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Perfect competition

and monopoly market

Classification of market

PERFECT
COMPETITION

IMPERFECT
COMPETITION

MONOPOLISTIC
COMPETITION

MONOPOLY

OLIGOPOLY

Classification of market
structures
Types of market

Perfect
competition

Monopolistic
competition

Oligopoly

Monopoly

Unlimited

Several

Few

One

Identical

Different

Identical/
Different

Unique

High

Very
high

Strong

Very
strong

Number of
suppliers
Products
Entry barrier

Market power

Non-price
competition

None

Low

None

Weak

None

Little

Much

None

I. Perfect competition
1. Definition
-

A type of market where products are identical


and there are unlimited suppliers and
consumers.

Examples: Agricultural products ....

I. Perfect competition
2. Characteristics
-

No entry barrier
Suppliers are price-taker
No market power
Symmetric information
No non-price competition (no
advertisement) due to identical inputs
- Not necessary to choose supplier

Perfect competition
3. Demand and
marginal revenue
curves
- Demand curve: parallel
with horizontal axis
- Marginal curve:
coinciding with demand
curve
- MR = P

P =MR
P*

Demand curves of a firm and of the whole industry in


perfect competiition market
(a) Demand Curve of a firm
Price

Price

(b) Demand Curve of the whole


industry

Demand
Demand

Quantity of output

Quantity of output

Perfect competition
4. Maximizing profit
MAX: MR=MC
In perfect competition: MR =
P

MC

P=MR

P*

MAX in perfect competition:

P=MC

Q*

Short run equilibrium

Perfect competition
Break-even, shut down point
= TR TC = Q (P - ATC)
P> ATCmin > 0 profit
P= ATCmin = 0 break-even point
P< ATCmin < 0 loss
 AVCmin< P < ATCmin continue producing
 P < AVCmin shut down

PERFECT COMPETITION
5. Producers surplus (PS)

- Is the sum over all units


produced of difference
between market price
of good and marginal
cost of production

P
MC

P=MR
P*

- The area below price line


and above marginal cost
curve
PS = TR VC
= + FC

PS

Q*

Producer Surplus for Market


Price
($ per
unit of
output)

Market producer surplus is


difference between P*
and S from 0 to Q*.

P*

Producer
Surplus

D
Output

Q*

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6. Competitive Firms
Short-Run Supply Curve
Price
($ per
unit)

Competitive firms supply curve is


portion of marginal cost curve above
AVC. Firm chooses output level where
P = MR = MC, as long as P > AVC.

MC

P2

ATC

P1

AVC

P = AVC

q1

q2 Output
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PERFECT COMPETITION
6. Competitive Firms
* Short-Run Supply Curve
Supply is upward sloping due to diminishing
returns
Higher price compensates firm for higher cost of
additional output and increases total profit
because applies to all units
How does firms output change in response to
input price change over time?
Marginal cost curve shifts, new intersection with
price
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PERFECT COMPETITION
Short-Run Market Supply Curve: Shows amount
of product whole market will produce at given
prices
Increased production leads to increased demand

Sum of supply curves of individual


producers
As price rises, firms expand production
for inputs, increases in input prices
Input price increases cause MC to rise
Lowers each firms output choice
Industry supply to be less responsive to change
in price than would be otherwise
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Industry Supply in Short Run


S
MC1

$ per
unit

MC2

MC3

Short-run
industry supply curve
is horizontal
summation of supply
curves of firms.

P3

P2
P1

Q
2

7 8

10

15

21
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PERFECT COMPETITION
6. Supply Curve
Industrys Long-Run supply curve
Shape of long-run supply curve depends on extent to
which changes in industry output affect prices firms pay for
inputs
Assume:
All firms have access to available production
technology
Output increased by using more inputs, not by invention
Market for inputs does not change with expansions and
contractions of industry
To analyze long-run industry supply, distinguish between
different types of industries
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Constant-Cost Industry
Industry whose long-run supply curve is
horizontal at price equal to minimum average
cost of production
Assume firm is initially in equilibrium
Demand increases, causing price increase
Individual firms increase supply
Positive profits in short run

Supply increases, causing market price to


decrease
Long run zero economic profits
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Long-Run Supply in ConstantCost Industry


$

Increase in demand increases


market price and firm output.
Positive profits cause market
supply to increase and price to fall.

MC

Q1 increases to Q2.
Long-run supply = SL = LRAC.
Change in output has no impact on
input cost.

S1

AC

P2

P2

P1

P1

S2

SL

D1
q1 q2

Output

Q1

Q2

D2
Output
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Increasing-Cost Industry
Prices of some or all inputs rises as production
is expanded when demand of inputs increases
When demand increases, prices increase and
production increases
Firms enter market increasing input demand
Costs increase, causing upward shift in supply
curves
Market supply increases but not as much
In increasing-cost industry, long-run supply
curve is upward sloping
More output produced, but only at higher price
needed to compete for increased input costs
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Long-Run Supply in IncreasingCost Industry


Due to increase in input prices, long-run
equilibrium occurs at higher price.

LMC2

$
LMC1

S1 S2

LAC2

LAC1

P2

Long run supply is upward


sloping.

P2

P3

P3

P1

P1

D1
q1

q2

Output

SL

Q1 Q2 Q3

D2
Output
20

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Decreasing-Cost Industry
Industry whose long-run supply curve is
downward sloping
Increase in demand causes production to
increase
Increase in size allows firm to take advantage
of size to get inputs cheaper
Increased production may lead to better
efficiencies or quantity discounts
Costs shift down and market price falls
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Long-Run Supply in
Decreasing-Cost Industry
$

Due to decrease
in input prices, long-run
equilibrium occurs at
lower price.

LMC1

Long run supply is downward


sloping.

S1

S2

LMC2LAC

LAC2 P

P2
P1

P1
P3

P3

SL
D1

q1 q2

Output

Q1 Q2 Q3

D2
Output
22

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7. Long-Run Competitive
Equilibrium Profits
Profit attracts firms
Supply increases until profit = 0

$ per
unit of
output

$ per
unit of
output

Firm

Industry
S1

LMC

$40

LAC

P1

S2

P2

$30

D
q2

Q1

Output

Q2

Output
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7. Long-Run Competitive
Equilibrium Losses
Losses cause firms to leave
Supply decreases until profit = 0

$ per
unit of
output

Firm

LMC

$ per
unit of
output
LAC

$30

Industry
S2

P2

S1

P1

$20

D
q2

Output

Q2

Q1

Output
24

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7. Long-run equilibrium
- Happen when:
- + No new supplier enter the market
- economic = 0

- + No existing supplier withdraw from the market


- accounting > 0

P=LACmin

Perfect competition
7. Long-run
equilibrium

P
LAC

LMC

- Enough time for new


entrants to build factory,
equip machinery...
- P more suppliers P
- P suppliers withdraw
P

P1
A

P=MR

P*
P2

O
Q2

Q*

Q1

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Summary
Perfect competition is optimal market
structure because:
Under market structure, firms will produce at
lowest cost
No super-profit in long-run
No dead-weight loss optimal social
welfare

Exercise
Good As market demand in a perfect competition
market is: P = 8260 Q. X an As supplier - has
long-run total cost: 2
LTC =

Q
+ 100Q + 1024
4

(Price and cost: USD, quantity: unit)


a. Calculate the long-run equilibrium for supplier X
b. Calculate the long-run equilibrium price and quantity for
industry A
c. Assume that all suppliers in the industry have the same longrun total cost. How many suppliers are there in this
industry?

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