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Perfect & Imperfect Competition (Demand as Seen by a Purely…

- - - - Yes, if price is equal to, or greater than, minimum average variable cost. This means that the firm is profitable or that its losses are less than its fixed cost.
    - - Produce where MR(=P) = MC; there, profit is maximized (TR exceeds TC by a maximum amount) or loss is minimized.
    - - Yes, if price exceeds average total cos (so that TR exceeds TC). No, if average total cost exceeds price (so that TC exceeds TR).
  - - - Assuming market price is $131
        
        Compare TC & TR Graphically to view the profit-maximizing points
        
        TC increases with output because more production requires more resources BUT the rate of increase in TC varies with the efficiency of the firm which in turn varies with the amount of variable inputs that are being combines with the firm's current amount of capital (which is fixed in the short run).
        
        TR = TC at two intersections which means TR covers all costs (including normal profit).
        This output is called: Break-Even Point: An output at which a firm makes a normal profit but not an economic profit.
        
        Any output within the 2 break-even points identified will yield an economic profit
        
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- - - - Therefore firms compares the marginal revenue (MR) and the marginal cost (MC) of each successive unit of output.
        
        Assuming that producing is preferable to shutting down, the firm should produce any unit of output whose marginal revenue exceeds its marginal cost because the firm would gain more in revenue from selling that unit than it would add to its costs by producing it. Conversely, if the marginal cost of a unit of output exceeds its marginal revenue, the firm should not produce that unit. Producing it would add more to costs than to revenue, and profit would decline or loss would increase.
        
        In the short run the firm will maximize profit or minimize loss by producing the output at which marginal revenue equals marginal cost (as long as producing is preferable to shutting down).
        
        MR=MC Rule
        
        P=MC (ONLY under Pure Competition)
  - - - Column 1: Output (Q) Column 2: Average Fixed Cost (AFC) Column 3: Average Variable Cost (AVC) Column 4: Average Total Cost (ATC) Column 5: Marginal Cost (MC) Column 6: Price=Marginal Revenue (MR) Column 7: Total Economic Profit (+) or Loss (-)
        
        Assuming Market Price therefore Marginal Revenue is $131
        
        Economic Profit = Total Revenue (TR (Price *Quantity)) - Average Total Cost (ATC)
        OR
        Economic
        Profit = (P-A)xQ
        This is a per-unit profit which can just be multiplied by the quantity/output
        A represents Average Total Cost
        
        Price = Marginal Cost = Marginal Revenue at the Profit Maximizing Output of X units
        
        The total economic profit is 9x(P-A) and is shown by the green rectangular area
        
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  - - - Column 1: Output (Q) Column 2: Average Fixed Cost (AFC) Column 3: Average Variable Cost (AVC) Column 4: Average Total Cost (ATC) Column 5: Marginal Cost (MC) Column 6: Price=Marginal Revenue (MR) Column 7: Total Economic Profit (+) or Loss (-)
        
        Wherever price P exceeds average variable cost AVC but is less than ATC, the firm can pay part, but not all of its fixed costs by producing. The loss is minimized by producing the output at which MC=MR (here 6 units).
        
        At that output, each unit contributes P-V to covering fixed cost, where V is the AVC at 6 units of output. The per-unit oss is A-P=$10.67, and the total loss is 6x(A-P), or $64, as shown by the red area.
        
        Assuming Market Price therefore Marginal Revenue is $81
  - - - Column 1: Output (Q) Column 2: Average Fixed Cost (AFC) Column 3: Average Variable Cost (AVC) Column 4: Average Total Cost (ATC) Column 5: Marginal Cost (MC) Column 6: Price=Marginal Revenue (MR) Column 7: Total Economic Profit (+) or Loss (-)
        
        Assuming Market Price therefore Marginal Revenue is $71
        
        The firm should not produce because at every output level the firm's average variable cost is greater than the price. The smallest loss it can incur by producing is greater than the $100 fixed cost it will lose by shutting down.
        
        The shutdown case reminds us of the qualifier to our MR=P=MC Rule. A competitive firm will maximize profit or minimize loss in the short run by producing that output at which MR (=P) = MC, provided that market price exceeds minimum average variable cost.
        
        If price P falls below the minimum AVC (here $74 at Q=5), the competitive firm will minimize its losses in the short run by shutting on There is no level of output at which the firm can produce and incur a loss smaller than its total fixed cost.
- - - - The P=MC rule and the competitive firm's short-run supply curve. Application of the P=MC rule, as modified by the shutdown case, reveals that the (solid) segment of the firm's MC Curve that lies above AVC is the firm's short-run supply curve. More specifically, at price P1, P=MC at point a, but the firm will produce no output because P1 is less than minimum AVC. At price P2 the firm will operate at point b, where it produces Q2 units and incurs a loss equal to its total fixed cost. At P3 it operates at point c, where output is Q3 and the loss is less than total fixed cost. With the price of P4, the firm operates at point d; in this case the firm earns a normal profit because at output Q4 price equals ATC. At price P5 the firm operates at point e and maximizes its economic profit by producing Q5 units.
        
        The above summarizes the MR=MC approach to determining the competitive firm's profit-maximizing output level. It also shows the equivalent analysis in terms of total revenue and total cost.
        
