perfect Competition

Q

P

Market Supply

Market Demand

pe


10/40

Perfect Competition

Q

PMarket Supply

pe

p

At a price of p, zero isdemanded from the firm.

Market Demand


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Perfect Competition

Q

P

Market Supply

pe

p

p

At a price of p the firm faces the entire

market demand.

At a price of p, zero isdemanded from the firm.

Market Demand


12/40

Perfect Competition

x Therefore, the demand curve faced

by the individual firm is ...


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Perfect Competition

Market

Supply

Market

Demand

Q

P

Firms Demand Curve

P

P* P*

y


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The Firms Short-Run Supply

Decision?

x Each firm is a profit-maximizer

x Each firm choose its output level by

solving

)()(max0

ycpyyy


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Decision?

What does the solution ys* look like?

)()(max0

ycpyyy


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Decision?)()(max

0ycpyy

y

(y)

yys*

0)()(

)( =yMCpdy

ydi

s

*

2

2

0)(

)( syyat

dy

ydii =

F.O.C.

S.O.C.


17/40


Decision?The first-order maximum profit conditionis

0)()( = yMCp

dy

yd

That is, MCp=

So at a profit maximum with ys* > 0, themarket price p equals the marginal

cost of production at y = ys*.


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Decision?P

y

pe

ys*y

At y = ys*,

p = MC

and MC

slopesupwards,

y = ys* is

profit-maximizing.

MCs(y)


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Decision?P

y

pe

ys*y

At y = y, p =MC and MC

slopes

downwards,y = y is

profit-

minimizing.

MCs(y)


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Decision?P

y

pe

y

So a profit-maximising

supply level

can lie onlyon the

upwards

sloping partof the firms

MC curve.

MCs(y)

ys*


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Decision?

x But not every point on the upward-

sloping part of the firms MC curve

represents a profit-maximum.

x The firm will choose an output level y

> 0 only if

)(yAVCp


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Decision?

x The firm will not supply any output if

)(yAVCp AVCs(y)

The firms short-run

supply curve


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Decision?

AVCs(y)

ACs(y)

MCs(y)

The firms short-run

supply curve

Shutdownpoint

P

y


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Short Run Market Supply Curve

P

Q

Market

Supply Curve

is the sum of

all the firmssupply

curves (MC)

S


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The Firms Long-Run Supply

Decision?

x The long-run is the circumstance in

which the firm can choose amongst

all of its short-run circumstances.

x How does the firms long-run supply

decision compare to its short-run

supply decisions?


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Decision?

x A competitive firms long-run profit

function is

x The long-run cost c(y) of producing y

units of output consists only of

variable costs since all inputs are

variable in the long-run.

)()( ycpyy


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Decision?

The firms long-run supply level

decision is to maximise,

)()( ycpyy


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Decision?

x Additionally, the firms economic

profit level must not be negative,

since the firm would exit the market

in that case. Therefore,

)(yATCp


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Decision?MC(y)

AC(y)

y

P


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Decision?MC(y)

AC(y)

y

P

p > AC(y)


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Decision?MC(y)

AC(y)

y

P

The firms long-run

supply curve


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Application: Tax Incidence In

Perfect Competition

Q

P

Market

Demand

Market

Supply

PC = PP

No tax: PC = PP


36/40


Perfect Competition

Q

P

Market

Demand

Market

Supply

PP

A tax is introduced.

PC

This is

the tax.


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Perfect CompetitionP

Market

Demand

Market

Supply

PP

The tax creates a wedge between the price firms

receive and the price consumers pays. The difference

is the tax.

PC

This is

the tax.


38/40


Perfect Competition

Q

P

Market

Demand

Market

Supply

PP

In the short run, the burden of the tax is shared (not

necessarily on a 50/50 basis) between consumers and

producers.

PC

This is

the tax


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Perfect CompetitionIn the short run,x The producers receives less for the

product.

x Some firms will continue to produceoutput at a loss once they are coveringtheir average variable costs.

x Some firms will experience losses and soexit the market.

x The supply curve shifts to the left and theprices consumers and producers faceincreases.


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Perfect CompetitionIn the Long Run,

x Consumers pay all of the tax (100%)

x Producers pay none of tax (0%)

x There are no firms making losses

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market types