The Demand Curve for a perfectly competitive firms shape

Horizontal

The Marginal Revenue Curve of a perfectly competitive firm is

The same as its demand curve

Why do we draw market supply curves upward sloping

Because market supply curves are the horizontal sum of firms' supply curves and firms supply curves are upward sloping

Why are firms supply curves upward sloping

Because the supply curve for each firm is the portion of its marginal cost (MC) curve that is above its average variable cost (AVC) curve—and this portion of the MC curve is upward sloping.

But why do MC curves have an upward-sloping portion?

According to the law of diminishing marginal returns, the marginal physical product (MPP) of a variable input eventually declines. When that happens, the MC curve begins to rise

Long run competitive equilibrium exists when firms have no incentive to

1. Enter or exit the industry 2. Produce more or less output 3. Change their plant size

Every Firm has to answer three questions

1. What price should the firm charge for all the good it produces and sells?

2. How many units of the good should the firm produce?

3. How much of the resources that the firm needs to produce its goods should it buy?

Market structure

Is a firms environment or setting whose characteristics influence the firms pricing and output decisions

Perfect competition is based on 4 assumptions

1. There are many sellers and many buyers, none of which is large in relation to total sales or purchases. 

2. Each firm produces and sells a homogenous product 

3. Buyers and sellers have all relevant information about prices, product quality, source of supply and so forth

4. Firms have easy entry and exit

Price taker

Which is a seller that does no have the ability to control the price of its product; in other words, such a firm takes the price determined in the market

Profit Maximization rule

Profit is maximized by producing the quantity of output at which MR= MC

Resource allocative efficiency

P=MC, or the situation in which firms produce the quantity of output at which price equals marginal cost

To produce or not

• If the price is about the average total cost, the firm maximizes profits by producing the quantity of output at which MR=MC

• If price is below average variable cost, the perfectly competitive firm minimizes losses by choosing to shut down- that is by not producing

• If price is below average total cost but above average variable cost the firm minimizes its losses by continuing to produce in the short run

Short-run (firm) supply curve

Is the portion of the firms marginal cost curve that lies above the average variable cost curve

Short-run (industry) supply curve

Horizontal sum of all existing firms short run supply curves

(Basically just add each point up and you get the industries supply curve)

The following characterize long-run competitive equilibrium

1. Economic profit is zero; that is, price (p) is equal to short run average total cost (SRATC)

   1. P=SRATC

      1. The logic of this condition is clear when we analyze what will happen if price is above or below short-run average total cost. If it is above, positive economic profits will attract firms to the industry in order to obtain the profits. If price is below, losses will result and some firms will want to exit the industry. Long-run competitive equilibrium cannot exist if firms have an incentive to enter or exit the industry in response to positive economic profits or losses. For long-run equilibrium to exist, there can be no incentive for firms to enter or exit. This condition is brought about by zero economic profit (normal profit), which is a consequence of the equilibrium price being equal to short-run average total cost.

2. Firms are producing the quantity of output which price (p) is equal to marginal cost (MC)

   1. P=MC

      1. Perfectly competitive firms naturally move toward the output level at which marginal revenue (or price, because, for a perfectly competitive firm, (MR= P) equals marginal cost.

3. No firm has an incentive to change its plant size to produce its current output; that is, at the quantity of output at which P=MC, the following condition holds

   1. SRATC=LRATC

      1. To understand this condition, suppose SRATC > LRATC at the quantity of output established in condition 2. Then the firm has an incentive to change its plant size in the long run because it wants to produce its product with the plant size that will give it the lowest average total cost (unit cost). It will have no incentive to change its plant size when it is producing the quantity of output at which price equals marginal cost and SRATC equals LRATC

The necessary conditions can be stated as, or when long run competitive equilibrium exists when: P = MC = SRATC = LRATC

Productive efficiency

A firm that produces its output at the lowest possible per unit cost (lowest ATC)

Industry adjustment to an increase in demand

1. We start at long-run competitive equilibrium, where P=MC=SRATC=LRatc

2. Then the market demand rises for the product produced by the firms in the industry, and the equilibrium price rises

3. As a consequence, the demand curve faced by an individual firm (the firms marginal revenue curve) shifts upwards

4. Next, existing firms in the industry increase the quantity of output because marginal revenue now intersects marginal cost at a higher quantity of output

