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Competitive Markets

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**Structure Fragmented Undifferentiated Products : Homogeneous**

Perfect Information about Price Equal Access to Resources

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Three Implication Price Takers Law of one Price Free Entry & Free Exit

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Profit Maximization Profit Maximization Condition

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TC TR Q TR,TC Profit MC MR = P MC > MR MC = MR MC < MR

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Price Q AR = P = MR D Firm Industry

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AVC AC MC P1 A C Q Price MR = P B Excess Profit

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AVC AC MC P1 A C Q Price MR = P

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AVC AC MC P1 A C Q Price MR = P B Loss

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AVC AC MC P1 A C Q Price MR = P B Loss

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AVC AC MC P1 A C Q Price MR = P B Loss

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AVC AC MC P1 P2 P3 P4 Q Price Shut Down Point

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AVC AC MC P1 P2 P3 P4 Q Price Shut Down Point Firm’s Supply

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**The Firm’s short run total cost curve is STC = 100 +20Q + Q2. **

Example The Firm’s short run total cost curve is STC = Q + Q2. The short run Marginal cost curve is SMC = Q If SFC = 100, while SVC = 20Q + Q2 Find AVC , Minimum level of average variable cost, supply curve

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Fixed Cost + Sunk Cost TFC = SFC + NSFC

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Price MC AC ANSC AVC B C P1 Minimum ANSC = P A Q Q

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**The Firm’s short run total cost curve is STC = 100 +20Q + Q2. **

Example The Firm’s short run total cost curve is STC = Q + Q2. The short run Marginal cost curve is SMC = Q If SFC = 36, while NSFC = 64 Find ANSC , Minimum level of average non sunk cost, supply curve

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**Firm Supply and Market Supply**

Q1 Q2 Q1+Q2 Q P

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**Short Run perfectly Competitive equilibrium**

D S D(P*) SAC Q* Q P P*

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**STC = 0.1 + 150Q2 , all fixed cost are sunk.**

The Market consists of 300 identical firms, and the market demand curve is given by D(P) = 60 – P. Each firm has a short run cost curve STC = Q2 , all fixed cost are sunk. The corresponding short run marginal cost curve SMC = 300Q. The corresponding average variable cost curve is AVC = 150Q. You should verify that the minimum level of AVC is 0. Thus, a firm will continue to produce as large as price is positive Find Short run equilibrium in market, at equilibrium, do the firm make positive profit?

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**Comparative Statics in short run**

Increase in the number of firm D S Q1 SAC Q1f Q P P1 S’ Q2 P2 Q2f

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**Long Run – Plant Adjustment**

Price Quantity P1 SAC1 MC1 SAC2 MC2 LAC LMC Q1 Q2

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Long Run Supply Curve Price Quantity P1 LAC LMC Q1 Q2 Q* P2 P*

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Long Run Supply Curve Price Quantity P1 LAC LMC Q1 Q2 Q* P2 P*

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**Free Entry and Long Run P* = MC ( Q* ) P* = AC ( Q* )**

1. Long Run Profit is maximized with respect to output and plant size. P* = MC ( Q* ) 2. Economic profit is Zero. P* = AC ( Q* )

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**Free Entry and Long Run 3. Demand equals Supply. D( P* ) = n Q* D S**

LAC Q* Q P P* SAC LMC SMC

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**In this market, each firm and potential entrant has a long – run average cost**

AC( Q ) = 40 – Q – 0.01Q2. And a corresponding long run marginal cost curve MC( Q ) = 40 – 2Q Q2. Where Q is thousand units per year. The Market demand curve is D( P ) = 25,000 – 1,000P, Where D(P) is also measured in thousand units. Find the long run equilibrium price, quantity per firm, and number of firms.

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**Long Run Market Supply Curve**

D S Q1 LAC Q1f Q P P1 SAC LMC S’ D’ P2 Q2f Q2 A B

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**Industry Long Run Supply Curve**

Constant Cost D S Q1 LAC Q1f Q P P1 LMC S’ D’ P2 Q2f Q2 A B SL

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**Industry Long Run Supply Curve**

Q1 LAC1 Q1f Q P P1 LMC1 S’ D’ P2 Q2f Q2 SL Increasing Cost P3 LMC2 LAC2

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**STC ( Q ) = 16 + Q2 SMC ( Q ) = 2Q D ( P ) = 110 – P**

Problem 1 The bolt industry currently consists of 20 producers, all of whom operate with identical short run total cost function STC ( Q ) = 16 + Q2 Where Q is the annual output. The corresponding short run marginal cost curve is SMC ( Q ) = 2Q The market demand for the bolts is D ( P ) = 110 – P Where P is the market price

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**a ) Assuming that all of the firm fixed cost is sunk, what is the firm’s short run supply curve?**

b ) What is the short run market supply curve? c ) Determine the short run equilibrium price and quantity in the industry.

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**The corresponding long run average cost function is **

Problem 2 Propylene is used to make plastic. The propylene industry is perfectly competitive, and each producer has a long run marginal cost function given by MC ( Q ) = 40 – 12Q + Q2 The corresponding long run average cost function is AC ( Q ) = 40 – 6Q + (1/3)Q2 The market demand curve for propylene is D ( P ) = 2200 – 100P

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**a ) What is long run equilibrium price in the industry?**

b ) At this price, how much would an individual firm produce? c ) How many firms are in the propylene market in long run competitive equilibrium. d ) Suppose the demand curve shifted so that it is now D ( P ) = A – 100P. How large would A have to be so that in the new long run competitive equilibrium, the number of propylene firms was twice what it was in the initial long run equilibrium?.

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**The long run total cost function for producers of mineral water is **

Problem 3 The long run total cost function for producers of mineral water is TC ( Q ) = cQ Where Q is the output of individual firm expressed as thousand liters per year. The market demand curve is D ( P ) = a – bP Find the long run equilibrium price and quantity in term of a, b, c, . Can you determine the equilibrium number of firms? If so, what is it? Why not?

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Chapter 8 Profit Maximization and Competitive Supply.

Chapter 8 Profit Maximization and Competitive Supply.

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