Title: Competitive firms and Markets
1Competitive firms and Markets
2Competition
- Firms are price takers.
- Firms demand curve is horizontal.
- Reasons for a horizontal demand curve
- Identical products from different firms
- Freedom of entry and exit
- Perfect knowledge of prices
- Low transaction costs.
- Where all conditions are satisfied Perfect
Competition.
3Profit
- p R C
- Definition of R straightforward.
- Costs
- Business profit includes only explicit costs,
e.g. workers wages and materials. - Owner doesnt take a salary, what remains is
profit. - Economic profit uses opportunity cost.
- Suppose profit was 20000 but you could earn a
salary of 25000, what should you do?
4Profit maximisation
p
, Profit
p
Profit
D
p
lt 0
p
gt 0
D
1
1
0
q
Quantity,
q
, Units
per day
Source Perloff
5Output decision
- Produce where profit is maximised.
6Profit maximisation
p
, Profit
p
Profit
D
p
lt 0
p
gt 0
D
1
1
0
q
Quantity,
q
, Units
per day
Source Perloff
7Output decision
- Produce where profit is maximised.
- Produce where marginal profit is zero.
- Marginal cost equals marginal revenue.
- p(q) R(q) C(q)
- Marginal Profit(q) MR(q) MC(q) 0
- MR(q) MC(q)
8Shutdown rule
- Shutdown if it reduces its loss.
- In the short-run, shutting down means revenue and
variable costs are zero. - It must continue to cover fixed costs.
- pR-VC-F2000-1000-3000-2000
- pR-VC-F500-1000-3000-3500
- Shutdown if revenue is less than avoidable cost.
- This rule is applicable in the long and short run.
9Short-run output decision
Cost, revenue,
Thousand
Cost,
C
Revenue
4,800
MR
8
1
2,272
p
1,846
426
p
(
q
)
p
426,000
100
0
284
140
100
q
me per year
, Thousand metric tons of li
p
, per ton
10
MC
AC
e
8
p
MR
426,000
p
6.50
6
284
140
0
q
, Thousand metric tons of li
me per year
10Short run shutdown decision
- Shutdown if revenue less than avoidable cost.
- In short run avoidable costs are variable costs.
11Short run shutdown decision
p
, per ton
MC
AC
b
6.12
AVC
6.00
A
62,000
p
5.50
e
B
36,000
5.14
5.00
a
q
, Thousand metric tons of lime per year
100
50
140
0
12Short run supply curve of the firm
p
, per ton
S
e
4
p
8
4
e
3
AC
p
7
3
AVC
e
2
p
6
2
e
1
p
5
1
MC
q
215
q
285
q
50
q
140
0
3
4
1
2
q
, Thousand metric tons of lime per year
13Industry SR supply curve with 5 identical firms
(a) Firm
(b) Market
p
, per ton
p
, per ton
3
2
7
7
S
S
1
1
S
S
4
S
6.47
6.47
AVC
5
S
6
6
5
5
MC
140
50
175
0
150
50
250
700
0
200
100
q
, Thousand metric tons
Q
, Thousand metric tons
of lime per year
of lime per year
14Industry SR supply curve with 2 different firms
p
, per ton
2
1
S
S
S
8
7
6
5
100
140
165
215
315
450
25
50
0
q
,
Q
, Thousand metric tons of lime per year
15SR equilibrium in the market
(a) Firm
(b) Market
p
, per ton
p
, per ton
8
8
S
1
S
1
D
e
1
7
7
E
6.97
1
AC
A
B
2
D
6.20
6
6
AVC
C
5
5
E
e
2
2
q
215
q
50
Q
1,075
Q
250
0
0
1
2
1
2
q
, Thousand metric tons
Q
, Thousand metric tons
of lime per year
of lime per year
16Supply curve of the firm in the long-run
p
, per unit
SR
S
LR
S
LRAC
SRAC
SRAVC
p
35
B
A
28
25
24
20
LRMC
SRMC
50
110
q
, Units per year
0
17Long run adjustment of the industry
- All factors are variable.
- Entry and exit are possible.
- Entry occurs with positive long-run profits
- Exit occurs with long-run losses
- Identical firms
- All firms make a loss when Pltmin(LAC), industry
supply is zero. - All firms make a profit if Pgtmin(LAC), number of
firms is indeterminate. Note that elasticity of
the industry supply curve increases with the
number of firms.
18Long run industry supply curve
(a) Firm
(b) Market
p
, per unit
p
, per unit
S
1
LRAC
Long-run market supply
10
10
LRMC
0
150
0
Q
, Hundred metric tons of oil per year
q
, Hundred metric tons of oil per year
19Upward sloping long run industry supply curve
- Limited entry
- New firms cannot enter because of legislative
control. - New firms only enter when profits exceed the
costs of entry. - Firms differ
- Minimum LAC is lower for some firms than others.
- Number of low LAC firms is limited.
- Input prices vary with output
- Increasing cost (firms in one industry account
for much of the supply of a particular input). - Decreasing cost (economies of scale in the input
supplier)
20Differing firms the LR supply curve for cotton
Price, per kg
Iran
S
1.71
United States
1.56
Nicaragua, Turkey
1.43
Brazil
1.27
Australia
1.15
Argentina
1.08
Pakistan
0.71
0
1
2
3
4
5
6
6.8
Cotton, billion kg per year
21Increasing cost industry
(a) Firm
(b) Market
p
, per unit
p
, per unit
2
MC
1
MC
2
AC
S
1
AC
e
E
2
2
p
2
e
E
1
1
p
1
q
q
Q
n
q
Q
n
q
q
, Units per year
Q
, Units per year
1
2
1
1
1
2
2
2
22Decreasing cost industry
(b) Market
(a) Firm
p
, per unit
p
, per unit
1
MC
2
MC
1
AC
2
AC
e
E
1
1
p
1
e
E
2
2
p
2
S
q
q
Q
n
q
Q
n
q
q
, Units per year
Q
, Units per year
1
2
1
1
1
2
2
2
23Long run competitive equilibrium
(a) Firm
(b) Market
, per ton
p
, per ton
1
2
D
D
MC
AC
SR
S
f
F
AVC
2
2
11
E
11
LR
S
2
10
10
e
E
F
f
1
1
1
7
7
100
0
150
165
1,500
0
2,000
3,300
3,600
q
, Hundred metric tons
Q
, Hundred metric tons
of oil per year
of oil per year
24Profit in the long run
- Free entry
- Entry occurs to the point where profits are zero
- No profit in long-run equilibrium
- Economic profit is revenue minus opportunity
cost. - Restricted entry
- Entry is often limited because of a limited
quantity of an input eg. land. - Profits become rent.
25Economic Rent
p
, per bushel
MC
AC
(including rent)
AC
(excluding rent)
p
p
Rent
q
q
, Bushels of tomatoes per year