ECO-101 Micro Economic Lecture 1

1. PERFECT
COMPETITION
Lecture

2. The Four Types of Market Structure
Monopoly Oligopoly Monopolistic
Competition
Perfect
Competition
• Tap water
• Cable TV
• Tennis balls
• Crude oil
• Novels
• Movies
• Wheat
• Milk
Number of Firms?
Type of Products?
Differentiated
products
Identical
products

3. Pure Monopoly
 Single seller
 No close substitutes
 Price Maker
 Blocked Entry
Example: Electricity

4. Monopolistic Competition
 Relatively large number of sellers
 Differentiated products
 Easy entry and Exit
Example: Furniture, Clothing

5. Oligopoly
 A few large producer
 Homogenous or differentiated
products
 Control over price but mutual
interdependence
 Entry Barriers
 Example: Mobile phone operators,
Air lines, automobiles, computers

6. Duopoly
 Two Producers
 Identical Products
 Barriers to entry
 Example: SNGPL Sui Northern Gas
Pipelines Limited.

7. Pure Competition
Very Large Numbers
Standardized Product
“Price Takers”
Free Entry and Exit
 Examples: Wheat or peanuts

8. Firm’s
Demand
Schedule
(Average
Revenue)
Firm’s
Revenue
Data
Pure Competition
PriceandRevenue
2 4 6 8 10 12
131
262
393
524
655
786
917
1048
$1179
Quantity Demanded (Sold)
P = MR = AR
TR
P QD TR MR
$131
131
131
131
131
131
131
131
131
131
131
0
1
2
3
4
5
6
7
8
9
10
$0
131
262
393
524
655
786
917
1048
1179
1310
$131
131
131
131
131
131
131
131
131
131
]
]
]
]
]
]
]
]
]
]

9. Total Revenue-Total Cost Approach
Profit Maximization in the Short
Run
(1)
Total Product
(Output) (Q)
(2)
Total Fixed
Cost (TFC)
(3)
Total Variable
Cost (TVC)
(4)
Total Cost
(TC)
(5)
Total Revenue
(TR)
(6)
Profit (+)
or Loss (-)
Price = $131
0
1
2
3
4
5
6
7
8
9
10
$100
100
100
100
100
100
100
100
100
100
100
$0
90
170
240
300
370
450
540
650
780
930
$100
190
270
340
400
470
550
640
750
880
1030
$0
131
262
393
524
655
786
917
1048
1179
1310
$-100
-59
-8
+53
+124
+185
+236
+277
+298
+299
+280
Now Let’s Graph The Results…Do You See Profit Maximization?

10. Marginal Revenue-Marginal Cost Approach MR =
MC Rule
Profit Maximization in the Short
Run
Important Features:
• Firm Will Shut Down Unless
MR at Least Meets MC
• Profit Maximization in All
Market Structures
• Can Be Restated P = MC

11. CostandRevenue $200
150
100
50
0
1 2 3 4 5 6 7 8 9 10
Output
Economic Profit
Marginal Revenue-Marginal Cost Approach MR =
MC Rule
Profit Maximization in the Short
Run
MR = P
MCMR = MC
AVC
ATC
P=$131
A=$97.78

12. Lower the Price to $81 and
Observe the Results!
CostandRevenue $200
150
100
50
0
1 2 3 4 5 6 7 8 9 10
Output
Loss
Marginal Revenue-Marginal Cost Approach MR =
MC Rule
Profit Maximization in the Short
Run
MR = P
MC
AVC
ATC
Loss Minimizing Case
P=$81
A=$91.67
V = $75

13. Lower the Price Further to
$71 and Observe the Results!
CostandRevenue $200
150
100
50
0
1 2 3 4 5 6 7 8 9 10
Output
Marginal Revenue-Marginal Cost Approach MR =
MC Rule
Profit Maximization in the Short
Run
MR = P
MC
AVC
ATC
Short-Run Shut Down Case
P=$71
Short-Run
Shut Down Point
P < Minimum AVC
$71 < $74
V = $74

14. The Marginal Revenue and Marginal
Cost Approach
 Firm should continue to increase output as
long as marginal revenue > marginal cost
 Remember that profit-maximizing output is
found where MC curve crosses MR curve from
below
 Finding the profit-maximizing output level for a
competitive firm requires no new concepts or
techniques

15. Measuring Total Profit
 Start with firm’s profit per unit
 Revenue =TR-TC
 Firm earns a profit whenever P > ATC
 A firm suffers a loss whenever P < ATC at
the best level of output

16. The Firm’s Short-Run Supply
Curve
 A competitive firm is a price taker
Takes market price as given and then
decides how much output it will produce
at that price

17. Competitive Markets in the Short-
Run
 Short-run is a time period too short
for firm to vary all of its inputs
Quantity of at least one input remains
fixed
 Let’s extend concept of short-run
from firm to market as a whole
 Conclusion
In short-run, number of firms in industry
is fixed

18. Profit and Loss and the Long Run
 In a competitive market, economic profit and loss are the
forces driving long-run change
 Expectation of continued economic profit (losses) causes
outsiders (insiders) to enter (exit) the market
 In real world entry and exit occur literally every day
 In some cases, we see entry occur through formation of an
entirely new firm
 Entry can also occur when an existing firm adds a new product to
its line
 Exit can occur in different ways
 Firm may go out of business entirely, selling off its assets and
freeing itself once and for all from all costs
 Firm switches out of a particular product line, even as it
continues to produce other things

19. Market Signals and the Economy
 In real world, demand curves for different goods and
services are constantly shifting
 As demand increases or decreases in a market, prices
change
 Economy is driven to produce whatever collection of
goods consumers prefer
 In a market economy, price changes act as market
signals, ensuring that pattern of production matches
pattern of consumer demands
 When demand increases, a rise in price signals firms to enter
market, increasing industry output
 When demand decreases, a fall in price signals firms to exit
market, decreasing industry output

20. Market Signals and the Economy
 Market signal
 Price changes that cause firms to change their
production to more closely match consumer demand
 No single person or government agency directs
this process
 This is what Adam Smith meant when he suggested
that individual decision makers act for the overall
benefit of society
 Even though, as individuals, they are merely trying to satisfy
their own desires
 As if guided by an invisible hand

21. Characteristic Pure
competition
Monopolistic
competition
Oligopoly Pure
Monopoly
# of firms Large number many few one
Type of product Standardized Differentiated Standardized &
Differentiated
Unique ;no
close substitute
Control over
price
none Some, but
within rather
narrow limits
Mutual decision considerable
Conditions of
entry
Very easy, free Relatively easy Significant
obstacles
Blocked
Non price
competition
None Brand names,
trade marks
Typically a
great deal
Advertising,
public relations
Examples Agriculture Retail trade,
dresses,
shoes
Steel,
automobiles,
farm
implements,
many
household
appliances
Local Utilities