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Perfect and Imperfect Competition - Coggle Diagram
Perfect and Imperfect Competition
Pure Competition in the Short Run
Four Market Models
Pure monopoly
A market structure in which one firm sells a unique product, into which entry is blocked, in which the single firm has considerable control over product price, and in which nonprice competition may or may not be found.
Monopolistic competition
A market structure in which many firms sell a differentiated product, entry is relatively easy, each firm has some control over its product price, and there is considerable nonprice competition.
Pure, or perfect, competition
A market structure in which a very large number of firms sells a standardized product, into which entry is very easy, in which the individual seller has no control over the product price, and in which there is no nonprice competition; a market characterized by a very large number of buyers and sellers.
Oligopoly
A market structure in which a few firms sell either a standardized or differentiated product, into which entry is difficult, in which the firm has limited control over product price because of mutual interdependence (except when there is collusion among firms), and in which there is typically nonprice competition.
Pure Competition: Characteristics and Occurrence
Very large numbers
Presence of a large number of independently acting sellers, often offering their products in large national or international markets
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).
Standardized product
Produce identical or homogeneous product. As long as the price is the same, consumers are indifferent about which seller to buy the product from.
Free entry and exit
No significant legal, technological, financial, or other obstacles prohibit new firms from selling their output in a competitive market.
Demand as Seen by a Purely Competitive Seller
Perfectly Elastic Demand
. The demand curve of a purely competitive firm is a horizontal line (perfectly elastic) because the firm can sell as much output as it wants at the market price
Average, Total, and Marginal Revenue
Total revenue
The total number of dollars received by a firm (or firms) from the sale of a product; equal to the total expenditures for the product produced by the firm (or firms); equal to the quantity sold (demanded) multiplied by the price at which it is sold.
Marginal revenue (MR)
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.
Average revenue
Total revenue from the sale of a product divided by the quantity of the product sold (demanded); equal to the price at which the product is sold when all units of the product are sold at the same price.
Profit Maximization in the Short Run: Total-Revenue–Total-Cost Approach
The only variable that the firm can control is its output
Maximize its economic profit (or minimize its economic loss) by adjusting its output
Can adjust its output only by changing the amount of variable resources (materials, labor) it uses.
Two ways to determine the level of output
The other is to compare marginal revenue and marginal cost
One method is to compare total revenue and total cost
Three questions a competitive producer will ask.
If so, in what amount?
What economic profit (or loss) will we realize?
Should we produce this product?
Break-even point
An output at which a firm makes a normal profit (total revenue = total cost) but not an economic profit.
Profit Maximization in the Short Run: Marginal-Revenue–Marginal-Cost Approach
Compares the marginal revenue (MR) and the marginal cost (MC) of each successive unit of output, with the goal of either increasing the size of its profit or decreasing the size of its loss.
In the initial stages of production, where output is relatively low, marginal revenue will usually (but not always) exceed marginal cost (MR > MC).
At later stages of production, where output is relatively high, rising marginal costs will exceed marginal revenue (MR < MC).
MR = MC rule
This output level is the key to the output-determining rule.
The principle that a firm will maximize its profit (or minimize its losses) by producing the output at which marginal revenue and marginal cost are equal, provided product price is equal to or greater than average variable cost.
Features of the 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.
The rule is an accurate guide to profit maximization for all firms whether they are purely competitive, monopolistic, monopolistically competitive, or oligopolistic.
For most sets of MR and MC data, MR and MC will be precisely equal at a fractional level of output. In such instances 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. Because the demand schedule faced by a competitive seller is perfectly elastic at the going market price, product price and marginal revenue are equal. So, under pure competition (and only under pure competition), we may substitute P for MR in the rule: When producing is preferable to shutting down, the competitive firm should produce at the point where price equals marginal cost (P = MC).
Profit-maximizing output
Every unit of output up to and including the ninth unit represents greater marginal revenue than marginal cost.Each of the first 9 units therefore adds to the firm’s profit and should be produced. The tenth unit, however, should not be produced.
Economic profit
Profit = (P - A) * Q
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
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).
Should this firm produce?
Yes, if 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.
Monopolistic Competition
A market structure in which many firms sell a differentiated product, entry is relatively easy, each firm has some control over its product price, and there is considerable nonprice competition.
Characterized by (1) a relatively large number of sellers; (2) differentiated products (often promoted by heavy advertising); and (3) easy entry to, and exit from, the industry.
Relatively Large Number of Sellers
Small market shares
The presence of a relatively large number of firms ensures that collusion (coordination) by a group of firms to restrict output and set prices is unlikely.
Independent action
The presence of a relatively large number of firms ensures that collusion (coordination) by a group of firms to restrict output and set prices is unlikely.
No collusion
Each firm has a comparatively small percentage of the total market and consequently has limited control over market price.
Product differentiation
A strategy in which one firm’s product is distinguished from competing products by means of its design, related services, quality, location, or other attributes (except price).
Qualities of product differentiation
Product Attributes
Service
Location
Brand Names and Packaging
Some Control over Price
Easy Entry and Exit
Advertising
Nonprice competition
Competition based on distinguishing one’s product by means of product differentiation and then advertising the distinguished product to consumers.
Monopolistically Competitive Industries
Economists measure the degree of industry concentration.Two such measures are the four-firm concentration ratio and the Herfindahl index.
Four-firm concentration ratio
The percentage of total industry sales accounted for by the top four firms in an industry.
Herfindahl index
A measure of the concentration and competitiveness of an industry; calculated as the sum of the squared percentage market shares of the individual firms in the industry.
Price and Output in Monopolistic Competition
Demand Curve
Highly but not perfectly elastic
Two reasons, the monopolistic competitor’s demand is not perfectly elastic
Monopolistic competitor has fewer rivals
Its products are differentiated, so they are not perfect substitutes
The Long Run
In the long run, firms will enter a profitable monopolistically competitive industry and leave an unprofitable one. Therefore a monopolistic competitor will earn only a normal profit in the long run or, in other words, will only break even.
The Short Run: Profit or Loss
Monopolistically competitive firms maximize profit or minimize loss using exactly the same strategy as pure competitors and monopolists: They produce the level of output at which marginal revenue equals marginal cost (MR = MC)
Monopolistic Competition and Efficiency
Economic efficiency requires each firm to produce the amount of output at which P = MC = minimum ATC. The equality of price and minimum average total cost yields productive efficiency.
The equality of price and marginal cost yields allocative efficiency
Excess capacity
Plant resources that are underused when imperfectly competitive firms produce less output than that associated with achieving minimum average total cost.