        The short-run supply curve tells us the amount of output the firm will supply at each price in
        a series of prices.
- - - - Quantity supplied has increased in direct response to an increase in product price and the desire to maximize profit.
- - - - Industry:
        
        Short-Run Competitive equilibrium for a firm and the industry: The horizontal sum of the 1,000 firm's individual supply curves (s) determines the industry supply curve (S). Given industry demand (D), the short-run equilibrium price and output for the industry are $111 and 8000 units and, in this case, realizes the economic profit represented by the green area.
- - - - a. Small Market Shares - thus limited control over market price
      - b. No collusion: Collusion by a group of firms to restrict output & set prices is unlikely
      - c. Independent action: Each firm can determine its own pricing policy without considering the possible reactions of rival firms.
    - - a. Product Attributes: Entails physical/qualitative differences in the products themselves. Real differences in functional features, materials, design, and workmanship are vital aspects of product differentiation.
      - b. Service: The prestige appeal of a store, the courteousness and helpfulness of clerks, the firm's reputation for servicing or exchanging its products, and the credit it makes available are all service aspects
      - c. Brand Names & Packaging: Differentiation created through use of brand names, trademarks, packaging, and celebrity connections
      - d. Some control over price: The monopolistic competitor's control over price is quite limited since there are numerous potential substitutes for its product but can help with product differentiation
    - - Relatively easy to enter & exit compared to oligopoly and monopoly due to being small firms, economies of scale are few and capital requirements are low
    - - The goal of product differentiation and advertising - so called non-price competition - is to make price less of a facto in consumer purchases and make product differences a greater factor
    - - Economists measure the degree of industry concentration - the extent to which the largest firms account for the bulk of the industry's output - to identify monopolistically competitive (vs Oligopolistic) industries.
        
        Two Measures
        
        Four-firm concentration ratio
        
        Four-Firm Concentration Ratio = Output of four largest firms/Total Output in the industry
        
        Four-firm concentration ratios are very low in purely competitive industries due to their small market share. In contrast ratios are high in oligopoly and pure monopoly.
        
        Industries in which the largest four firms account for 40% or more of the market are generally considered to be oligopolies if less than 40 then likely considered as Monopolistically Competitive
        
        Herfindahl index
        
        This index is the sum of the squared % market shares of all firms in the industry
        
        The Herfindahl purposely gives more weight to larger firms than smaller ones
        
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  - - - The Short Run: Profit/Loss
        
        Monopolistically Competitive Firms use same strategy as pure competition in the short run
        
        Produce output where MR=MC BUT Charge price P1 to realize an economic profit, shown by the green are [=(P1-A1)xQ1]
        
        But with less favourable demand/costs, the firm may incure a loss in the short run. where the firm must minimize its loss and therefore produce output Q2 where MR=MC and as determined by demand curve chage P2. Because P2 is less than ATC A2, the fir incurs a per-unit loss of A2-P and a total loss represented as the red area [=(A2-P2)xQ2]
        
        a.
        
        b.
        
        The Long Run: Only a Normal Profit
        
        In the long run, firms will enter a profitable monopolistically competitive industry and leave an unprofitable one.
        
        A monopolistic competitor will earn only a normal profit in the long run or will only break even. (Cost curves include both explicit & implicit costs including normal profit)
        
        As new firms enter the demand curve faced by the typical firm shifts to the left because each firm has a smaller share of total demand and now faces a larger number of close-substitutes and it therefore reduces its economic profit
        
        When industry suffers short-term losses, some firms will exit in the long run which will ensure an expanded share of total demand where the surviving firms will see demand curves shift to the right and their losses will disappear and give way to normal profits.
        
        c.
        
        The monopolistic competitor maximizes profit or minimizes loss by producing the output at which MR=MC. The economic profit shown in (a) will induce new firms to enter, eventually eliminating economic profit. The loss shown n (b) will cause an exit of firms until normal profit is restored. After succh entry and exit, the price will settle in (c) to where it just equals average total cost at the MR=MC output. At this price P3 and output Q3, the monopolistic competitor earns only a normal profit, and the industry is in long-run equilibrium.
  - - - Economic Efficiency requires each firm to produce the amount of output at which P=MC=Minimum ATC. The above equality yields productive efficiency The good is being produced in the least costly way, and the price is just sufficient to cover average total cost, including a normal profit.
        
        The equality of price and marginal cost yields allocative efficiency. The right amount of output is being produced, and thus the right amount of society's scarce resources is being devoted to this specific use.
        
        How efficient is monopolistic competition, as measured against the above triple equality? P = MC = Minimum ATC
        
        Quantity:
        
        Excess Capacity:
        
        The inefficiency of monopolistic competition: In long-run equilibrium a monopolistic competitor achieves neither productive nor allocative efficiency. Productive efficiency is not realized because production occurs where the average total cost A3 exceeds the minimum average total cost A4. Allocative efficiency is not achieved because the product price P3 exceeds the marginal cost M3. The results are an underallocation of resources as well as an efficiency loss and excess production capacity at every firm in the industry. This firm's efficiency loss is area acd and its excess production capacity is Q4-Q3
  - - - Benefits of Product Variety
        
        The product variety and product improvement are a benefit for society - one that offset the cost of the inefficiency associated with monopolistic competition.
        
        It further differentiates products and expands choices.
        
        Product Differentiation creates a trade-off between consumer choice and productive efficiency.
        The stronger the product differentiation, the greater is the excess capacity and, therefore, the greater is the productive inefficiency.
        BUT
        The greater the product differentiation, the more likely it is that the firms will satisfy the great diversity of consumer tastes.
        The greater the excess-capacity problem, the wider the range of consumer choice.
        
        Complexities
        
        The monopolistically competitive firm juggles 3 factors - price, product, and advertising - in seeking maximum profit. It must determine what variety of product, selling at what price, and supplemented by what level of advertising will result in the greatest profit.
        In practice, this optimal combination cannot be readily forecast but must be found by trial and error.