Econ 1900 Laura Lamb 1

1. Perfect competition 2. Monopolistic competition 3. Oligopoly 4. Pure Monopoly 2

 What are the major characteristics of each market model? 3

 Large number of firms  Standardized products  Price takers  Easy entry & exit of firms 4

 Then why do we study it? ◦ helps analyze industries with characteristics similar to perfect competition. ◦ provides a context in which to apply revenue and cost concepts developed in previous chapters. ◦ provides a norm or standard against which to compare and evaluate the efficiency of the real world. 5

 Demand is perfectly elastic for each firm ◦ Not for the industry ◦ Individual firms can sell as much as they want at the market price 6

 Average Revenue  Total Revenue  Marginal Revenue 7

Product priceQuantity Demanded Total RevenueMarginal Revenue

1. Compare total revenue & total cost 2. Compare marginal revenue & marginal cost 9

Consider the Maple Syrup Market:  The North American maple syrup market produces nearly 30 million litres/year. More than 80% is produced in Canada. The number of firms can only be estimate because some are very small and sell their output in a small local market. There are about 9,500 producers in Canada & about 2,000 in the US.  Maple syrup is not quite a standardized good, but is close. At the wholesale level, the market is highly competitive and a good example for perfect competition. 10

Total Revenue & Total Cost Schedule for Dave’s Maple Syrup Quantity (cans/day) Total Revenue ($/day) Total cost ($/day) Economic profit ($/day)

Where is the break-even point? How do we describe the profit at this point? 12

MR = MC rule: in the short run, a firm will maximize profit by producing at the output level where MR = MC. 13

Quantity (cans/day) Total Revenue $/day MR $/day Total Cost $/day MC $/day Economic Profit

***The MR=MC rule is applicable to all market models*** 15

Note: for perfectly competitive firms: MR = MC is equivalent to P= MC Why? 16

1. If average cost is $8/can, what is the economic profit? 2. Suppose the price dropped from $8/can to $6/can, how would the profit maximizing level of output change? 3. Now suppose, the price drops to $4/can. How much should Dave produce? 17

Quantity (cans/day) Total revenue ($/day) MR ($/day)Total cost ($/day) MC ($/day)Economic profit (TR-TC)

 If a loss is incurred, the firm should continue to produce as long as the price is greater than average variable cost (AVC).  Modified rule: MR = MC if P>minimum AVC 19

In the example of Dave’s Maple Syrup:  when P=$8, quantity supplied = 10  when P=$4, quantity supplied = 8 ◦ appears rational in light of the law of supply! ◦ The short-run supply curve is the section of the MC curve starting at minimum AVC (and above). 20

In what situations would the supply curve for the firm shift? 21

Quantity supplied by 1 firm Total quantity supplied by 1000 firms Product priceTotal quantity demanded ,000 8,000 6,000 5, ,000 5,000 6,000 10,000 22

 Is the industry profitable at the equilibrium? 23

1. The firm should produce is P≥minimum AVC 2. The firm should produce the quantity at MR=MC 24

 Individual firms must take price as given, but the supply plans of all competitive producers as a group are a major determinant of product price. 25

Assumptions: 1. Entry and exit of firms are the only long‑run adjustments 2. Firms in the industry have identical cost curves. 3. The industry is a constant‑cost industry  the entry and exit of firms will not affect resource prices or location of unit‑cost schedules for individual firms. 26

**In the long run, product price = minimum ATC 27

 If P>minimum ATC →economic profits will attract new firms to the industry →increased supply of the product →price is driven down to minimum ATC.  If P<minimum ATC →economic losses will cause some firms to leave the industry →decreased supply of the product →price is driven up to minimum ATC. 28

A change in consumer tastes increases the demand for product  trace the steps to a new long-run equilibrium  Illustrate with two graphs, one for the firm and one for the industry. 29

Household income decreases causing a fall in demand for the product.  trace the steps to a new long-run equilibrium  Illustrate with two graphs, one for the firm and one for the industry. 30

**In the long run, equilibrium price & quantity always occur where ATC is at a minimum for a perfectly competitive firm. 31

 The product price will be exactly equal to each firm’s point of minimum average total cost. 32

 Perfectly elastic ◦ Level of output does not affect price in the long- run. 33

 Upward sloping as industry expands output. 34

 Downward sloping as the industry expands output. 35

In the long run: ◦ Productive efficiency occurs where P = minimum ATC ◦ Allocative efficiency occurs where P = MC  allocative efficiency implies maximum consumer and producer surplus. 36

 When a pharmaceutical company introduces a new drug, it typically owns the patent and can price and produce as a monopolist, earning economic profits.  When patent rights expire, firms pursuing economic profits enter the market for that drug.  Prices of these drugs typically drop percent. ◦ Those lower prices increase efficiency and consumer surplus. 37