5. In the long run, new firm begin to enter the industry because price is currently above average total cost and there are positive economic profits

6. As new firms enter the industry, the market (industry) supply curve shifts rightward

7. 7-8. As a consequence equilibrium price falls until long run competitive equilibrium is reestablished- that is until economic profit is zero once again

Constant Cost Industry

ATC does not change as output increases or decreases when firms enter or exit the industry. Horizontal long run supply curve

Increasing Cost industry

ATC increases as firms enter the industry and output increases; ATC decrease as firms exit the industry and output decreases. Upward sloping long run supply curve

Decreasing- Cost industry

ATC decrease as firms enter the industry and output increases; atc increase as firms exit the industry and output decreases. Downward sloping long run supply curve

Profit form two perspective

• Incentive

  • Prompting or encouraging certain behavior

• Signal

  • Identifies where resources are most welcome 

Higher costs mean Higher prices in a perfectly competitive market

If rise in cost in one firm, then no. If in all or many, yes.

Will the perfectly competitive firm advertise

Maybe. Not as individuals but as a market maybe

Supplier set price versus market determined price: collusion or competition

Can be collusion or that all firms are price takers

Total Revenue =

Total Revenue= Price * Quantity

Marginal Revenue=

Marginal Revenue= (Change in total revenue)/(change in quantity)

Revenue Lost=

Revenue Lost- (Initial price- new price) * Initial quantity

Theory of Monopoly

1. There is one seller

2. A single seller sells a product that has no substitutes

3. The barriers to entry are extremely high

Barriers to Entry

1. Legal Barriers

   1. Include public franchises, patents, and government licenses

      1. A public franchise is a right given by the government to have a firm have an exculusive right

2. Economies of Scale

   1. In some industries, low average unit costs are only obtained by large scale production. Having to produce on this scale is pricy and risky. Creating a natural barrier to entry. If its so pronounced that only one firm can exist this is called a natural monopoly

3. Exclusive ownership of a necessary resource

   1. Firms may be protected by government with exclusive access to a resource

Government Monopoly and Market Monopoly

• Government Monopoly

  • Exist when high barriers take the form of patents, government franchises, or competition is legally prohibited

• Market Monopoly

  • Exist when high barriers take the form of economies of scale or exclusive ownership, or when competition is not legally prohibited.

Price Searcher

A seller that has the ability to control, to some degree, the price of the product it sells

Monopolists Demand and Marginal Revenue

• The demand curve for the monopoly firm IS the demand curve for the industry; The monopoly is the industry, which is downward sloping

• For the monopolist, Price (P) > MR; since in order to gain more buyers, they need to lower price. Price reduction gains and loses revenue

Monopolists Demand curve and Marginal revenue curve

• The monopolies demand curve lies above the marginal revenue curve

Price and Output for profit maximization for a monopoly

• Seeks to maximize profit produces at the quantity of output at which MC=MR; and charges at the highest price per unit at which this quantity of output can be sold

• Monopolist cant charge any price it wants; only the highest price that the demand curve allows it to. 

If a Firm maximizes revenue, does it automatically maximize profit to?

1. Price is the total difference between total revenue and total cost 

   1. Profit= TR-TC

2. Since TC is the sum of Total Fixed Cost (TFC) and Total Variable cost (TVC); we can rewrite the profit equation as

   1. Profit = TR - (TFC+TVC)

3. Maximizing Profit is the same as maximizing total revenue under one condition: TVC=0. When this happens we can drop it

   1. Profit= TR - TFC

4. Therefore profit maximization is the same as revenue maximization only where there are no variable costs

Profit =

Profit= TR - TC; Profit= TR - (TFC+TVC)

Differences Between Perfect Competition and Monopolies

• Price, Marginal Revenue, and Marginal Cost

  • For the perfectly competitive firm, P=MR; for the monopolist P>MR. The demand curve for a competitive firm is  the marginal revenue curve; while the monopolists demand curve lies above the marginal revenue curve

  • The perfectly competitive firm charges a price equal to its marginal costs; while a monopolist firm charges a price greater than its marginal costs

