1 / 32

Readings

Readings. Readings. Baye 6 th edition or 7 th edition, Chapter 8. Overview. Overview. Overview. Competitive Price and Quantity. Competitive Price and Quantity. Overview

morrie
Download Presentation

Readings

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Readings • Readings • Baye 6th edition or 7th edition, Chapter 8 BA 445 Lesson A.8 Competitive Markets

  2. Overview • Overview BA 445 Lesson A.8 Competitive Markets

  3. Overview BA 445 Lesson A.8 Competitive Markets

  4. Competitive Price and Quantity • Competitive Price and Quantity BA 445 Lesson A.8 Competitive Markets

  5. Overview Competitive Price and Quantity starts with price set to the competition, then quantity set where marginal cost equals price — provided that production is better than shutting down. • Competitive Price and Quantity BA 445 Lesson A.8 Competitive Markets

  6. Perfect Competition Environment Many buyers and sellers. Homogeneous (perfectly substitutable) products across sellers. Example: USB Thumb Drives from SanDisk or Kingston. Perfect product information for both buyers and sellers. Free exit from the industry (from selling) at any time. Free entry into the industry (begin selling) in the long run. You can change capital in the long run. So free entry means you can enter if you have the capital. • Competitive Price and Quantity BA 445 Lesson A.8 Competitive Markets

  7. Preview of Perfect Competition Implications What effect did cancer have on the cigarette industry? Demand down, so price, quantity, and profit down (according to demand-supply analysis). But, profit down makes some producers exit. As some producers exit, industry supply down. As industry supply down, price and profit start back up. Adjustment continues until producers stop exiting, which means profits back to where they started. Remaining producers thus regain profits in the long run. • Competitive Price and Quantity BA 445 Lesson A.8 Competitive Markets

  8. Preview of Perfect Competition Implications General implications: Firms are price takers. They each set price P = competitor’s price Marginal revenue MR = P (since R = P x Q, with P constant) In the short-run, firms may earn profits or losses (negative profits). Entry (if short-run profits are positive) and exit (if negative) forces long-run profits to zero. • Competitive Price and Quantity BA 445 Lesson A.8 Competitive Markets

  9. Competitive Price and Quantity Since few producers are perfectly competitive, why analyze perfect competition? • Many small businesses are almost perfectly competitive. • We could analyze them as monopolistic competitors, but the predictions would be almost like perfect competitors. • Gives an extreme contrast to monopoly. • Illuminates the danger of competition to managers, and the importance of product differentiation to reduce competition. • Chevron with Techron (an additive for cleanliness) • Standard Oil “Put a tiger in your tank” BA 445 Lesson A.8 Competitive Markets

  10. Setting Price to Match the Competition • Competitive Price and Quantity $ $ S Pe Df D QM Qf Demand and Supply for USB Thumb Drives Demand for SanDisk Thumb Drives (perfectly elastic) BA 445 Lesson A.8 Competitive Markets

  11. Setting Quantity General rule, set Q where MC(Q) = MR(Q). Since, MR(Q) = constant competitive-equilibrium price Pe, equate MC(Q) = Peto set Q. Calculating Profit P = Pex Q – C(Q) = (Pe – C(Q)/Q) x Q = (Pe – ATC) x Q • Competitive Price and Quantity BA 445 Lesson A.8 Competitive Markets

  12. Competitive Price and Quantity MC $ ATC AVC Qf Setting Quantity and Calculating Profit Profit = (Pe- ATC)  Q > 0 Pe Pe = MC(Q) ATC Q BA 445 Lesson A.8 Competitive Markets

  13. Competitive Price and Quantity MC $ ATC AVC Q Setting Quantity and Calculating Profit Profit = (Pe- ATC)  Q < 0 ATC Pe = MC(Q) Pe Q BA 445 Lesson A.8 Competitive Markets

  14. Competitive Price and Quantity A Numerical Example • Given • Competitor’s Price =$10 • C(Q) = 5 + Q2 • Optimal Price? • P = $10 • Optimal Output? • MR = P = $10 and MC = 2Q • Set 2Q = 10 • Q = 5 units • Optimal Profit? • PQ - C(Q) = $(10)(5) - $(5 + 52) = $20 > 0 BA 445 Lesson A.8 Competitive Markets

  15. Efficient Quantity • Efficient Quantity BA 445 Lesson A.8 Competitive Markets

  16. Efficient Quantity OverviewEfficient Quantity is implied when price and willingness to pay equals marginal cost. — So, after your market purchases, there is no deal between you and an electronics supplier that can benefit you both. BA 445 Lesson A.8 Competitive Markets

