Microeconomics I

Microeconomics IUndergraduate Programs

Fernando Branco

2006-2007Second Semester

Sessions 5&6

Microeconomics I Undergraduate Programs

2006-2007 • Second Semester • Session 5&6 ©Fernando Branco

Perfect competition

A perfectly competitive market is characterized by:– Many sellers and buyers (“small”);

– Products are perfect substitutes (homogeneous);

– Agents have perfect information relative do products and prices;

– There are no transaction costs;

– There is free entry and exit.



Market demand and firm demand

Clients will want to buy from the lowest cost seller.

P

Q

P m

D Market

D i



How much does a firm want to supply in the market?– It depends on the market price.

The firm chooses the quantity to maximize its profits:

)(Max qCpq )(qCMgp

The second order condition requires that the marginal costs are increasing.

Firm’s supplyand marginal costs



Firm’s supply:short run and long run

In the short run:– There is supply only if the price exceeds the

average variable cost.

In the long run:– There is supply only if the price exceeds the

average (total) cost.



The market equilibrium in the short run results from the intersection of supply and demand:

q

pSSi

D

p*

qi* q*

Market equilibrium: short run



The market equilibrium in the long run depends on the productive structure only.

q

CS (MC)

ACp*

qi*

The demand determines the number of active suppliers only.

Market equilibrium:long run



Properties of the equilibrium

The equilibrium in a competitive market allows for efficient transactions:

– P=MC;

– Global surplus is maximized;

– In the long-run, the average cost is minimized.



Comparative staticsin the equilibrium

What is the impact on the equilibrium if the demand expands?

What is the impact on the equilibrium if the price of an input increases?

What is the impact on the equilibrium if there is a technological innovation that reduces costs?



Monopoly market

A single firm serves the “relevant market”:– There are no close substitutes;– Monopolies are often “local” monopolies.

The demand of the market is the same as the demand of the firm.

The firm has control over the price:– But the price charged determines the quantity

sold.



Sources of monopoly

Entry barriers;

Economies of scale;

Economies of scope.



How much should the firm sell?

The firm chooses a quantity to maximize its profit:

)(Max qCP(q)q )()( qCMgqRMg

The monopolist’s decision

Graphical analysis.

The impact of fixed costs.

Why not a supply curve?



Q

P, C

DAC

MR

MC

P*

Q*

The monopolist’s decision: a graph



Q

P, C

P*

Q*

AC

DMR

MC

Q

P, C

AC

DMR

MC

P*

Q* Q

P, C

AC

DMR

MC

P*

Q*

The fixed costs



Q

P, C

D1

D2

MC

P2*

Q*

P1*

Why not a supply curve?



Topics in the monopoly

A monopolist with two-plants:

Price discrimination:– Perfect price dicrimination (first-degree);– Second-degree price discrimination;– Third-degree price discrimination:

• The monopolist with two markets.

BA MCMCMR



How much to produce in each plant?

)()()(Max BBAABABA qCqCqqqqP

BABA MCMCpqqdQ

dP

Equalize the marginal cost in each plant. Graphic analysis.

Monopolist with two plants



Q

P, C

D

RMg

CMg

CMg1

CMg2

Q1*Q2* Q*

P*

Monopolist with two plants: graphic



Perfect price discrimination

What if the monopolist could charge different prices for different transaction?– The monopolist could charge a price per

transaction: • exactly the amount that the buyer would be willing to

pay.

The volume of transactions would be maximzied;

The monopolist would get the full surplus.



Q

P

Q3Q2Q1

P1

P2

P3

CMg

Q

P

P1

P2

P3

P4

P5

P6

P7

Q1 Q2 Q3 Q4 Q5 Q6 Q7

Increasing discrimination



Second degree price discrimination

Discrimination for several types of buyers.

Examples:– Discounts, two-part tariffs, blocks.

The monopolist increases the profit and the quantity transacted.



Third-degree price discrimination

Charge different prices in different markets.

Example of a monopolist with two-markets:

– Marginal revenues are equalized.

MCMRMR BA



Many buyers and sellers Firms produce differentiated goods:

– Each has close substitutes. Free entry and exit.

Product demand and entry. In the short-run, behave as a monopolist. In the long-run, demand adjusts and monopolist has zero profit.

Monopolistic competition



Firms’ decisions

Each firm maximizes profits as monopolists do:

)();(Max iiiiii qCqnqP

It is important to distinguish between the short-run (fixed n) and the long-run (n varies).– In the long-run demand adjusts so that:

npqi

iii

iip

qMCp

;,

1)(

ii ACp

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Microeconomics I