Monopolistic Competition Perfect Competition aka Pure Competition Oligopoly Monopoly.

Monopolistic Competition

Perfect Competitionaka Pure Competition

Oligopoly

Monopoly

Perfect Competition

Monopolistic Competition

OligopolyMonopoly

Pure Competition

Monopolistic Competition Oligopoly Monopoly

Number of Firms

Barriers to Entry

Non-price Competition

Price Taker/Maker

Product type

Many small Many small A few large one

Diff or Homog oneDifferentiatedHomogeneous

large largenonenone

maker makertaker/seekertaker

yes yesyesno

Considers action or reaction of other firms

Need to stress differences?

Long run profits possible?

Ability to influence market price?

As important as price?

1. Many Sellers2. Identical Products

Characteristics?

4. No Non-Price competition

6. Price Taker

3. Easy Entry and Exit

5. SR profits/losses, no LR profits

Output

Price Firm

Output

Price Market

Perfect Competition• Market supply & demand determine price.• The firm’s demand will be perfectly

elastic. • Firms can sell as much as they want at P• Above P, they lose business• Below P they lose revenue.

P

Marketdemand

Marketsupply

Firm’sdemand

P

Firms must take the market price

Number of Cakes

Marginal Revenue

Marginal Cost

0

1 40 25

2 40 10

3 40 15

4 40 25

5 40 35

6 40 45

7 40 65

8 40 91

$120

110

100

90

80

70

60

50

40

30

20

10

01 2 3 4 5 6 7 8 Number of Cakes

Marg

inal C

ost

an

d M

arg

inal R

even

ue

Marcia’s Marginal Cost and Marginal Revenue

Profits

Losses

• The two conditions necessary for long-run equilibrium in a price-taker market are depicted here.

• At the price established in the market, firms in the industry earn zero economic profit

• The quantity supplied and the quantity demanded must be equal in the market, as shown below at P1 with output Q1.

Output

Price Firm

P1

q1

MC ATC

d1

Long-run Equilibrium

Output

Price Market

P1

D

Ssr

Q1

Price

Quantity

$6

$5

$4

$3

$2

$1

10 20 30 40 50 600

Price = Demand = MR

Operating at Minimum ATC

Equilibrium

ATCMC

Normal Profit

Earn economic profit MR > ATC

MR = ATC

Short Run Profits

Short Run Losses

Shut DownFirm can’t cover AVC, minimize

losses by shutting down

MR < AVC

Output

Price Firm

MC

ATC

AVC

P3

Firm covers AVC, but not AFC:

MR < ATC, but MR > AVC

MR

Output

Price Firm

MC

ATC

AVC

• The marginal cost curve (MC) is the firm’s supply curve.

• At P2 MR = MC at q2.

• Below MC = AVC, the firm will shut down Output = 0 below P1,,

• At P3 MR = MC at q3.

The Supply Curve

P2

P3

q2 q3

P1

q1

MC is the firm’s

Supply Curve

Entry or Exit?

Supply

Profits?

Case 1: Prices rise

Output

Price

Output

Price

• Consider the market for toothpicks. A new candy that sticks to teeth causes the market demand for toothpicks to increase from D1 to D2 … market price increases to

P2 …

MarketFirm

P1 P1

q1 Q1

D1

S1MC ATC

d1

An Increase in Market Demand

shifting the firm’s demand curve upward. At the higher price, firms expand output to q2 and earn short-run profits.• Economic profits will draw competitors into the industry, shifting the market supply curve from S1 to S2.

P2 d2

q2

D2

S2

Q2

P2

Output

Price

Output

Price

• After the increase in market supply, a new equilibrium is established at the original market price P1 and a larger rate of output (Q3).• As the market price returns to P1, the demand curve facing the firm returns to its original level.• In the long-run, economic profits are driven down to zero.

