Lecture 4 & 5 18.02.13

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  • See Section 6-3 in the main text, and Figure 6-3.
  • See Section 8-1 in the main text, and Figure 8-2.
  • See Section 8-1 in the main text, and Figure 8-2.
  • See Section 8-1 in the main text, and Figure 8-2.
  • See Section 8-3 in the main text.
  • See Section 8-3 in the main text.
  • See Section 8-3 in the main text.
  • See Section 8-3 in the main text.
  • See Section 8-3 in the main text.
  • Lecture 4 & 5 18.02.13

    1. 1. EC-103Semester 2Lectures 4 & 5Market structure, perfect competition,monopoly and imperfect competition
    2. 2. Firms in competitive marketsAn industry is a group of firms which produce similar products.The total output of an industry is the output of firms within thatindustry.A characteristic of an industry is they can have varying numbersof firms making up the output.Microsoft is the only supplier of ‘Windows’ products.However, the UK has over 100,000 farms producing agriculturalproducts.
    3. 3. In the next couple of lectures we will be examining why someindustries have many producers, some a few and others onlyone.Initially we will examine two special benchmark cases, which willhelp us understand what determines market structure and thebehaviour of sellers, perfect competition and monopoly.
    4. 4. Characteristics of a perfectly competitive market•there are many buyers and sellers in the market therefore actions of any single buyer or seller has no affect on marketprices• firms take the market price as given as a result have a horizontal demand curve• the product sold by all firms is the same – homogeneous• there is perfect customer information• firms can freely enter or exit the market
    5. 5. The competitive firm’s demand curvePriceQuantityP D=AR=MRFor competitive firms, marginal revenue equals price
    6. 6. Objective of a perfectly competitive firm•The goal of a competitive firm is to maximise profits•Maximum profits are where the difference between total costsand total revenue is greatest•Profit maximisation is found where marginal costs equalsmarginal revenueΠ max where MC = MR
    7. 7. REVISIONMaximizing profitsOutputQ1EMC,MRMCMR0If MR > MC, an increasein output will increaseprofits.If MR < MC, a decreasein output will increaseprofits.So profits are maximizedwhen MR = MC at Q1(so long as the firmcovers variable costs)
    8. 8. The supply curve under perfect competition (1)• Above price P3 (pointC), the firm makes profitabove the opportunitycost of capital in theshort run• At price P3, (point C),the firm makesNORMAL PROFITSP1£OutputSAVCSMCQ1SATCP3ACQ3
    9. 9. The supply curve under perfect competition (2)• Between P1 and P3, (Aand C), the firm makesshort-run losses, butremains in the market• Below P1 (the SHUT-DOWN PRICE), the firmfails to cover SAVC, andexitsP1£OutputSAVCSMCQ1SATCP3ACQ3
    10. 10. The supply curve under perfect competition (3)– showing how much thefirm would produce ateach price level.P1£OutputSAVCSMCQ1SATCP3ACQ3• So the SMC curve above SAVCrepresents the firm’s SHORT-RUN SUPPLY CURVE
    11. 11. The firm and the industry in the short rununder perfect competition (1)INDUSTRYOutput£QPSRSSDFirmSACP£OutputSMCD=MR=ARq
    12. 12. The firm and the industry in the short rununder perfect competition (1)INDUSTRYOutput£QPSRSSDFirmMarket price is set at industry level at the intersection ofdemand and supply– the industry supply curve is the sum of the individual firm’ssupply curvesSACP£OutputSMCD=MR=ARq
    13. 13. The firm and the industry in the short rununder perfect competition (2)INDUSTRYFirmThe firm accepts price as given at P– and chooses output at q where SMC=MR to maximize profitsSACP£OutputSMCD=MR=ARqOutput£QPSRSSD
    14. 14. The firm and the industry in the short rununder perfect competition (3)INDUSTRYOutput£QPSRSSDAt this price, profits are shown by the shaded area.These profits attract new entrants into the industry.As more firms join the market, the industry supply curve shiftsto the right, and market price falls.SRSS1P1SACFirmP£OutputSMCD=MR=ARq Q1
    15. 15. Long-run equilibriumINDUSTRYFirmLACP*£OutputLMCD=MR=ARq*The market settles in long-run equilibrium when the typicalfirm just makes normal profit by setting LMC=MR at the minimumpoint of LAC. Long-run industry supply is horizontal.If the expansion of the industry pushes up input prices (e.g. wages)then the long-run supply curve will not be horizontal, but upward-sloping.SRSSDOutput£QP*LRSS
    16. 16. A Shift in Demand in the Short Run andLong Run• An increase in demand raises price and quantityin the short run.• Firms earn profits because price now exceedsaverage total cost.
    17. 17. An Increase in Demand in the Short Run and Long RunFirm(a) Initial ConditionQuantity (firm)0PriceMarketQuantity (market)Price0DDemand, 1SShort-run supply, 1P1ATCLong-runsupplyP11QAMC1q
    18. 18. An Increase in Demand in the Short Run and Long RunCopyright © 2004 South-Western (diagrams)MarketFirm(b) Short-Run ResponseQuantity (firm)0PriceMC ATCProfitP1Quantity (market)Long-runsupplyPrice0D1D2P1S1P2Q1AQ2P2Bq1 q2If market demand curve shifts from D1 to D2In the short run the new equilibrium is P2Q2Individual firms increase output from q1 to q2 (along MC curve) as price increasesThe shaded area shows resulting profits, which attaches more firms to the industry
    19. 19. An Increase in Demand in the Short Run and Long RunCopyright © 2004 South-WesternP1Firm(c) Long-Run ResponseQuantity (firm)0PriceMC ATCMarketQuantity (market)Price0P1P2Q1 Q2Long-runsupplyBD1D2S1AS2Q3Cq1This shifts the supply curve from S1 to S2Industry output increases to Q3, price falls to P1 and the individual output of the firmfalls to q1. Increase in market supply is made up of firms entering the marketproducing output q1
    20. 20. Why the Long-Run Supply Curve Might Slope UpwardWhilst a constant Long-Run supply curve may exist other casesare possible.For example, when an industry expands its output, the increaseddemand for inputs (materials, labour etc.) may lead to anincrease in their prices.This shifts up the average cost curve, reducing profits, attractingfewer firms and price settles above P1 resulting in an upwardsloping long-run supply curve.If input costs fall as a result of increased demand, the long-runsupply curve may be downward sloping.

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