The firm in the short run 1. Alternative market structures 1. Alternative market structures 2. Assumptions of perfect competition 2. Assumptions of perfect competition 3. Short run equilibrium for the firm 3. Short run equilibrium for the firm 4. Derivation of the supply curve 4. Derivation of the supply curve

ALTERNATIVE MARKET STRUCTURES Classification of markets Classification of markets –number of firms –freedom of entry to industry –nature of product –nature of demand curve The four market structures The four market structures –perfect competition –monopoly –monopolistic competition –Oligopoly Structure conduct performance Structure conduct performance Classification of markets Classification of markets –number of firms –freedom of entry to industry –nature of product –nature of demand curve The four market structures The four market structures –perfect competition –monopoly –monopolistic competition –Oligopoly Structure conduct performance Structure conduct performance

Features of the four market structures

2. Assumptions – Perfect Competition Assumptions (or characteristics) Assumptions (or characteristics) –(i) firms are price takers price takers price takers horizontal demand schedule (=AR, MR) horizontal demand schedule (=AR, MR) –(ii) freedom of entry new firms can enter the market new firms can enter the market –(iii) identical products Homogenous – no brands thus no advertising Homogenous – no brands thus no advertising –(iv) perfect knowledge Assumptions (or characteristics) Assumptions (or characteristics) –(i) firms are price takers price takers price takers horizontal demand schedule (=AR, MR) horizontal demand schedule (=AR, MR) –(ii) freedom of entry new firms can enter the market new firms can enter the market –(iii) identical products Homogenous – no brands thus no advertising Homogenous – no brands thus no advertising –(iv) perfect knowledge

3. Short run equilibrium Two measures of profit Two measures of profit (a) Normal profit (a) Normal profit –level of profit keeping the firm in the same industry (long run) (b) Supernormal profit (b) Supernormal profit –level (or rate) in excess of normal profit Short-run equilibrium of the firm Short-run equilibrium of the firm –Price, output & profit Two measures of profit Two measures of profit (a) Normal profit (a) Normal profit –level of profit keeping the firm in the same industry (long run) (b) Supernormal profit (b) Supernormal profit –level (or rate) in excess of normal profit Short-run equilibrium of the firm Short-run equilibrium of the firm –Price, output & profit

3. Short run equilibrium A) Price A) Price –price determined by demand & supply –P e on figure B) Output B) Output –profits maximised where MC=MR –output = Q e –market price is not affected by Q e firms output is a small % of total output firms output is a small % of total output A) Price A) Price –price determined by demand & supply –P e on figure B) Output B) Output –profits maximised where MC=MR –output = Q e –market price is not affected by Q e firms output is a small % of total output firms output is a small % of total output

fig O O Price (£) AR, MR (£) PePe S D D = AR = MR Q (millions)Q (hundreds) (a) The market(b) The firm Short run equilibrium – perfect competition

3. Short run equilibrium C) Profit C) Profit (i) If AC < AR AC includes normal profit AC includes normal profit firm makes supernormal profit – see figure firm makes supernormal profit – see figure a short run outcome a short run outcome

fig O £ (b) Firm Q (thousands) O (a) Industry P Q (millions) S D PePe MC AR D = AR = MR QeQe AC Short-run equilibrium of industry and firm under perfect competition

3. Short run equilibrium C) Profit C) Profit –if AC > AR MC = MR is loss minimising MC = MR is loss minimising Should the firm continue production? Should the firm continue production? Yes, as long as price (=AR) > AVC Yes, as long as price (=AR) > AVC See Figure See Figure

fig QeQe P1P1 D 1 = AR 1 = MR 1 AR 1 OO (a) Industry P£ Q (millions) S D (b) Firm MC AC Q (thousands) Loss minimising under perfect competition

4. The short run supply curve of the firm Equal to the short run marginal cost curve Equal to the short run marginal cost curve –supply curve: relates P to Q –MC curve: relates Q (production) to Costs –For profit max MR = MC; thus P = MC (since P = MR) Firms supply depends on costs of production Firms supply depends on costs of production –MC is upward sloping; supply upward sloping –MC rise as output rises (diminishing returns) –higher price induces greater output

fig OO (a) Industry P£ P1P1 Q (millions) S D1D1 (b) Firm D 1 = MR 1 MC Q (thousands) Deriving the short-run supply curve a = S