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Competitive Markets

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Structure Fragmented Undifferentiated Products : Homogeneous Perfect Information about Price Equal Access to Resources 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 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 Q Profit MC MR = P 0 0 MC > MRMC = MRMC < MRMC > MR

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Price Q Q AR = P = MR D FirmIndustry

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AVC AC MC P1 A C Q Price 0 MR = P B Q Excess Profit

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AVC AC MC P1 A C Q Price 0 MR = P Q

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AVC AC MC P1 A C Q Price 0 MR = P B Q Loss

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AVC AC MC P1 A C Q Price 0 MR = P B Q Loss

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AVC AC MC P1 A C Q Price 0 MR = P B Q Loss

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AVC AC MC P1 P2 P3 P4 Q Price 0 Shut Down Point

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AVC AC MC P1 P2 P3 P4 Q Price 0 Shut Down Point Firm’s Supply

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The Firm’s short run total cost curve is STC = Q + Q 2. The short run Marginal cost curve is SMC = Q The Firm’s short run total cost curve is STC = Q + Q 2. The short run Marginal cost curve is SMC = Q Example If SFC = 100, while SVC = 20Q + Q 2 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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AVC AC MC P1 A C Q Price 0 Minimum ANSC = P B Q ANSC

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The Firm’s short run total cost curve is STC = Q + Q 2. The short run Marginal cost curve is SMC = Q The Firm’s short run total cost curve is STC = Q + Q 2. The short run Marginal cost curve is SMC = Q Example If SFC = 36, while NSFC = 64 Find ANSC, Minimum level of average non sunk cost, supply curve

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Firms Market p Q1Q2Q1+Q2 QQ PP Firm Supply and Market Supply

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Short Run perfectly Competitive equilibrium D S D(P*) SAC Q*Q P Q P P*

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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 = Q 2, 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 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 = Q 2, 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 Q1 f Q P Q P P1 S’ Q2 P2 Q2 f

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Long Run – Plant Adjustment Price Quantity P1 SAC1 MC1 SAC2 MC2 LAC LMC Q1Q2

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Long Run Supply Curve Price Quantity P1 LAC LMC Q1Q2Q* P2 P*

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Long Run Supply Curve Price Quantity P1 LAC LMC Q1Q2Q* P2 P*

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Free Entry and Long Run 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 D(P*) = n*Q* LAC Q*Q P 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 – 0.01Q 2. And a corresponding long run marginal cost curve MC( Q ) = 40 – 2Q Q 2. 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. In this market, each firm and potential entrant has a long – run average cost AC( Q ) = 40 – Q – 0.01Q 2. And a corresponding long run marginal cost curve MC( Q ) = 40 – 2Q Q 2. 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 Q1 f Q P Q P P1 SAC LMC S’ D’ P2 Q2 f Q2 A B

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Industry Long Run Supply Curve D S Q1 LAC Q1 f Q P Q P P1 LMC S’ D’ P2 Q2 f Q2 A B SLSL Constant Cost

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Industry Long Run Supply Curve D S Q1 LAC 1 Q1 f Q P Q P P1 LMC 1 S’ D’ P2 Q2 f Q2 SLSL Increasing Cost P3 LMC 2 LAC 2

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Problem 1 The bolt industry currently consists of 20 producers, all of whom operate with identical short run total cost function STC ( Q ) = 16 + Q 2 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 The bolt industry currently consists of 20 producers, all of whom operate with identical short run total cost function STC ( Q ) = 16 + Q 2 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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c ) Determine the short run equilibrium price and quantity in the industry. b ) What is the short run market supply curve? a ) Assuming that all of the firm fixed cost is sunk, what is the firm’s short run supply curve?

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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 + Q 2 The corresponding long run average cost function is AC ( Q ) = 40 – 6Q + (1/3)Q 2 The market demand curve for propylene is D ( P ) = 2200 – 100P 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 + Q 2 The corresponding long run average cost function is AC ( Q ) = 40 – 6Q + (1/3)Q 2 The market demand curve for propylene is D ( P ) = 2200 – 100P

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c ) How many firms are in the propylene market in long run competitive equilibrium. b ) At this price, how much would an individual firm produce? a ) What is long run equilibrium price in the industry? 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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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? 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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