Pure competition in the short run
Four Market Modules
Pure Monopoly one firm is the sole seller producing an unique product. Additional firms are blocked from entering the industry.
Pure Competition large number of firms producing a standardized product. Entry or exit to the industry is easy.
Oligopoly few firms producing standardized or different products. Each firm is effected by the decisions of its rivals.
Monopolistic Competition large number of firms producing different products. Entry or exit to the industry is easy.
Characteristics and Occurrence
Very Large Numbers independently acting sellers, usually offering their products in large national or international markets.
Price Takers firms do not exert control over product price.
Standardized Products identical or homogeneous products. Sellers made no effort to differentiate their products.
Free Entry and Exit no significant legal, technological or financial obstacles prohibited new firms from entering the industry.
Perfectly Elastic Demand an individuals output represents a small fraction of the markets total output. Therefor, for an individual firm, the market price is fixed. The demand curve for an individual firm will plot as a straight, horizontal line.
Profit Maximization in the Short Run
Marginal and Average Revenue coincide with the firm's demand curve. Total Revenue rises with the product price with each additional unit sold.
Purely competitive firms maximize their economic profit by adjusting their output.
There are two methods that will determine the level of output to a) maximize profit or b) minimize loss 1- compare total revenue to total cost. 2- compare marginal revenue to marginal cost.
Total-Revenue-Total-Cost Approach
Should we produce this product?
What economic profit (or loss) will we recognize?
If so, at what amount?
A firm's profit is maximized at the output where total revenue exceeds total cost with the maximum amount.
The vertical distance between TR and TC is the total-economic-profit curve.
Marginal-Revenue-Marginal-Cost Approach
Assuming producing is preferable to shutting down, a firm should produce where marginal revenue exceeds marginal cost.
The profit-maximizing guide is known as the MR=MC Rule.
Economic-profit = Profit = (P-A) x Q
Loss-Minimizing case Whenever P exceeds 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 where MR=MC. At this output, each unit contributes P-V where V is AVT at said unit of output. Per unit loss is A-P, total loss is (unit of output) x (A-P).
Shutdown Case If price falls below the minimum AVC the firm will minimize its losses in the short run by shutting down. There is no level of output where a firm can produce and incur a loss smaller that its total fixed cost.
Marginal Cost and Short Run Supply
The solid segment of a firms MC curve that lies above AVC is the firms short-run supply curve.
Because of the law of diminishing returns, marginal cost will rise as more units of output is produced. Because of this a purely competitive firm must receive successively higher prices to motivate it to produce more units of output.
Changes is factors such as technology, will recult in a shift of the demand curve and decrease or increase supply.
To determine the equilibrium price we need a) total supply schedule b)total demand schedule.
We assume a particular number of firms in the industry have the same supply schedule. We then sum up the quantities supplied at each price level to obtain the total supply schedule.
To determine the equilibrium price and output, we must compare the total-supply data to the total-demand data. Assume that the total demand is the product price and the total quantity demanded. By comparing the total quantity supplied and total quantity demanded at multiple possible prices, we can determine the equilibrium price and quantity.
Monopolistic Competition
Small Market Shares a firm has a small percentage of the total market and limited control over market price.
Independent Action there is no feeling of interdependence among firms.
No Collusion collusion by a group of firms to restrict output and set prices is unlikely.
Monopolistic Competitive Industries
Advertising
Differentiated Products
Brand name and Packaging
Service
Product attributions
Location
Some control over price
Easy Entry and Exit compared to pure competition industries, entry to the monopolistic industry is easy.
Differentiation would be useless if the public was not made aware of these differences. Therefor advertising is used.
Four-Firm Concentration Ratio is the ratio of output of the four largest firms in an industry, relative to total industry sales.
Herfindahl Index is the sum of the squared percentage market shares of all firms in the industry.
The Firms Demand Curve is highly, but not perfectly, elastic because monopolistic competition has fewer rivals and no perfect product substitutes due to differentiation.
In the short run, these firms maximize profit (or minimize loss) the same way a purely competitive industry does.
In the long run these firms will earn normal profit (break even).
Losses: Firms Leave When suffering short-run losses, some firms will exit in the long-run resulting in less substitute products and expanding the share of demand. This will cause a rise in the demand curves of surviving firms.
Complications Due to differentiation and financial barriers, entry to the industry might not be as free as it is in theory. Firms with well known brand-names might also have advantages other firms do not have, and might realize modest economic profits in the long-run.
Profits: Firms Enter In the short-run, economic profits attract new rivals and causes the demand curve of existing firms to fall as they now hold an even smaller share of the market demand and also faces more substitute-able products.
In monopolistic competition, neither productive or allocative efficiency occurs in the long run. To produce the profit-maximizing output, ATC would be higher than optimal from societies perspective and productive efficiency would not be achieves. Profit-maximizing price also exceeds marginal cost causing an under-allocation of resources.
Excess capacity is the gap between minimum-ATC output and profit-maximizing output. This gap is usually caused when firms are producing less than the minimum-ATC causing plant and equipment to be underused.