Upload
lyquynh
View
220
Download
2
Embed Size (px)
Citation preview
College of Education
School of Continuing and Distance Education 2014/2015 – 2016/2017
ECON 101
Introduction to Economics1
Session 11 –Market Structures(Perfect Competition)
Lecturer: Mrs. Hellen A. Seshie-Nasser, Department of Economics Contact Information: [email protected]
Session Overview
• The conditions of the market that firms operate in influence the behavior of firms.
• The influence of the market depends on the nature of the product involved and the number of firms competing for market share.
• This session provides analysis of the competitive market and its influence (combined with costs) on the behavior of firms operating in this market structure.
Slide 2 Mrs. Hellen Seshie-Nasser, Dept .of Economics,
University of Ghana
Session Objectives
• At the end of the session, the student should be able to: – Understand the competitive market structure. – Identify and explain the assumptions/characteristics of the
competitive market – Understand the competitive firm – Understand how price and output is determined in the competitive
market. – Understand how the firm is a price-taker. – Be able to calculate Total Revenue, Average Revenue and Marginal
Revenue of the firm. – Understand equilibrium of the firm and how a competitive firm
determines its output. – Have a good understanding of the graphical determination of
profit-maximizing output by the firm. – Understand short and long run profitability of the competitive firm.
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 3
Session Outline
The key topics to be covered in the session are as follows:
• The Competitive Market (characteristics)
• Price determination in the Competitive Market
• Production Decisions and Profit Maximization/Equilibrium
• Profit in the Short Run
• The Firms short run decision to shutdown
• The competitive firms’ supply curve
• Profit in the long run
Slide 4
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Reading List
• Lipsey R. G. and K. A. Chrystal. (2007). Economics. 11th Edition. Oxford University Press.
• Bade R. and M. Parkin. (2009). Foundations of Microeconomics. 4th Edition. Boston: Pearson Education Inc.
• Begg. D. Fischer S. and R. Dornbusch. (2003). Economics. 7th Edition. McGraw-Hill .
Slide 5
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Market Structures
• Market is normally defined as a group of firms and buyers in touch with each other to buy or sell goods for services.
• Market structure refers to the conditions under which competition occurs in a market.
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 6
What is a Competitive Market?
• A perfectly competitive market has the following characteristics:
– There are many buyers and sellers in the market.
– The goods offered by the various sellers are largely the same/homogeneous. E.g. Sachet water
– Firms can freely enter or exit the market.
– There is perfect information / knowledge in the market
• As a result of its characteristics, the perfectly competitive market has the following outcomes:
– The actions of any single buyer or seller in the market have a negligible impact on the market price.
– Each buyer and seller takes the market determined price as given.
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 7
Revenue
• Total revenue for a firm is the selling price times the quantity sold.
TR = (P Q)
• Total revenue is proportional to the amount of output sold by the competitive firm.
• Average revenue tells us how much revenue a firm receives for the typical unit sold.
• Average revenue is total revenue divided by the quantity sold.
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 8
• Average revenue equals the price of the good.
Average Revenue =Total revenue
Quantity
Price Quantity
Quantity
Price
Marginal revenue is the change in total revenue from an additional unit sold.
MR =TR/ Q
For competitive firms, marginal revenue equals the price of the good.
The Revenue of a Competitive Firm
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 9 Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Table 1: Total, Average, and Marginal Revenue for a Competitive Firm
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 10
Profit Maximization
• The goal of a competitive firm is to maximize profit.
• This means that the firm will want to produce the quantity that maximizes the difference between total revenue and total cost.
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 11
Table 2: Profit Maximization: A Numerical Example
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 12
Profit Maximization for a Competitive Firm
Quantity 0
Costs and
Revenue
MC
ATC
AVC
MC 1
Q 1
MC 2
Q 2
The firm maximizes profit by producing the quantity at which marginal cost equals marginal revenue.
Q MAX
P = MR 1 = MR 2 P = AR = MR
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 13 Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Profit Maximization
• Profit maximization occurs at the quantity where marginal revenue equals marginal cost.
– When MR > MC increase Q
– When MR < MC decrease Q
– When MR = MC profit is maximized.
• However, for the competitive firm, Price = MR, and the equilibrium can be re-written as
P = MC
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 14
Profit as the Area between Price and Average Total Cost
Copyright © 2004 South-Western
(a) A Firm with Profits
Quantity 0
Price
P = AR = MR
ATC MC
P
ATC
Q
(profit-maximizing quantity)
Profit
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 15
Loss as the Area between Price and Average Total Cost
Copyright © 2004 South-Western
(b) A Firm with Losses
Quantity 0
Price
ATC MC
(loss-minimizing quantity)
P = AR = MR P
ATC
Q
Loss
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 16
Copyright © 2004 South-Western
(c) A Firm with zero economic / normal profit
Quantity 0
Price
ATC MC
(loss-minimizing quantity)
P = AR = MR P ATC,
Q
Zero Economic/Normal Profit
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 17
Why Do Competitive Firms Stay in Business if they make Zero Profit?
• Profit equals total revenue minus total cost.
• Total cost includes all the opportunity costs of the firm.
• In the zero-profit equilibrium, the firm’s revenue compensates the owners for the time and money they expend to keep the business going.
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 18
The Firm’s Short-Run Decision to Shut Down
• A shutdown refers to a short-run decision not to produce anything during a specific period of time because of current market conditions.
• Exit refers to a long-run decision to leave the market.
