KINH TẾ VI MÔ 2015 chapter 5 micro 1 5 market structure

©Kieu Minh, FTU, 2014 3 5.1 Competitive market Perfectly Competitive Markets Profit Maximization Competitive Firm Competitive Market Supply Curve Producer Surplus ©Kieu Minh, FTU, 2

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Market Structure

Chapter 5

By Tran Thi Kieu Minh, MSc

Microeconomics

Contents

Perfect Competitive Market

Monopoly

Monopolistic Competition

Obligopoly

©Kieu Minh, FTU, 2014

2

The four types of market structure

Economists who study industrial organization divide markets into four types:

monopoly, oligopoly, monopolistic competition, and perfect competition

3

5.1 Competitive market

Perfectly Competitive Markets Profit Maximization Competitive Firm Competitive Market Supply Curve

Producer Surplus

4

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5.1.1 Perfectly Competitive Markets

1. Price Taking

 The individual firm sells a very small share of the total

market output and the individual consumer buys too small a

share of industry output, therefore, cannot influence market

price o have any impact on market price

 Price taker

2. Product Homogeneity

 The products of all firms are perfect substitutes

3. Free Entry and Exit

 Buyers can easily switch from one supplier to another

 Suppliers can easily enter or exit a market

5

E g.Total, average, & marginal revenue - competitive firm

Quantity (Q) Price (P) Total revenue (TR=P ˣ Q) Average revenue (AR=TR/Q) Marginal revenue (MR=ΔTR/ΔQ)

1 gallon

2

4

6

8

$6

6

$6

12

24

36

48

$6

6

$6

6

The Competitive Firm

D=AR=MR

$6

Output (gallons)

Price

$ per

gallon

100 200

D

$6

S

Price

$ per gallon

Output (millions

of gallons)

100

7

The Competitive Firm

Demand curve faced by an individual firm is a horizontal line at the market price P

 Firm’s sales have no effect on market price

Average revenue = P

Marginal revenue = P

Profit Maximizing: For a perfectly competitive firm, profit maximizing output occurs when

( )

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P rofit maximization for a competitive firm

Costs

and

Revenue

At the quantity Q1, marginal revenue MR1 exceeds marginal cost MC1, so raising production

increases profit At the quantity Q2, marginal cost MC2 is above marginal revenue MR2, so

reducing production increases profit The profit-maximizing quantity QMAX is found where the

horizontal price line intersects the marginal-cost curve

Quantity

0

ATC

AVC P=AR=MR P=MR 1 =MR 2

MC

MC 1

MC 2

Q 2

Q 1 Q MAX

The firm maximizes profit

by producing the quantity

at which marginal cost

equals marginal revenue

9

Ma rginal cost as the competitive firm’s supply curve

Price

An increase in the price from P1 to P 2 leads to an increase in the firm’s profit-maximizing quantity from Q1 to Q2 Because the marginal-cost curve shows the quantity supplied by the firm at any given price, it is the firm’s supply curve

Quantity

0

ATC AVC

MC

P 1

P 2

Q 2

Q 1

10

5.1.2 Competitive Firm’s Decision

Shutdown

During a specific period of time

Because of current market conditions

Exit

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Competitive Firm’s Decision

The firm’s short-run decision to shut down

The portion of its marginal-cost curve

That lies above average variable cost

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The competitive firm’s short-run supply curve

Costs

In the short run, the competitive firm’s supply curve is its marginal-cost curve (MC) above

average variable cost (AVC) If the price falls below average variable cost, the firm is

better off shutting down

Quantity

0

ATC

MC

AVC

1 In the short run, the firm produces on the

MC curve if P>AVC,

2 .but

shuts down

if P<AVC

13

Competitive Firm’s profit

Profit = TR – TC = (P – ATC) ˣ Q

Loss = TC - TR = (ATC – P) ˣ Q

= Negative profit

14

Profit as the area between price and average total cost

Price

Quantity

0

(a) A firm with profits

Profit

MC

ATC P=AR=MR P

Q

(profit-maximizing quantity)

ATC

Price

Quantity

0

(b) A firm with losses

Loss

MC

ATC

P=AR=MR P

Q (loss-minimizing quantity) ATC

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Case study: Near-empty restaurants and off-season miniature golf

 Restaurant – stay open for lunch?

