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MARKET STRUCTURES, Efficiency
Economic efficiency requires each firm to…
MARKET STRUCTURES
PURE COMPETITION
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Perfectly Elastic Demand: Horizontal line (perfectly elastic), firm can sell as much output as it wants at the market price
Market **Demand the curve will slope downwards
-MR -is the change in TR that results from selling one more unit of output
-Total Revenue is a straight lline that slopes upward to the right-constant
-MR coincides with the demand curve because product price is constant
-The AR curve equals price and also coincides with the demand curve
D=MR=AR
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Marginal Cost and SR Supply
-Quantity supplied increases as price increases
-economic profit is higher at higher prices
-solid segment of the firms MC curve that lies above AVC is the firms short run supply curve
-where Price=ATC, a normal profit will be earned
Changes in Supply:
Factors that alter costs and shift the MC or short run supply curve to a new location are:
a. Price of variable inputs
b. Technology
Firm and Industry: Equilibrium price
Market Equilibrium price is the total quantity supplied equals total quantity demanded.
The horizontal sum of the 1000 firms' individual supply curves (s) {s=MC} determines the industry supply curve (S)
Fallacy of Composition: the false notion that what is true for the individual (or part) is necessarily true for the group (or whole)
MONOPOLISTIC COMPETITION
Characteristics:
Relatively large number of sellers
Differentiated products
Easy entry to; exit from industry
Nonprice competition (is to make price less of a factor and to make product differences a greater factor; if advertising is successful, the firms demand curve will shift to the right and become less elastic)
Monopolistically Competitive industries-Industry concentration, the extent to which the largest firms account for the bulk of the industry's output are measured by:
- Four-Firm concentration ratio = Output of four largest firms/Total Output in the industry
- The Herfindahl index: calculated as the sum of the squared percentage market shares of the individual firms in the industry
PRICE AND OUTPUT
-Demand curve is not perfectly elastic since the monopolistic competitor has fewer rivals and its products are differentiated, so they are not perfect substitutes.
-The price elasticity of demand faced by the monopolistically competitive firm depends on the number of rivals and the degree of product differentiation (more rivals and weaker the product differentiation, the greater the price elasticity of each sellers demand).
Short Run: Profit or Loss
- a monopolistic competitor will maximize profit or minimize loss by producing the level of output at which marginal revenue equals marginal cost
Economic Profit = (P1-A1) x Q1Loss= ( A2-P2) x Q2
Long Run Equilibrium
- Firms will enter a profitable monopolistically competitive industry and leave an unprofitable one
-Normal profit/break even
Product VarietyBenefits:
- Product variety and product improvement is a benefit to society
-If a product is differentiated, consumer can choose from a wide range of types, styles, brands-Improvement of product expands choices, obligates rivals to imitate/or improve their product
Efficiency
Economic efficiency requires each firm to produce the amount of output at which P = MC = minimum ATC (Productive efficiency)
The equality of Price and Marginal Cost yields Allocative efficiency
In monopolistic competition, neither productive nor allocative efficiency occurs in long run equilibrium because in productive efficiency the average total cost exceeds minimum average total cost; allocative efficiency is not achieved because the product price exceeds the marginal cost.
Excess Capacity
Plant resources that are underused when imperfectly competitive firms produce less output than that associated with achieving minimum average total cost.
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Shutdown Case:
P < AVC (the competitive firm will minimize its losses in the short run by shutting down.