The Adjustment

MarketFirm

P1 P1

q1 Q1

D1

S1MC ATC

d1

P2 d2

q2

D2

S2

Q2

P2

Slr

Q3

d1

Price

Quantity

$6

$5

$4

$3

$2

$1

10 20 30 40 50 600

Price = Demand = MR

SR Profits

1. Price goes up

ATC

2. Firms enter, Supply increases3. Price goes down

4. No LR Profits

MC

Entry or Exit?

Supply

Case 2: Prices fall

Profits?

Output

Price

Output

Price

A Decrease in Demand

MarketFirm

P1 P1

q1 Q1

D1

S1MC ATC

d1

P2 d2

q2 Q2

P2

• If, instead, something causes market demand for toothpicks to decrease from D1 to D2 … the market price falls to

P2 shifting the firm’s demand curve downward, leading to a reduction in output to q2. The firm is now making losses.

• Short-run losses cause some competitors to exit the market, and others to reduce the scale of their operation, shifting the market supply curve from S1 to S2.

S2

D2

Output

Price

Output

Price

The Adjustment:

MarketFirm

P1 P1

q1 Q1

D1

S1MC ATC

P2 d2

d1

q2

D2

S2

Q2

P2

• After the decrease in market supply, a new equilibrium is established at the original market price P1 and a smaller rate of output Q3.• As the market price returns to P1, the demand curve facing the firm returns to its original level.• In the long-run, economic profit returns to zero.• Note the long-run market supply curve is flat Slr.

Q3

Slrd1

Price

Quantity

$6

$5

$4

$3

$2

$1

10 20 30 40 50 600

P = D = MRSR

Losses

1. Price goes down

ATC

2. Firms leave, Supply decreases3. Price goes up

4. No LR Losses

MC

Short Run Profits

Supply shifts out and price drops

Cause firms to enter the marketShort Run LossesCause firms to leave the marketSupply shifts in and price rises

In competitive price-taker markets, firmsa. can sell all of their output at the market price.b. produce differentiated products.c. can influence the market price by altering their output level.d. are large relative to the total market.

When we say that a firm is a price taker, we are indicating that thea. firm takes the price established in the market then tries to

increase that price through advertising.b. firm can change output levels without having any significant

effect on price.c. demand curve faced by the firm is perfectly inelastic.d. firm will have to take a lower price if it wants to increase the

number of units that it sells.

In price-taker markets, individual firms have no control over price. Therefore, the firm’s marginal revenue curve is

a.a downward-sloping curve.b. indeterminate.c. constant at the market price of the product.d.precisely the same as the firm’s total revenue curve.

If marginal revenue exceeds marginal cost, a price-taker firm shoulda. expand output. b. reduce output.c. lower its price. d. do both a and c.

When firms in a price-taker market are temporarily able to charge prices that exceed their production costs,

a. the firms will earn long-run economic profit.b. additional firms will be attracted into the market until price falls to

the level of per-unit production cost.c. the firms will earn short-run economic profits that will be offset by

long-run economic losses.d. the existing firms must be colluding or rigging the market,

otherwise, they would be unable to charge such high prices.

Suppose a restaurant that is highly profitable during the summer months is unable to cover its total cost during the winter months. If it wants to maximize profits, the restaurant shoulda. shut down during the winter, even if it is able to cover its variable costs during that period.b. continue operating during the winter months if it is able to cover its variable costs.c. go a out of business immediately; losses should never be tolerated.d. lower its prices during the summer months.

expand output

This graph illustrates a firma.capable of earning economic profit.b.that is only able to break even when it maximizes profit.c.taking economic losses.d.that should shut down immediatelyThis graph depicts the cost curves of a firm in a price-taker industry. At what output would the firm’s per-unit cost be at a minimum?a. 100 c. 150b. 125 d. an output > 150For the above graph, if the market price is $30, what is the

firm’s profit-maximizing output and maximum profit.a. output, 125; economic profit, zerob. output, 125; economic profit, between $1,000 and $1,250c. output, 150; economic profit, $1,500d. output, 150; economic profit, between $1,250 and $1,500