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CHAPTER 10 - PURE COMPETITION IN THE SHORT RUN - Coggle Diagram
CHAPTER 10 - PURE COMPETITION IN THE SHORT RUN
Four Market Models
Pure / Perfect Competition
Standardized Product
NO Control over price
Very easy and no obstacles to entry
NO Nonprice competition
Characteristics of Pure Competition
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
Rare in the real world - but a good model to compare other types of models
Pure Monopoly
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
Monopolistic Competition
Many number of firms
Differentiated product types
Some control over price - but narrow limits
Relatively easy entry
Nonprice competition - advertising, brand names, trademarks
CHAPTER 13 - MONOPOLISITC COMPETITION
Small Amount of Monopoly Power with Large Amount of Competition
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
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
Herfindahl Index = Sum of squared percentage of market shares of all firms in a particular industry
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
Shor Run Losses
Long-Run Equilibrium
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
Relatively Large Number of Firms - say less than 100
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
Differentiated Products
Product Attributes
Service
Location
Brand Names & Packaging
Some Control over price due tot Product Differentiation
Easy Entry / Exit from Industry
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
Oligopoly
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
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
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
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
Economic Profit = (P - A) x Q
Loss Minimizing Case
FIRM SHOULD STILL PRODUCE WHEN
Loss is less than FIXED COSTS
Price is bigger than VARIABLE COSTS
Shut-Down Case
FIRM SHOULD SHUT DOWN WHEN
Price is always less than AVERAGE VARIABLE COSTS at all units of output
Marginal Cost & Short-Run Supply
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
