ECONOMICS 200 PRINCIPLES OF MICROECONOMICS

ECONOMICS 200 PRINCIPLES OF MICROECONOMICS Professor Lucia F. Dunn Department of Economics

Market Structure • Refers to the degree of competitiveness in the market for any commodity. • The concept “market” is defined by a particular kind of product or service. — is interchangeable with the word “industry”.

Perfect Competition A. Characteristics 1. Homogeneous Products 2. Customer Information 3. Output of firm at minimum of LRAC is small relative to the industry. 4. Price Taker (or Quantity Searcher) 5. Free Entry and Exit

Perfect Competition B. If firm is a price taker, its actions have no noticeable impact on prices. — Firm feels it must always sell at the going market price.  So demand curve is horizontal Perfectly Elastic D Q1 Q2 Q3 Q 0

Perfect Competition C. Aggregate over all small competitive firms gives the “industry” or “total market” demand curve. Total Market Demand 0 Q Competitive Industry Demand Curve

Perfect Competition D. How is the going market price determined? S D D 0 0 Q Q Industry Individual Competitive Firm

Revenue Concepts 1. Total Revenue (or Total Expenditure) 2. Average Revenue 3. Marginal Revenue MR = Change in revenue that comes from selling an extra unit

Perfect Competition For Competitive Firm: Demand = Price = AR = MR D = AR = MR 0 Q

Rule for Profit-Maximization (All Type of Firms) I. Should shut down if: TVC > TRor AVC > AR = P So if AVC > P  Shut Down. II. Firm should expand production up to the point where: MC = MR

Rule for Profit-Maximization (2) (All Type of Firms) MC Loss MR=AR=P=D  0 Q1 Q* Q2 Q

Profit-Maximization for Competitive Firm MC AVC D=P=MR=AR 0 QE Q 1. P > AVC 2. MC = MR or MC = P since MR = P QEis an equilibrium point. – Market forces will automatically keep the firm at that point.

Profit-Maximization for Competitive Firm Supply for competitive firm is same as its MC curve above AVC. MC AVC 4 D4 = MR4 3 D3 = MR3 2 D2 = MR2 1 D1 = MR1 Do = MR0 0 Q1 Q2 Q3 Q4 Q – with Po , firm will shut down.

Profit-Maximization for Competitive Firm S 4 3 2 1 0 Q1 Q2 Q3 Q4 Q

Profit-Maximization for Competitive Firm Result: The Supply Curve of a perfectly competitive firm is identical to its Marginal Cost curve in the range above the average variable cost. Wow!! MC and Supply Curve!!

Profit Short-Run Equilibrium of Competitive Firm MC ATC B D1 = MR1 C 0 Q1 Q  = TR – TC TC =ATC  Q So:  = OP1BQ1 – OACQ1 = AP1BC (Shaded Area)

Reaching Long-Run Equilibrium of Competitive Firm With positive , new firms enter industry and price will fall as supply shifts right. 1 2 Price will fall.

Reaching Long-Run Equilibrium of Competitive Firm So for individual firm : MC SRATC D1 = MR1 D2 = MR2 A D3 = MR3 0 Q Q3 • Price and demand will continue to shift downward until  = 0. At Q3 : TR = OP3AQ3 TC = OP3AQ3 So: = 0 * For competitive firm there is zero economic profit in the long-run equilibrium.

Short-Run Equilibrium of Competitive Firm with Losses SRATC MC C B D1=MR A 0 Q1 Q  = TR – TC = OP1AQ1 – OBCQ1 = P1BCA (Shaded Area is loss)

Reaching Long-Run Equilibrium of Competitive Firm When loss occurs, firms will exit industry.  Supply will shift left. 2 1 Price will rise.

Reaching Long-Run Equilibrium of Competitive Firm So price and demand will rise until the loss is eliminated. SRATC MC D3 = MR3 D2 = MR2 D1 = MR1 0 Q3 Q Things settle down and reach long-run equilibrium at Q3 with P3 and  = 0.

SRATC1 SRATC2 SRATC3 $ (Costs) LRATC MC 0 QMIN Q (Output) Profit-Maximization for Competitive Firm NOTE: In the long run, the demand curve is just tangent to SRATC curve.  It will be tangent at the minimum point of SRATC. (It is geometric fact that when a U-shaped curve is tangent to a horizontal line, it is tangent at its minimum point).

Profit-Maximization for Competitive Firm • So in the long run equilibrium in competitive industries, firm produce at the minimum point of both the short-run and long-run ATC curve.  Very Efficient Long-Run Equilibrium Is Efficient!

THANK YOU! HAVE A NICE DAY.

ECONOMICS 200 PRINCIPLES OF MICROECONOMICS