Extremely Competitive MarketsPart 1: Closed Economies

Characteristics of Extremely Competitive Markets

Many buyers and sellers, or

“Easy” entry and exit in the presence of significant extranormal profits

Little or no product differentiation

Price takers

P = AR = MR

MC

Profit Maximization for a Firm in an Extremely Competitive Market

Quantity0

Price

Qc

P = AR = MR

MC

Why Qc is the Profit Maximizing Output Level

Quantity0

Price

Qc

MC(Q1)

Q1

MC(Q2)

Q2

Pc

At Q2: MC(Q2) > MR(Q2)

At Q1: MC(Q1) < MR(Q1)

MC

The Marginal Cost Curve is the Competitive Firm’s Supply Curve

Quantity0

Price

P2=MR2

P1=MR1

Q1 Q2

Because it shows how much the firm is willing to produce at any given price

Qc

Measuring Profit for the Competitive Firm

Quantity0

Price

P = AR = MR

ATCMC

Pc

ATC

Profit

The Firm’s Short Run Supply Decision

Quantity

ATC

AVC

0

Price

MC

If P < AVC, shut down

If P > AVC, keep producing in the short run

If P > ATC, keep producingIn the longer run, at a profit

The Firm’s Short Run & Long Run Supply Curves

Quantity0

MC

ATC

AVC

The firm’s SR supply curve

The firm’s LR supply curve

Price

Individual Firm and Industry Supply

Firm Type A Firm Type B

P/Q P/Q MCBMCA

$20

$15

$10

4 6 8 Q/t 2 3 4 Q/t

Firms Types A and B together

P/Q

$20

$15

$10

6 9 12 Q/t

Total Industry Supply

P/Q

$20 $15

$10

300 400 500 600 Q/t

Total industry =50 firms type A50 firms type B

Extremely Competitive Market Outcome

Price

Industry supply

$20 $15

$10

Market demand

100 200 300 450 500 600 Quantity

Industry LR Supply, all firms identical

Individual identical firms Industry

$/Q $/Q MC AC Industry Demand

LR Supply

q Q/t Q=nq Q/t

Industry LR Supply, all firms not identical

Individual non-identical firms Industry

P/Q MC AC2

AC1

q1 q2 Q/t Q1 Q2 Q/t

D1 D2 D3

LR Supply

Strategy: What Size Plant to Build

Output/day

0

Avg. total costATC with

small plantATC with

medium plantATC with

large plant

Small plant Medium plant Large plant

Strategy: Identifying Economies of Scale

Diseconomies

of scale

Output per day0

Averagetotal cost

Economies

of scale

Constant Returnsto scale

Strategy: Identifying Economies of Scope

Cost of producing x alone = C(x)

Cost of producing y alone = C(y)

Cost of producing 2 goods together = C(x,y)

Economies of scope are present if:C(x,y) < C(x) + C(y)

Measure or degree of economies of scope:

[C(x) + C(y)] – C(x,y) C(x,y)