    • Perfect Competition: P=MR and P=MC

    • Monopoly: P >MR and P>MC

• Consumers Surplus

  • Greater in perfectly competitive market than the monopolistic market

• Monopoly or Nothing

  • Although consumers get more surplus under perfect competition, sometimes due to natural barriers there is no way for any firm to be profitable, or there is no market. A monopolistic firm though can create a market by being able to lower costs. In perfect competition some markets will not exists, making it monopoly or nothing

Case against monopoly

• Deadweight loss of monopoly

  • The net value of the difference between the competitive quantity of output P=MC, and the monopoly quantity of output P>MC; the loss due to not producing the competitive quantity of output

• Rent seeking

  • If a market is monopolized, part of the consumers' surplus that is loss to the consumer is transferred- becomes profit for the monopoly; in economics this is called rent seeking

    • Rent seeking is: Actions of individuals and groups that spend resources to influence public policy in the hope of redistributing (transferring) income to themselves from others.

• X-Inefficiency

  • The increase in costs, due to the organizational slack in a monopoly, resulting from the absence of competitive pressure to push costs down to their lowest possible level

Rent seeking is:

Actions of individuals and groups that spend resources to influence public policy in the hope of redistributing (transferring) income to themselves from others.

Price Discrimination

A price structure in which the seller charges different prices for the product it sells and the price differences do not reflect cost differences.

Perfect Price Discrimination

price structure in which the seller charges the highest price that each consumer is willing to pay for the product rather than go without it; sometimes called discrimination among units

Second-degree price discrimination

price structure in which the seller charges a uniform price per unit for one specific quantity, a lower price for an additional quantity, and so on; sometimes called discrimination among quantities

Third Degree price discrimination

price structure in which the seller charges different prices in different markets or charges different prices to various segments of the buying population; sometimes called discrimination among buyers

Why would a monopolist practice price discrimination

A perfectly price-discriminating monopolist receives the maximum price for each unit of the good it sells; a single-price monopolist does not. For the monopolist who practices perfect price discrimination, price equals marginal revenue

Conditions of Price Discrimination

• The seller must exercise some control over price; that is, must be a price searcher

• The seller must be able to distinguish among buyers who are willing to purchase at different prices

• Reselling the good must be impossible or too costly; Arbitrage must not be possible

  • Arbitrage is buying a good at a low price and selling it for a higher price

Arbitrage

• Arbitrage is buying a good at a low price and selling it for a higher price

Does the perfectly price discrimination monopolist also produce an inefficient level of output

No, It and the competitive firm both produce at which P=MC

Theory of Monopolistic Competition

1. There are many sellers and buyers. This is the same assumption for perfect competition

2. Each Firm (in the industry) produces and sells a slightly differentiated product. Difference among the products may be due to names, packaging, location, and so on and so on. It may be real or imagined.

3. Entry and exit are easy. 

The Monopolistic Competitors Demand Curve

• The firm has many rivals

• Does not sell exactly the same product but still has substitutes are not perfect

• The elasticity of demand is not as great as that of perfectly competitive firm

• The curve is not horizontal; it is downward sloping

The Relationship Between Price and Marginal Revenue for Monopolistic Competitor

• Since it has a downward sloping demand curve, it has to lower its price to sell and additional unit of the good it produces. Thus P>MR

• It produces the quantity of output at which MR=MC, for this quantity, the monopolistic competitor charges the highest price it can charge p1

Will there be profits in the long run for a monopolistic competitor

• If the firms in a monopolistic competitive market are currently earning profit, then they will most likely not continue to earn profit in the long run. Because of the 3^rd part of the theory. The shift for each firm may shift to the left

Excess Capacity: What is it, and is it 'good' or 'bad'

  Excess Capacity Theorem

            A monopolistic competitor will produce an output smaller than the one that would minimize its units costs               of production

The monopolistic competitor operates at excess capacity as a consequence of it downward-sloping demand curve.

The Monopolistic Competitor and Two Types of Efficiency

IF a firm is allocative efficient if it charges a price that is equal to its marginal cost, P=MC. The monopolistically competitive firm charges a price that is greater than marginal cost, P>MC, it is not allocative efficient. 