  17. Efficient Quantity Features of Competitive Equilibrium • P = MC • That implies output is socially efficient. • Any other output can be changed to make all concerned better off. For example, suppose P = $2 and MC = $1 for candy. • P = $2 means there is some consumer willing to buy another candy for nearly $2. • MC = $1 means there is a firm that can produce and distribute another candy for $1. • All concerned would be better off if the firm produced and sold another candy for $1.50. • The consumer gains nearly $.50 surplus; the producer, $.50 surplus. • No one else is affected. BA 445 Lesson A.8 Competitive Markets

  18. Competitive Entry and Exit • Competitive Entry and Exit BA 445 Lesson A.8 Competitive Markets

  19. Competitive Entry and Exit OverviewCompetitive Entry and Exit are determined by profits. Positive profit causes entry, slightly-negative profit causes exit in the long run, and significantly-negative profit causes exit in the short run. BA 445 Lesson A.8 Competitive Markets

  20. Competitive Entry and Exit Shutdown Decision Rule A profit-maximizing firm should continue to produce in the short run even if profit is negative as long as its operating lossis less than its sunk cost, since sunk costis the loss if shut down. • Recall the simplifying assumption that FC = sunk cost • Operating loss P = PQ – TC > -FC, or PQ > TC – FC = VC. • P > VC/Q = AVC implies continue to produce in the Short Run. • P = VC/Q = AVC implies its does not matter if produce in the Short Run. • P < VC/Q = AVC implies immediate shut down in the Short Run. BA 445 Lesson A.8 Competitive Markets

  21. Competitive Entry and Exit MC $ ATC AVC Q In the Short-Run, should this firm shut down?P > AVC, so continue producing in the short run.Slightly-negative profit ATC Pe = MC(Q) Pe Q BA 445 Lesson A.8 Competitive Markets

  22. Competitive Entry and Exit MC $ ATC AVC Q In the Short-Run, should this firm shut down?P < AVC, so immediately shut down in the short run. Significantly-negative profit ATC Pe = MC(Q) Pe Q BA 445 Lesson A.8 Competitive Markets

  23. Competitive Entry and Exit MC $ ATC AVC Qf Firm’s Short-Run Supply CurveProfit maximization MC = P and the shutdown rule imply the firms short-run (FC > 0) supply is MC above Min AVC. P = min AVC Qf* BA 445 Lesson A.8 Competitive Markets

  24. Competitive Entry and Exit S1 S2 SM 25 43 18 20 30 10 Short-Run Market Supply Curve • The number of firms is fixed in the short run (because capital is fixed). • The market supply curve is the horizontal summation of each individual firm’s supply at each price. Market Firm 1 Firm 2 P P P 15 5 Q Q Q BA 445 Lesson A.8 Competitive Markets

  25. Competitive Entry and Exit Long Run Adjustments if profits are positive • If the industry is perfectly competitive, not only are firms price takers but there is free entry into the industry. • Firms producing perfect substitutes enter the industry if profits in the industry are positive. BA 445 Lesson A.8 Competitive Markets

  26. Competitive Entry and Exit $ $ S Pe Df D QM Qf Firm Market Effect of Entry on PriceAs firms enter, market supply increases and prices decrease. S* Entry Pe* Df* BA 445 Lesson A.8 Competitive Markets

  27. Competitive Entry and Exit $ MC AC QL Q Effect of Entry on Firm’s Price, Output, and Profit. Entry continues until P = PQ – C = 0, meaning P = C/Q = AC, or P = min AC. Pe Df Df* Pe* Qf* BA 445 Lesson A.8 Competitive Markets

  28. Competitive Entry and Exit Summary of competitive markets • Short run profits lead to entry. • Entry increases market supply, drives down market price, increases market quantity. • Lower price means lower quantity supplied by each firm. • Profit and price adjustment continues until the long run, where profits are zero. BA 445 Lesson A.8 Competitive Markets

  29. Competitive Entry and Exit MC $ ATC AVC Qf Features of Long Run Competitive EquilibriumP = minimum AC P = min AC Qf* BA 445 Lesson A.8 Competitive Markets

  30. Competitive Entry and Exit Features of Long Run Competitive Equilibrium • P = minimum AC • Price depends solely on cost. • Why does a Mercedes cost more to consumers than a Honda? • Any long-run difference in price is from a difference in production cost. BA 445 Lesson A.8 Competitive Markets

  31. Review Questions • Review Questions • You should try to answer some of the review questions (see the online syllabus) before the next class. • You will not turn in your answers, but students may request to discuss their answers to begin the next class. • Your upcoming Exam 1 and cumulative Final Exam will contain some similar questions, so you should eventually consider every review question before taking your exams. BA 445 Lesson A.8 Competitive Markets

  32. BA 445 Managerial Economics End of Lesson A.8 BA 445 Lesson A.8 Competitive Markets

More Related