Your Federal Quarterly Tax Payments are due April 15th

# Perfect competition II. Monopolistic competition by kvw36946

VIEWS: 600 PAGES: 21

• pg 1
```									 Perfect competition II.
Monopolistic competition

Ing. Michaela Krčílková
Review of last lecture

Golden rule of profit maximization: MR=MC
Valid for all firms no matter on market structure

Perfect competition
Large number of buyers and sellers
Homogenous product                          Firms are price takers
Free entry and exit

Perfectly competitive firm faces to horizontal demand => decision
of individual firm cannot influence market price

Along horizontal demand: MR=P=AR

Profit maximizing condition in perfect competition can be written
as: MC=P
Short run decision – graphical analysis

We will combine revenue and costs with demand to
determine profit maximizing output decisions

In the short run, capital is fixed and firm must choose
levels of variable inputs to maximize profits

We can look at the graph of MR, MC, ATC and AVC to
determine profits

The point where MR = MC = P, the profit maximizing output
is chosen
Perfect competition – choosing output: Short run

MC
CZK
Lost Profit
50                          Lost Profit                 for q2>q*
for q1<q*

40      B                                 A                AR=MR=P
ATC
30                                                 AVC
q1 : MR = 40, MC = 25
MR > MC
20
q2: MR = 40, MC = 55
MC > MR
10                                                           q*: MR = 40, MC = 40
MC = MR

0       1   2   3   4   5   6    7    8   9    10      11
Output
q1 q* q2
Profit is
Profit in short run
difference
between total
revenue and
total cost =
this                                                          MC
CZK
represents the
area of            50
rectangle
CDEF
Total revenue          40 D                                                     AR=MR=P
is price                                                       C
ATC
multiplied by
quantity = this
30 E                                     F         AVC
represents the
area of
rectangle
ABCD                   20
Total cost can
be calculated
as ATC                 10
multiplied by
quantity = this
A                               B
represents the             0       1   2   3   4   5   6   7   8     9    10    11
area of                                                         q*                Output
rectangle
ABEF
Loss in short run
Profit =TR-TC
Here the cost
is higher than
revenue i.e.
firm loses                                                      MC
=> this        CZK
represents the
area of          50
rectangle
CDEF
Total revenue         40
is P*q                                                                  ATC
=> this                                                   F
30 E                                              AVC
represents the
D                           C                   AR=MR=P
area of
rectangle
ABCD                  20
Total cost can
be calculated
as ATC*q              10
=> this
represents the                A                           B
area of                   0       1   2   3   4   5   6   7    8   9    10    11
q*                    Output
rectangle
ABEF
Supply curve of perfectly competitive firm

S        MC
CZK
q1          P1
50
q2              P2

q3                  P3
40
The firm chooses the                                                        ATC P4
output level where                                         q4
P = MR = MC,                                                            AVC
30
as long as P > AVC.

=> Supply curve is
MC above AVC           20

10

0   1   2   3   4   5   6   7    8        9    10    11
Output
Producer surplus for a firm

At q* MC = MR.         CZK
Between 0 and q*,             Producer    MC   AVC
MR > MC for all units.         Surplus

Producer                                    P
surplus is
area above
MC to the
price

Producer surplus is
sum of differences
between market
price and marginal                      q*      Output
cost over all units
Producer surplus for a market

Adding up surplus for all   CZK
producers in the market
given total market                                 S
producer surplus

Producer                    Producer
surplus for                  Surplus
market is
area above              P*
market
supply and
below
market price                                    D

q*   Output
Output choice in long run

In short run a firm chooses
CZK
output where P = MC
=> qSR                       MC
LMC
ATC
In the long run, a firm can alter
all its inputs, including the size    P*
LAC
of the plant => this changes
curves of marginal and average
cost (MC=>LMC, AC=>LAC)

In the long run, a firm adjusts its
size and will produce where long
run marginal cost equals price
=>qLR

Given firm gains positive profit          qSR         qLR   Output
in long run (P > LAC)
Output choice in long run

CZK                                                                             S1
MC                          P
LMC                                                 S2
ATC
P*
LAC

P=minLAC

D

qSR           qLR   Output                    q*       q*

Positive economic profit encourage new               The process continue untill positive
firms to enter the market                          economic profit exists

Long run equilibrium arises when price is
Entry of new firms causes shift of market           equal to minimum average cost =>
supply to the right and fall in price                        P = minAC
Long-run equilibrium

All firms maximizes profit
Condition of equality of marginal revenue and cost is fulfilled
MR = MC and P = MC

No firm has incentive to enter or exit industry
P=min LAC

Output is produced at the lowest possible cost (min AC)
=> Perfect competition is PRODUCTIVE EFFICIENT

The most preferred output is produced (D=S and P=MC)
=> Perfect competition is ALLOCATIVE EFFICIENT
Imperfect competition

Imperfect competition arises because some of the assumptions
of perfect competition are broken

Monopolistic competition

Monopoly

Oligopoly
Monopolistic competition - assumptions

Large number of buyers and sellers – same as in perfect
competition

Free entry and exit – same as in perfect competition

Heterogeneous product – in perfect competition product is
homogenous
Resources of product differentiation

Location

Accompanying services

Quality differentials

Product image
Monopoly power

Product differentiation causes that consumers prefer good of
one firm to goods of other firms

Each firm has its own consumers and faces to the downward sloping
demand curve

Firm can sell more products only if lower the price

Decision of firm about the product influences the price => monopoly
power

Amount of monopoly power depends on degree of product
differentiation
Profit maximization in monopolistic competition

The main objective of firms under the monopolistic competition is
maximization of profit

Golden rule of profit maximization is: MR=MC

In monopolistic competition firm faces to downward sloping demand,
from that follows:

Total revenue curve is non-linear

Average revenue curve is equal to demand curve (P=AR)

Marginal revenue does not equal to price = then marginal revenue
curve differs from demand curve (MR<P=AR)
Monopolistic competition

Firm faces downward sloping
demand
CZK
P = 100 − q

Total revenue is then non-linear

TR = P * q = (100 − q)q = 100q - q 2

Average revenue is equal to the price
– and then average revenue curve is
equal to the demand curve

DSR
TR 100q − q 2
AR =    =          = 100 − q ⇒ AR = P
q    q

Marginal revenue does not equal to
MRSR            the price – then the marginal revenue
curve is not demand curve

Quantity
dTR d(100q − q 2 )
MR =     =              = 100 − 2q ⇒ MR ≠ P
dq     dq
Monopolistic competition – short run

CZK                                A firm will produce output
MC              where MR=MC (indicated by
red point)
AC
PSR
Consumers are willing to
purchase given amount of
AC                                product for price PSR (derived
from demand curve, indicated
DSR    by yellow point)

The price is above the
MRSR          average cost then the firm
gains profit (Indicated by
QSR          Quantity   yellow rectangle)
Monopolistic competition – long run

CZK                                 In long run firm can change its
LMC               size => Long-run decision is then
related to the long run curves
LAC         (LMC, LAC)

PLR
Positive profit encourage new
firms to enter the industry
AC
Some consumers are enticed by
DLR
SR      new firms => demand curve and
curve of marginal product move
DSR      down

MRLR
SR            This process continue until
economic profit exists
QLR       MRLR Quantity
In LR economic profit is zero
Monopolistic competition – conclusion

Firm under the monopolistic competition determines the output
according to condition MR=MC

The price is determined by demand curve. The price does not
equal to the marginal cost =>monopolistic competition is then
allocative inefficient

In short run firms can gain positive economic profit

In long run due to the entrance of new firms economic profit is
zero => in long run P=AC

```
To top