Oligopoly: Assumptions and Real-World Behavior

1. There are few sellers and many buyers

2. Firms produce and sell either homogenous or differentiated products

3. The Barriers to entry are significant

Produces at the quantity of output at which MR=MC

Concentration Ratio

Is the percentage of industry sales (or assets, output, labor force, or some other factor) accounted for by x number of firms in the industry. Usually 4 or 8, but can be any number (although very small)

A high concentration ratio implies that few sellers make up the industry; a low concentration  ratio implies that more than a few sellers make up the industry

Does not take in account foreign competition and competition from substitute domestic goods

      Cartel Theory

      A theory of oligopoly in which oligopolistic firms act as if there were only one firm in the industry

Cartel

      An organization of firms that reduces output and increases price in an effort to increase joint profits

Benefits of Cartels

• If the industry is long run competitive equilibrium, the firms will reduce output than a new price emerges. This increases profit.

Cons of Cartels

• Even if legal, can be costly even when numbers of seller is small

• Formulating Cartel Policy can be difficult

• Have to make sure no new, non cartel members, can enter the industry

• There is an incentive to cheat since it increases profit for that one firm

Game Theory

Is a mathematical technique used to analyze the behavior of decision makers who

1. Try to reach an optimal position through game playing or the use of strategic behavior

2. Are fully aware of the interactive nature of the process at hand, and

3. Anticipate the moves of other decision makers

Are Markets Contestable?

Assumptions of the Contestable Markets theory

1. Entry into the market is easy and exit from it is costless

2. New firms entering the market can produce the product at the same cost that current firms produce it

3. Firms exiting the market can easily dispose of their fixed assets by selling them elsewhere

The conclusions based on the assumptions

1. Even if an industry is composed of small firms, or just one, the firms do not necessarily perform in a noncompetitve way. May act competitive in a contestable market

2. Profits can be zero in an industry even if the number of sellers in the industry is small

3. If the market is contestable, inefficient producers cannot survive. 

4. A contestable market encourages firms to produce at their lowest possible average total cost.

Big note for the different theories: Perfectly competitive, monopolistic, monopolistic competition and oligopoly

The conditions are sufficient not necessary. Can still be efficient with any of the theories, just perfectly competitive is sufficient 

Characteristics and Consequences of Market Structures: The table

Antitrust Law

Legislation passed for the stated purpose of controlling monopoly power and preserving and promoting competition

• A Monopoly

• Produces a smaller output than is produced by a perfectly competitive firm with the same revenue and cost consideration

• Charges a higher price, and 

• Causes a deadweight loss

• Sherman Act (1890)

• Was passed to deal with mergers of companies. A Merger occurs when two companies combine under single ownership of control. At the time, the organization that companies formed by combing was called a trust; which gave us the term antitrust. This act has two provisions

  • "Every contract, combination in the form of trust or otherwise conspiracy, in restraint of trade or commerce among the several states, or with foreign nations, is hereby declared to be illegal"

  • "Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons to monopolize any part of the trade or commerce... Shall be guilty of a misdemeanor"

• This act was written vague as it does not explain what specific acts constitute a restrain of trade

Merger

occurs when two companies combine under single ownership of control

Trust

Organization that companies formed by combing

• Clayton Act (1914)

• Makes the following business practices illegal when their effects 'may be to substantially lessen competition or tend to create a monopoly'

  • Price discrimination

  • Exclusive dealing

  • Typing Contracts; Arrangements made whereby the sale of one product is dependent on the purchase of some other product or products

  • The acquisition of competing companies stock if the acquisition reduces competition.

    • Although this does not prevent the acquisition of physical assets 

  • Interlocking Directorates; the directors of one company cannot sit on the board of another company in the same industry

• Federal Trade Commission Act (1914)

• The broadest and most general language of any antitrust act. It declares 'unfair methods of competition in commerce' to be illegal. However the issue of what to decide is what's unfair or too aggressive is not addressed. This act also sets up the Federal Trade Commission (FTC) to deal with unfair methods of competition. 

• Robinson-Patman Act (1936)

• Was passed in an attempt to decrease the failure rate of small businesses by protecting them from the competition of large and growing chain stores. Large chain stores were getting discounts from suppliers and therefore giving discounts to the buyers of large chain stores. This act says that suppliers have to give the same discount to every stores. 

