2 Four Market Models 1. Perfect Competition 2. Pure Monopoly 3. Monopolistic Competition 4. Oligopoly
3 Perfect Competition Chapter 14
4 Perfect Competition Characteristics
5 1. Very Large Numbers Many buyers/sellers acting independently of each other Operating on a national or international scale No one buyer/seller has power to influence the price
6 Think about The burrito market: - If one person said, I refuse to buy a burrito unless the price is $1 would that cause the price to change? - NO! There are enough of us that would be willing to pay more than $1 for a burrito and this person wouldn t have any impact.
7 Think about The burrito market: - If Moe s decided to start charging $40 for a burrito, would that work? - NO! People would simply go to another burrito place (Chipotle for those that enjoy subpar food and Willy s for those with good taste) that charged less than that for a burrito. There is a wide selection available!
8 2. Firms Are Price Takers Actions by any one firm do not influence the market equilibrium price
9 3. Homogeneity Standardized product Perfect substitutes
10 Tricky Homogeneity is difficult to achieve. Every burrito place offers a burrito but they aren t always EXACTLY the same. Best example of homogeneity are natural products such as produce and milk.
11 4. Free Entry and Exit No obstacles stopping firms from opening or closing What might be a real world example of an obstacle for a firm joining a market?
12 Introduction to Competitive Markets Read the packet and answer the following two questions on your own sheet of paper. Please write the question and answer and turn in before you leave class. If you do not finish this is homework! 1. What markets in your local economy most closely resemble Adam Smith s ideal of perfect competition? 2. What characteristics does the hamburger market in your area share with a perfectly competitive industry? What conditions for perfect competition does it violate?
13 Revisiting an old friend DEMAND CURVE Two different curves One for the industry One for the individual firm
14 Industry Demand Curve Downward sloping demand curve for Industry All firms acting together can affect the price of a good
15 Pizza Industry Demand
16 Individual Firm Demand Curve Horizontal (perfectly elastic) demand curve for each individual firm No one firm can influence the price level Price is the same for each unit sold
17 Individual Pizza Firm Demand Curve
18 When drawing them You must draw them side by side!
19 Perfect Competition Firms in a perfectly competitive market are profit maximizing To find out how to make the most profit = look at different types of revenue and costs
20 Total Revenue (TR) TR = Price X Quantity sold
21 Average Revenue (AR) Revenue per unit Average Revenue= Total Revenue Quantity Sold Average Revenue= Price (only in perfect competition!)
22 Marginal Revenue (MR) Addition to total revenue from selling one more unit Marginal Revenue= Price (only in perfect competition!)
23 Introducing Mr. Darp Aka the Demand Curve for the Perfectly Competitive Firm MR = Marginal Revenue D = Demand AR = Average Revenue P = Price
24 How much should the firm produce? At the quantity level where profits are maximized At what quantity (or quantities) is profit maximized for the Ceasers? - 4 and 5 gallons!
25 How much should the firm produce? We need to go to the magic spot (I know that doesn t sound good but just go with it) Magic Spot :MR = MC What point is that at for the Ceasers? At five gallons!
26 How much should the firm produce? The short way to decide how much we should produce is find MR = MC
27 Quick Review ATC =? And the curve looks like what? AVC =? And the curve looks like what? MC =? And the curve looks like what?
28 Graphs Look at the graphs on the back of your dairy farm sheet. Figure One: - What happens if we produce at Q1? - Marginal Revenue is greater than marginal cost - If we made one more unit, would we make more revenue?
29 Graphs Look at the graphs on the back of your dairy farm sheet. Figure One: - What happens if we produce at Q2? - Marginal cost is greater than marginal revenue - How can we increase profit?
30 Graphs Look at the graphs on the back of your dairy farm sheet. Figure One: - So what will we actually end up doing? - We will end up producing at Qmax, where MR = MC
31 Three Rules 1. If MR > MC = firm should produce more 2. If MR < MC = firms should produce less 3. If MR = MC = firm is maximizing profit
32 MC = Supply Curve MC = the supply curve for the perfectly competitive firm. It shows the quantity supplied by the firm at any given price.
33 1. Economic Profit P > ATC Good Thing!
34 2. Normal Profit Break-even point MR = MC = P = ATC Still a good thing!
35 3. Loss ATC > P > AVC Bad Thing Still operating because you are covering your AVC Would lose more money if you went out of business.
36 4. Shutdown Point P = AVC Indifferent between shutting down and producing Will lose the same amount of money whether or not you closed down
37 5. Shutdown P < AVC No longer covering your AVC so you must shut down