PPF with Economies of Scale

1
PPF with Economies of Scale
BMW
480
240
60
480
240
60
Land Rover
2
Monopolistic competition

P
AC
MC
D
MR
Q
3
Monopolistic competition model

• MR Price
• Sales Q A B Price
• where B responsiveness of demand to price
  changes
• Higher B demand more elastic
• Lower B demand less elastic
• Price A/B Q/B

4
Monopolistic competition model

• MR Price
• MR Price Q/B
• Hence MR lt Price unless B is very large
• Note lower B (inelasticity) implies greater
  difference between Price and MR

5
Monopolistic competition model

• Average Cost
• AC declines with increasing quantity (Q)
• See Eskom large fixed cost (Fcost)

cost
AC F/Q MC
MC
Q
6
Krugmans Monopolistic competition model

• Large of firms with differentiated products
• Can set own price, but sales depend on competitor
• Cannot affect average price, dont think
  strategically about competitor
• If profit entrance of new firms
• until P AC
• If firms are the same (symmetric) then, in
  equilibrium Pfirm Pindustry

7
Monopolistic competition model

• Sales of firm Q S1/n b (P Pind)
• Where
• S total sales of industry
• n number of firms in industry
• b responsiveness of firms sales to its price
• P price charged by firm
• Pind average price of competitors
• Hence
• If firm charges more than competitors smaller
  market share
• If firm charges less than competitors bigger
  market share
• Different to perfect Competition where D price
  leads to a total loss of market share

8
Monopolistic competition model

• The firm will sell more
• the higher the demand in the industry (S)
• the higher the price of other competitors (Pind)
• The firm will sell less
• the higher its own price (P)
• the higher the number of firms (n) in the industry

9
Monopolistic competition model

• Equilibrium in the model
• Assume that all firms are symmetric
• - same demand function
• - same cost function
• Which allows us to concentrate on n price in
  the industry (variety and price)

10
Monopolistic competition model

• Q S1/n b (P Pind) In equilibrium P
  Pind
• If P Pind then Q S/n (market share)
• Cost Curve (CC)
• AC Fcost/Q c replace Q S/n (market share)
• n(Fcost/S) c
• Logic the more firms (n) in the industry the
  smaller the market share (S/n) and therefore the
  higher the AC
• \ CC is upward sloping in relation to the number
  of firms

11
Monopolistic competition model

• Price Curve (PP)
• Sales Q S1/n b (P Pind)
• Q (S/n SbPind) Sb P
• Q A B P
• MR price Q/B
• price Q/Sb replace Q S/n (in
  equilibrium)
• price 1/bn
• Profit max MC MR
• c P 1/bn
• P c 1/bn
• Logic the higher the number of firms (n) the
  higher the competition and therefore the lower
  the price
• \ the PP (price curve) is downward sloping in
  relation to the number of firms

12
Monopolistic competition model

• At n1 P1 gt AC1 thus profits attract new firms \
  n increases
• Result AC rises with smaller mkt share and P
  falls (competition)

Price Cost
(AC n(Fcost/S) c)
CC
P1
Pind AC
AC1
(P c 1/bn)
PP
Number of firms
nequilibrium
n1
13
Monopolistic competition model trade

• Autarky
• Variety (n) and scale of production (AC) are
  constrained by market size (S)
• Trade
• increases of market size through integration of
  an identical economy/country (2S)
• \ increase in S to 2S leads to lower AC
• AC n (Fcost/2S) c
• CC shifts down

14
Monopolistic competition model trade

• With trade higher S reduces AC and CC1 shifts to
  CC2.

Price cost
CC1
(AC n(Fcost/S) c)
CC2
(AC n(Fcost/2S) c)
Pautarky
PFree trade
PP
(P c 1/bn)
Number of firms
naut
nfree trade
15
Monopolistic competition model trade

• Outcome
• Number of firms (variety) increased for
  integrated market (both countries together)
• Each firms produces a greater quantity of its
  product and experiences internal EoS
• 3) Price of goods decreased with lower AC
• Total variety produced at home falls while trade
  makes a greater overall variety available
• Similar countries export and import similar
  products gtgtgt intra-industry trade