  • Some economists believe that, rather than preserving and strengthening competition, this act limits it. The act seems to be more concerned about a certain group of competitors than about the process of competition and the buying public as a whole

• Wheeler-Lea Act (1938)

• Empowers the FTC to deal with false and deceptive acts or practices. 

• Celler-Kefauver Antimerger Act (1950)

• Designed to close the merger loophole in the clayton act. Bans anticompetitive mergers that occur as a result of one company's acquiring the physical assets of another company

Unsettled Points in Antitrust Policy

1. Does the Definition of the Market Matter

   1. How a market is defined- broadly or narrowly- help determine whether a firm is considered a monopoly. Recently they've been defined more broadly than narrowly

2. Concentration Ratios

   1. Have been used to gauge the amount of competition in an industry. But they have two major problems

      1. Does not address foreign competition. Competition may be competitive in general but domestically it may be oligopolies or monopolies

         1. The Justice department uses the Herfindahl index, which measures the degree of concentration in an industry, is equal to the sum of the squares of the market shares of each firm in the industry

            1. Herfindahl Index= (S₁)²+ (S₂)² + .... (S_n)²

            2. The mergers will be blocked if it increases the index by more than 200 points in a highly concentrated markets (Markets with an index greater than 2,500)

               1. 0-1000= Unconcentrated or Competitive

               2. 1,500-2,500=Moderately concentrated industry

               3. >2,500= Highly concentrated industry

3. Innovation and Concentration Ratios 

   1. Some economists say that concentration ratios should not play as large as a role in mergers as a merger's affect innovation. It is used to conventional wisdom that smaller firms have a higher incentive to innovate to receive more buyers, but the opposite is true. Smaller firms have a greater risk if the innovation goes wrong, so they tend to innovate less. 

Herfindahl index

1. which measures the degree of concentration in an industry, is equal to the sum of the squares of the market shares of each firm in the industry

   1. Herfindahl Index= (S₁)²+ (S₂)² + .... (S_n)²

   2. The mergers will be blocked if it increases the index by more than 200 points in a highly concentrated markets (Markets with an index greater than 2,500)

      1. 0-1000= Unconcentrated or Competitive

      2. 1,500-2,500=Moderately concentrated industry

      3. >2,500= Highly concentrated industry

Three types of basic mergers

1. Horizontal merger: A merger between firms that are selling similar products in the same market; Buying competition

2. Vertical Merger: A merger between companies in the same industry but at different stages of the production process; Buying production components

3. Conglomerate Merger: A merger between companies in different industries

The Federal government looks most carefully at proposed horizontal mergers

Common Misconceptions about antitrust policy

Some people believe that all the big issues in antitrust policy have been settled. Predatory pricing practices are illegal, but how low can a price be before its predatory? For how long till it is deemed predatory? How much competition is reduced until it is substantial

Network Monopolies

• A Network Good

  • Is a good whose value increases as the expected number of units sold increases. 

  • This can result in a monopoly since the more bought the more useful it becomes, the popular will get more popular. 

• Antitrust Policy for Network Monopolies

  • Currently the authorities move against it on how it behaves, not what it is. If it takes predatory or exclusionary practices to maintain its monopoly position the authorities will take action

• Innovation and Network Monopolies

  • The situation may be different for network monopolies because high switching costs can make it an industry standard. If a network good becomes an industry standard it make create a lock-in effect. This will make switching less likely and will stop people from switching so they have little reason to innovate

    • Lock-in effect- The situation in which a product or technology becomes the standard and is difficult or impossible to dislodge from that role

• A Network Good

• Is a good whose value increases as the expected number of units sold increases. 

• This can result in a monopoly since the more bought the more useful it becomes, the popular will get more popular. 

Lock-in effect

The situation in which a product or technology becomes the standard and is difficult or impossible to dislodge from that role

Natural Monopolies

Produce at where they can maximize profits at MR=MC up to the level of demand

Regulating the Natural Monopolies

1. Price Regulation

   1. Marginal cost pricing. The objective is to set a price for the natural monopoly firm that equals its marginal cost at the quantity of output at which demand intersect marginal cost

2. Profit Regulation

   1. Governments may want the natural monopoly to earn only zero economic profits. If so, the government will require the natural monopoly to charge a price that equals ATC, and to supply the quantity of demanded at that price. Sometimes this is called average cost pricing. 