 Fixed costs

Not relevant

Are sunk costs in short run

 Variable costs – relevant

 Shut down if revenue from lunch < variable costs

 Stay open if revenue from lunch > variable costs

 Operator of a miniature-golf course

 Ignore fixed costs

 Stay open if revenue > variable costs

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Quiz1

 A competitive Firm ABC has average production cost

($) of

a. What is the short-run supply curve of the firm?

b. If market price is $30, what is the optimum quantity

of the firm? How much is the maximum profit?

c. What is the firm’s decision if market price decreases

to $10? Explain

75 2

q

  

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Competitive Market Supply Curve

Short run: market supply with a fixed number

of firms

For P > AVC: supply curve is MC curve

Add up quantity supplied by each firm

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S h ort-run market supply

Price

In the short run, the number of firms in the market is fixed As a result, the market supply curve,

shown in panel (b), reflects the individual firms’ marginal-cost curves, shown in panel (a) Here,

in a market of 1,000 firms, the quantity of output supplied to the market is 1,000 times the

quantity supplied by each firm

Quantity (firm)

0

(a) Individual firm supply

MC

100

$2.00

Price

Quantity (market)

0 (b) Market supply

200

1.00

Supply

100,000

$2.00

200,000 1.00

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Quiz 2

A competitive market of a good A has 1000 similar sellers, each has production cost of:

Market demand of good A is :

1. What is the market supply curve of good A?

2. What is the equilibrium price and quantity?

3. What is the optimum selling quantity of each seller?

2

1

2

20000 500

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5.1.3 Producer Surplus

In the short-run:

 Price is greater than MC on all but the last unit of output

 Therefore, surplus is earned on all but the last unit

The producer surplus is the sum over all units produced

of the difference between the market price of the good

and the marginal cost of production

Area above supply to the market price

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Producer Surplus for a Firm

Producer Surplus

Producer surplus

is area above MC

to the price

Price ($ per unit of output)

Output

AVC

MC

A

B

P

q *

At q * MC = MR

Between 0 and q ,

MR > MC for all units

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Producer Surplus for a Firm

Producer surplus

is also ABCD = Revenue minus

variable costs

Price

($ per

unit of

output)

Output

Producer

Surplus

AVC

MC

A

B

P

q *

C

D

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Producer Surplus for a Market

D

P *

Q *

Producer Surplus

Market producer surplus is

the difference between P*

and S from 0 to Q *

Price ($ per unit of output)

Output

S

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5.2 Monopoly

Monopolist Demand and Marginal Revenue Profit maximization Market power Price discrimination Microeconomics

26

5.2.1 Monopolist

close substitutes

Monopoly resources

Government regulation

The production process

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Why Monopolies Arise

 Monopoly resources

 A key resource required for production is owned by a single

firm

 Higher price

 Government regulation

 Government gives a single firm the exclusive right to

produce some good or service

 Government-created monopolies

Patent and copyright laws

Higher prices; Higher profits

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Why Monopolies Arise

 The production process

 A single firm can produce output at a lower cost than can a larger number of producers

 Natural monopoly

 Arises because a single firm can supply a good or service to

an entire market at a smaller cost than could two or more firms

 Economies of scale over the relevant range of output

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Demand and Revenue

 A Monopolist’s Demand Curve

 Price maker

 Sole producer

 Downward sloping demand

 Market demand curve: P = f (Q)

 A monopolist’s revenue

 Total revenue: TR = Px Q = f (Q) x

Q

 Average revenue: AR = TR/Q

 Marginal revenue: MR = △TR/△Q

= TR’(Q)

 Can be negative

 Always: MR < P

 MR curve – is below the demand

curve

Price

Q

0

Demand

30

MR

6.2.2 Profit maximization

 Profit maximization

 If MR > MC – increase production

 If MC > MR – produce less

 Maximize profit

Produce quantity where MR=MC

Intersection of the marginal-revenue curve and the marginal-cost curve

31

Profit maximization for a monopoly

Costs

and

Revenue

A monopoly maximizes profit by choosing the quantity at which marginal revenue equals

marginal cost (point A) It then uses the demand curve to find the price that will induce

consumers to buy that quantity (point B)

Quantity

0

Average total cost

Demand

Marginal revenue Marginal cost

Q MAX

B Monopoly

price

A

1 The intersection of the marginal-revenue curve and the marginal-cost curve determines the profit-maximizing quantity

2 and then the demand curve shows the

price consistent with this quantity

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Profit maximization

Profit maximization

Price equals marginal cost

Price exceeds marginal cost

A monopoly’s profit

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The monopolist’s profit

5

Costs

and

Revenue

The area of the box BCDE equals the profit of the monopoly firm The height of the box

