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Unit 4: Perfect and Imperfect Competition - Coggle Diagram
Unit 4: Perfect and Imperfect Competition
Pure Competition in the Short Run
Characteristics of Pure Competition
Standardized (Identical) product
"Price takers" - A seller (or buyer) that is unable to affect the price at which a product or resource sells by changing the amount it sells (or buys).
Very large numbers
Free entry and exit - no significant obstacles.
Demand as seen by a Purely Competitive Seller
The demand experienced by a purely competitive firm is perfectly elastic—horizontal on a graph—at the market price.
Marginal revenue and average revenue for a purely competitive firm coincide with the firm’s demand curve; total revenue rises by the product price for each additional unit sold.
Average Revenue
- Total revenue from the sale of a product divided by the quantity of the product sold; equal to the price at which the product is sold when all units of the product are sold at the same price.
Marginal Revenue
- The change in total revenue that results from the sale of 1 additional unit of a firm’s product; equal to the change in total revenue divided by the change in the quantity of the product sold.
Total Revenue
- The total number of dollars received by a firm from the sale of a product; equal to the total expenditures for the product produced by the firm; equal to the quantity sold multiplied by the price at which it is sold.
Total-revenue-total-cost approach to profit maximization
Confronted with the market price of its product, the competitive producer will ask three questions: (1) Should we produce this product? (2) If so, in what amount? (3) What economic profit (or loss) will we realize?
The vertical distance between Total Revenue and Total Cost is plotted as a total-economic-profit curve. The verticle distance is the maximum economic profit.
Total revenue and total cost are equal where the two curves intersect. Total revenue covers all costs, but there is no economic profit. Economists call this output a break-even point: an output at which a firm makes a normal profit but not an economic profit.
Marginal-revenue-marginal-cost Approach
The firm compares the marginal revenue and the marginal cost of each successive unit of output, with the goal of either increasing the size of its profit or decreasing the size of its loss.
the firm should produce any unit of output whose marginal revenue exceeds its marginal cost because the firm will gain more in revenue from selling that unit than it will 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. The firm would be making a increasing loss.
Output-determining rule
: As long as producing some positive amount of output is preferable to shutting down and producing nothing, the firm will maximize profit or minimize the loss in the short run by producing the quantity of output at which marginal revenue equals marginal cost (MR = MC).
MR = MC Rule:
The rule applies only if producing is preferable to shutting down. If marginal revenue does not equal or exceed average variable cost, the firm will shut down rather than produce.
This rule is an accurate guide to profit maximization for all firms.
MR and MC will be precisely equal at a fractional level of output, the firm should produce the last complete unit of output for which MR exceeds MC.
The rule can be restated as P = MC when applied to a purely competitive firm. The demand schedule faced by a competitive seller is perfectly elastic, therefore product price and marginal revenue are equal.
By subtracting the average total cost from the product price, we obtain a per-unit profit. Multiplying that amount by the total units of output, we determine the profit.
Profit = (P - A) x Q
Why would a firm still produce if its running at a loss?
If the loss is less than the firm’s fixed costs, which is the loss the firm would incur in the short run by closing down. The firm receives enough revenue per unit to cover its average variable costs and also to apply against fixed costs.
If the market price is below the minimum average variable cost, the firm will minimize its losses by
shutting down
.
Marginal Cost and Short-Run Supply
Short-run supply curve
- A supply curve that shows the quantity of a product a firm in a purely competitive industry will offer to sell at various prices in the short run; the portion of the firm’s short-run marginal cost curve that lies above its average-variable-cost curve.
Output Determination in Pure Competition in the Short Run
Should this firm produce?
Yes, if the 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.
What quantity should this firm produce?
Produce where MR (= P) = MC; there, profit is maximized (TR exceeds TC by a maximum amount) or loss is minimized.
Will production result in economic profit?
Yes, if price exceeds average total cost (so that TR exceeds TC). No, if average total cost exceeds price (so that TC exceeds TR).
Changes in such factors as the prices of variable inputs or in technology will alter costs and shift the MC or short-run supply curve to a new location.
Product price is a given fact to the individual competitive firm, but the supply plans of all competitive producers as a group are a basic determinant of product price. This is exemplified by the 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
- Small market shares, No collusion, Independent action.
Differentiated products
- Product attributes, Service, Location, Brand names and packaging, some control over price.
Easy Entry and Exit
The goal of product differentiation and advertising—so-called
nonprice competition
—is to make price less of a factor in consumer purchases and to make product differences a greater factor.
Two measures of industry concentration:
A
four-firm concentration ratio
, expressed as a percentage, is the ratio of the output (sales) 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.
In the
short run
, a monopolistic competitor will maximize profit or minimize loss by producing the level of output at which marginal revenue equals marginal cost.
In the
long run
, easy entry and exit of firms cause monopolistic competitors to earn only a normal profit.
The equality of price and minimum average total cost yields
productive efficiency.
The equality of price and marginal cost yields
allocative efficiency
. The right amount of output is being produced, and thus the right amount of scarce resources is devoted to this specific use.
the gap between the minimum-ATC output and the profit-maximizing output identifies
excess capacity
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 exceeds the minimum average total cost. Allocative efficiency is not achieved because the product price exceeds the marginal cost.
Four Market Models
Monopolistic Competition
- Involves many firms who produce differentiated products. Relatively easy to enter. Some control over price.
Oligopoly
- A few firms that produce standardized or differentiated products. Limited/considerable control over price. Significant obstacles to entry.
Pure/Perfect Competition
- A very large number of firms producing standardized products. Easy entry and exit. No control over price.
Pure Monopoly
- One firm is the sole seller that produces unique non-substitutable goods. Considerable control over price. Blocked conditions of entry.