3. Output Regulation

   1. Governments can mandate a quantity of output it wants the natural monopoly to produce. If they want higher profits they can be obtained by lowering costs. 

• It may not always turn out the way it was intended. For each type of regulation they require information which can have problems in gathering said information

  • The cost of information is not easy to determine, even for the natural monopoly itself

  • The cost information can be rigged (to a degree) by the natural monopoly, and therefor the regulators will not get a true picture of the firm

  • The regulators have little incentive to obtain accurate information, because they are likely to keep their jobs and prestige even if they work with less-than-accurate information

• Also regulatory lag can cause problems

  • Regulatory Lag

    • Is the period between the time that a natural monopoly costs change and the time that the regulatory agency adjusts prices to account for the change

Theories of Regulation

Capture theory of regulation, public interest theory of regulation, public choice theory of regulation

• Capture theory of regulation

• Holds that no matter what the motive is for the initial regulation and the establishment of the regulatory agency, eventually the agency will be captured by the special interests of the industry being regulated. This theory has been supported by

  • Many cases, persons who have been in the industry are asked to regulate the industry. Such people make feel a bond and may feel inclined to cater to them

  • At regulatory hearing, members of the industry attend in greater force than do taxpayers and consumers. Thus regulators are more likely to hear and respond to the industries side of the story

  • Members of the regulated industry make a point of getting to know the members of the regulatory agency. They may talk frequently about business matters; perhaps socialize. The bond between the two can impact regulatory measures

  • After they either retire or quit their jobs, regulators often go to work for the industries they once regulate

• Public Interest theory of regulation   

• This theory holds that regulators are seeking to do- and will do through regulation- what is in the best interest of the public or society at large

• Public Choice theory of regulation

• This theory suggests that, to understand the decision of regulatory bodies, we must first understand how the decision affects the regulators themselves. This theory predicts that the outcomes of the regulatory process will tend to favor the regulators instead of either business interests or the public.

MRP or Marginal Revenue Product=

MRPT= (Change in total revenue) / (Change in quantity of the factory); =MR MPP; =VMP for a perfectly competitive firm; <VMP for all other market structures;=p * MPP for a perfectly competitive firm

Marginal Revenue=

MR= P for a perfectly competitive firm

MRP; TR; MR; MPP; VMP; P; TC; MFC; EL

MRP=Marginal Revenue Product

TR= Total Revenue

MR= Marginal Revenue

MPP=Marginal Physical Product

VMP=Value Marginal Product

P= Price

TC= Total Cost

MFC= Marginal factor cost

E_L= Coefficient of elasticity of demand for labor or, simply, the elasticity coefficient

Demand for a Factor

All firms- whatever the structure- purchase factors in order to make products to sell. 

Derived demand

Demand that is the result of some other demand. For example, factor demand is derived from the demand for the products that the factors go to produce.

Marginal Revenue Product

Is the additional revenue generated by employing an additional factor unit, such as one more unit of labor

Value Marginal Product

The price of a good multiplied by the marginal physical product of the factor

Marginal Factor Cost

Is the additional cost incurred by employing an additional factor unit

Factor price taker

A firm that can buy all of a factor it wants at the equilibrium price. Such a firm faces a horizontal (flat, perfectly elastic) supply curve of factors.

How many units of a factor should a Firm buy

Based on marginal analysis, continue buying additional units of the factor until the additional revenue generated by employing an additional factor unit is equal to the additional cost incurred by employing and additional factor units; or more simply until MRP=MFC

When there is more than one factor, How much of each factor should the Firm buy?

The firm should purchase the two factors until the ratio of MPP to price for one factor equals the ration of MPP to price for the other factor

Least-cost rule

Rule that specifies the combination of factors that minimizes costs and so requires that the following condition be met MPP₁/P₁=MPP₂/P₂ where the subscript numbers stand for the different factors

Three main determinants of elasticity of demand for labor

1. The elasticity of demand for the product that labor produces

2. The ratio of labor costs to total costs

3. The number of substitute factors