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 19
The Firm’s Short-Run Decision to Shut Down
• The firm considers its sunk costs when deciding to exit, but ignores them when deciding whether to shut down.
– Sunk costs are costs that have already been committed and cannot be recovered.
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 20
The Firm’s Short-Run Decision to Shut Down
• The firm shuts down if the revenue it gets from producing is less than the variable cost of production.
– Shut down if TR < TVC
– TR/Q < TVC/Q
– Thus, shut down if P < AVC
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 21
Loss as the Area between Price and
Average Total Cost
Copyright © 2004 South-Western
(b) A Firm with Losses
Quantity 0
Price
ATC MC
(loss-minimizing quantity)
P = AR = MR P
ATC
Q
Loss
AVC1
AVC2
A firm making loss but with AVC1 will continue to produce. But a firm making loss, with AVC2 will shut down
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 22
The Competitive Firm’s Short Run Supply Curve
MC
Quantity
ATC
AVC
0
Costs
Firm
shuts
down if
P < AVC
Firm ’ s short-run
supply curve
If P > AVC, firm will
continue to produce
in the short run.
If P > ATC, the firm
will continue to
produce at a profit.
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 23
The Firm’s Long-Run Decision to Exit or Enter a Market
• The portion of the marginal-cost curve that lies above average variable cost is the competitive firm’s short-run supply curve.
• In the long run, the firm exits if the revenue it would get from producing, is less than its total cost.
– Exit if TR < TC
– Exit if TR/Q < TC/Q
– Exit if P < ATC
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana Slide 24
The Supply Curve in a Competitive Market
• Market supply equals the sum of the quantities supplied by the individual firms in the market.
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana Slide 25
The Short Run: Market Supply with a Fixed Number of Firms
• For any given price, each firm supplies a quantity of output so that its marginal cost equals price.
• The market supply curve reflects the individual firms’ marginal cost curves.
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana Slide 26
Figure 6: Market Supply with a Fixed Number of Firms
Copyright © 2004 South-Western
(a) Individual Firm Supply
Quantity (firm) 0
Price
MC
1.00
100
$2.00
200
(b) Market Supply
Quantity (market) 0
Price
Supply
1.00
100,000
$2.00
200,000
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana Slide 27
The Long Run: Market Supply with Entry and Exit
• Firms will enter or exit the market until profit is driven to zero.
• In the long run, price equals the minimum of average total cost.
• The long-run market supply curve is horizontal at this price.
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana Slide 28
Figure 7: Market Supply with Entry and Exit
Copyright © 2004 South-Western
(a) Firm ’ s Zero-Profit Condition
Quantity (firm) 0
Price
(b) Market Supply
Quantity (market)
Price
0
P = minimum ATC
Supply
MC
ATC
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 29
The Long Run: Market Supply with Entry and Exit
• At the end of the process of entry and exit, firms that remain must be making zero economic profit.
• The process of entry and exit ends only when price and average total cost are driven to equality.
• Long-run equilibrium must have firms operating at their efficient scale.
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana Slide 30
A Shift in Demand in the Short Run and Long Run
• An increase in demand raises price and quantity in the short run.
• Firms earn profits because price now exceeds average total cost.
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana Slide 31
Figure 8: An Increase in Demand in the Short Run and Long Run
Firm
(a) Initial Condition
Quantity (firm) 0
Price
Market
Quantity (market)
Price
0
D Demand, 1
S Short-run supply, 1
P 1
ATC
Long-run supply
P 1
1 Q
A
MC
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 32
Figure 8: An Increase in Demand in the Short Run and Long Run
Market Firm
(b) Short-Run Response
Quantity (firm) 0
Price
MC ATC Profit
P 1
Quantity (market)
Long-run supply
Price
0
D 1
D 2
P 1
S 1
P 2
Q 1
A
Q 2
P 2
B
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 33
Figure 8: An Increase in Demand in the Short Run and Long Run
P 1
Firm
(c) Long-Run Response
Quantity (firm) 0
Price
MC ATC
Market
Quantity (market)
Price
0
P 1
P 2
Q 1 Q 2
Long-run supply
B
D 1
D 2
S 1
A
S 2
Q 3
C
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 34
Why the Long-Run Supply Curve Might Slope Upward
• Some resources used in production may be available only in limited quantities.
• Firms may have different costs.
• Marginal Firm
– The marginal firm is the firm that would exit the market if the price were any lower.
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 35
The Firm’s Long-Run Decision to Exit or Enter a Market
• A firm will enter the industry if such an action would be profitable.
– Enter if TR > TC
– Enter if TR/Q > TC/Q
– Enter if P > ATC
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana Slide 36
Figure 4 : The Competitive Firm’s Long-Run Supply Curve
Copyright © 2004 South-Western
MC = long-run S
Firm exits if P < ATC
Quantity
ATC
0
Costs Firm ’ s long-run supply curve
Firm enters if P > ATC
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 37
The Supply Curve in a Competitive Market
• The competitive firm’s long-run supply curve is the portion of its marginal-cost curve that lies above average total cost.
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana Slide 38
Figure 4: The Competitive Firm’s Long-Run Supply Curve
Copyright © 2004 South-Western
MC
Quantity
ATC
0
Costs
Firm ’ s long-run supply curve
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 39
The Supply Curve in a Competitive Market
• Short-Run Supply Curve
– The portion of its marginal cost curve that lies above average variable cost.
• Long-Run Supply Curve
– The marginal cost curve above the minimum point of its average total cost curve.
Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana
Slide 40