CHAPTER 10 - PURE COMPETITION IN THE SHORT RUN

Four Market Models

Pure / Perfect Competition

Pure Monopoly

Monopolistic Competition

Oligopoly

Standardized Product
NO Control over price
Very easy and no obstacles to entry
NO Nonprice competition

Many number of firms
Differentiated product types
Some control over price - but narrow limits
Relatively easy entry
Nonprice competition - advertising, brand names, trademarks

Few Firms
Standardized / differentiated product types
Control over price is limited by mutual independence and considerable if collusion occurs
Significant obstacles to entry
Nonprice competition is typically large particularly with differentiated products

ONE firm
Unique product and no close substitutes
Considerable price control
Entry for new firms is blocked
Nonprice advertising is usually Public Relations type advertising

Characteristics of Pure Competition

Rare in the real world - but a good model to compare other types of models

Very Large Numbers of independent firms
FX Market
Stock Market

Standardized Product
All substitutes independent of firm
Example is Cap Screw made to standard

Price Takers
Cannot change market price - only adapt to it
Increasing price by firm would drive customers to next firm
Decreasing price would shrink profit

Free Entry & Exit - no obstacles to entry

Perfectly Elastic Demand @ Market Price for INDIVIDUAL FIRM

Cannot achieve a higher price by restricting output
Does not need to lower price to increase sales volume - can sell whatever it wants at market price Screenshot 2021-04-05 091835

MARKET DEMAND is downward sloping curve

Entire Industry Can Affect Price by acting independently and all changing industry output volumes

Average, Total & Marginal Revenue

Demand Schedule = average revenue schedule

Total Revenue = Price X Quantity

MARGINAL REVENUE = change in revenue that results in selling one more unit of output = PRICE

Profit Maximization in the Short-Run

Only variable under control is OUTPUT

Purely competitive firm can maximize profits or minimize loses by only changing OUTPUT in short-run

2 Ways -
1 - Compare Total Revenue to Total Cost
2 - Compare Marginal Revenue to Marginal Cost

Can Also apply to all market models

3 Questions
1 - Should we produce?
2 - If so at what quantity?
3 - What economic P/L will be realized?

Total Revenue is increasing Straight Line Graph
Total Costs increases with quantity but varies with firms efficiency - Reflects the Law of Diminishing Returns - there is a point at which rate of Total Cost Increases for more output

Break-Even Point
TR = TC (2 places)
Normal Profit - but no Economic Profit

Economic Profit is made between 2 break-even points
Can also see profit maximizing case easily by graphically analyzing

Screenshot 2021-04-05 094051

Marginal Revenue - Marginal Cost Approach

If operation is preferable to shutting down
Firm MUST PRODUCE at any point where MR > MC
Firm MUST STOP when MC > MR

MC = MR Rule
= Price (For Purely competitive firm)

When Producing is better than shutting down a firm will maximize profits or minimize losses in the short-run at this point

Profit Maximizing Case Screenshot 2021-04-05 100156

Economic Profit = (P - A) x Q

Loss Minimizing Case Screenshot 2021-04-05 100447

FIRM SHOULD STILL PRODUCE WHEN

Loss is less than FIXED COSTS
Price is bigger than VARIABLE COSTS

Shut-Down Case Screenshot 2021-04-05 100927

FIRM SHOULD SHUT DOWN WHEN

Price is always less than AVERAGE VARIABLE COSTS at all units of output

Marginal Cost & Short-Run Supply Screenshot 2021-04-05 101650

Portion of a Firms Marginal Cost Curve that lies ABOVE its Average Variable Cost Curve is the firms short-run SUPPLY Curve

Changes in determinants of supply will shift the short-run supply curve as they alter the MC of the firm - example wages increase

Market supply including short run supply curve is obtained by taking total summation of all firms in that industry

Equilibrium price and quantity is found by taking market supply and market demand and seeing where they intersect

Fallacy of Composition - A statement that is valid for one firm - may not be true for all the firms in that pure competition market

One firm is a price taker
All the firms are price makers

CHAPTER 13 - MONOPOLISITC COMPETITION

Small Amount of Monopoly Power with Large Amount of Competition

Relatively Large Number of Firms - say less than 100

Differentiated Products

Easy Entry / Exit from Industry

Small Market Shares and therefore limited control over price

Collusion in unlikey due to larger number of firms

Independent Action - firms are not interdependent on one-another and can each determine their own pricing policy

Product Attributes

Service

Location

Brand Names & Packaging

Some Control over price due tot Product Differentiation

Typically Small firms
Economies of scale and capital requirements are low
However some barriers to entry such as financial barriers to advertising

Nonprice Competition

Advertising the Differentiated products that these firms offer compared to their competitors

Monopolistically Competitive Industries

Industry Concentration Measured Using 2 Methods to identify oligopoly versus monopolistic competition:
4 firm concentration Ratio
Herfindahl Index

4 Firm Concentration Ratio = Output by largest 4 firms / Total Output of Industry

Herfindahl Index = Sum of squared percentage of market shares of all firms in a particular industry

If bigger than 40% - Oligopoly
If less than 40% Monopolistic Competition

Use with CAUTION as values are national where competition is often local in nature

Pure Competition - Index approaches 0

Pure Monopoly - Index approaches 100

Price & Output in Monopolistic Competition

Demand Curve for Firm

Highly Elastic

Fewer Rivals
Fewer options for Substitutes

Short Run Demand Curve
Monopolistic Competition use same methods as pure competition to maximize profits and minimize losses

Short Run Profits Screenshot 2021-04-05 105313

Shor Run Losses Screenshot 2021-04-05 105339

Long-Run Equilibrium Screenshot 2021-04-05 105500

Profits - Firms Enter
Firms enter when industry shows short-run profits
Demand curve for firm shifts left as market share becomes more divided by all the firms

Losses - Firms Leave
Demand curve for remaining curve shifts to right

Market reaches equilibrium and remaining firms only earn a normal profit
Some firms achieve greater product differentiation which results in sustained Economic Profit
Some barriers to entry may be more difficult in real world situations