(BC) is price minus average total cost, which equals profit per unit sold The width of the

box (DC) is the number of units sold

Quantity

0

Demand Average

total

B E

D

Marginal revenue

Q MAX

Average total cost Marginal cost

Monopoly

price

C

Monopoly

profit

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5.2.3 Market Power

 A firm's market power: its ability to price above marginal cost

 Lerner index, named after the American economist Abba Lerner (1903-1982), was formalized in 1934

 higher numbers implying greater market power

 For a perfectly competitive firm (where P=MC), L=0; such a firm has no market power

P MC P

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6.2.4 The Welfare Cost of Monopolies

 Monopoly

 Produce quantity where MC = MR

 Produces less than the socially efficient quantity of output

 Charge P>MC

 The deadweight loss:

Triangle between: demand curve and MC curve

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The inefficiency of monopoly

8

Costs and Revenue

Because a monopoly charges a price above marginal cost, not all consumers who value the good at more than its cost buy it Thus, the quantity produced and sold by a monopoly is below the socially efficient level The deadweight loss is represented by the area of the triangle between the demand curve (which reflects the value

of the good to consumers) and the marginal-cost curve (which reflects the costs of the monopoly producer)

Quantity

0

Demand

Marginal revenue Monopoly

quantity

Marginal cost Monopoly

price

Efficient quantity

Deadweight loss

 A

Q

dQ MC P DWL

*

)

(

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The Welfare Cost of Monopolies

 The monopoly’s profit: a social cost?

 Monopoly

 Higher profit

 Not a reduction of economic welfare

Bigger producer surplus

Smaller consumer surplus

 Monopoly profit

 Not a social problem

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Quiz 3

A monopolist has MC = 4 + Q and FC of $1000

He faces the demand of P = 160 – Q (P & C: $/kg, Q : kg)

1. What are the optimum quantity and price of the monopoly? How much is the maximum profit?

2. How much is the consumer surplus created by this monopoly?

3. How much is the DWL?

4. Government places a tax of $4/kg for the product of the monopoly How does profit change?

5. Graph the results

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5.2.5 Price Discrimination

Price discrimination

different customers

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Perfect First-Degree Price Discrimination

If the firm can perfectly price discriminate, each consumer

is charged exactly what they are willing to pay

 Additional profit from producing and selling an incremental unit is now the difference between demand and marginal cost

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P*

Q*

Without price discrimination,

output is Q* and price is P*

Variable profit is the area

between the MC & MR (yellow)

Perfect First-Degree Price Discrimination

Quantity

$/Q

With perfect discrimination, firm will choose to produce Q**

increasing variable profits to include purple area

Consumer surplus is the area above P* and between

0 and Q* output

P max

D = AR

MR

MC

Q**

P C

42

First-Degree Price Discrimination

 In practice perfect price discrimination is almost never possible

 Firms can discriminate imperfectly

 Can charge a few different prices based on some estimates

of reservation prices

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First-Degree Price Discrimination

Examples of imperfect price discrimination

 Lawyers, doctors, accountants

 Car salesperson (15% profit margin)

 Colleges and universities (differences in financial aid)

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First-Degree Price Discrimination in Practice

Quantity

D

MR

MC

$/Q

P 2

P 3

P 1

P 5

P 6

Six prices exist resulting

in higher profits With a single price P* 4 , there are fewer consumers

P* 4

Q*

Discriminating up to

P 6 (competitive price) will increase profits

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Second-Degree Price Discrimination

In some markets, consumers purchase many units of a

good over time

 Demand for that good declines with increased consumption

Electricity, water, heating fuel

Firms can engage in second degree price

discrimination

 Practice of charging different prices per unit for different

quantities of the same good or service- Block pricing

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Second-Degree Price Discrimination

= P 0 and Q = Q 0 With second-degree discrimination there are three blocks with prices

P 1 , P 2 , & P 3

Quantity

D

MR

MC

AC

P 0

Q 0

Q 1

P 1

1st Block

P 2

Q 2

2nd Block

P 3

Q 3

3rd Block

Different prices are charged for different quantities or

“blocks” of same good

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Third-Degree Price Discrimination

 Practice of dividing consumers into two or more

groups with separate demand curves and charging

different prices to each group

1 Divides the market into two-groups

2 Each group has its own demand function

 Examples: airlines, premium v non-premium liquor,

discounts to students and senior citizens, frozen v canned

vegetables, magazines

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Third-Degree Price Discrimination

 How can the firm decide what to charge each group of consumers?

1 Total output should be divided between groups so that MR for each group are equal

2 Total output is chosen so that MR for each group of consumers is equal to the MC of production

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