Back to the question: Why care about perfect competition? Look at the underlying assumptions o Price taking benavior o Homogenous products o Frictionless markets(no problems with information no transaction COStS o Freedom of entry and exit Are these assumptions realistic? O No e Perfect competition has certain desirable welfare properties o Maximizes our measure of welfare Consumer surplus(CS)+ Producer Surplus(ps)added across all firms o Producer surplus same as profits 6
6 Back to the question: Why care about perfect competition? Look at the underlying assumptions oPrice taking behavior oHomogenous products oFrictionless markets (no problems with information, no transaction costs) oFreedom of entry and exit Are these assumptions realistic? oNo Perfect competition has certain desirable welfare properties. oMaximizes our measure of welfare: Consumer surplus (CS) + Producer Surplus (PS) {Added across all firms) oProducer surplus same as profits
Continued. W=CS+丌 MC Q Welfare at MC pricing: a+B+r Welfare at a higher price: a+ p Some redistribution but net loss Deadweight loss
7 Continued: n i W CS i Welfare at MC pricing: Welfare at a higher price: Some redistribution but net loss Deadweight loss
Note on zero profit condition: o If there is freedom of entry and exit then the factors of production must earn equal to normal return: (Zero profit condition e When firms make zero profit price equals average cost II=(P-AC)Q PAC Ac MC PC eqm with MC free entry PC eaim 8
8 Note on zero profit condition: If there is freedom of entry and exit then the factors of production must earn equal to normal return: (Zero profit condition) When firms make zero profit price equals average cost: P AC)( Q
Classical monopoly: Other extreme market form e Features O Single seller o Uniform price(to differentiate from price discriminating monopoly o Single plant(to differentiate from a multi plant monopoly) o Consumers still competitive o The seller has market power(is a price maker): faces a downward sloping demand curve Monopolists profit ∏=TR-TC II=PQ-TC(Q) Now price is not a constant but will vary with the output chosen by the monopolist
9 Classical Monopoly: Other extreme market form Features oSingle seller oUniform price (to differentiate from price discriminating monopoly) oSingle plant (to differentiate from a multi plant monopoly). oConsumers still competitive The seller has market power (is a price maker): faces a downward sloping demand curve. Monopolist’s profit: PQ TC Q)( TCTR Now price is not a constant but will vary with the output chosen by the monopolist
Profit maximization by the monopoly Continued o In maximizing profit the monopolist can choose either quantity or price (whichever is chosen the other follows from the demand curve we will follow the convention that monopolist chooses quantity) O FO.c 0 Q d@ o dp d 7C()=0 do d@ dQ →MR=MC Monopolist in order to maximize profits chooses an output such that marginal revenue is equal to marginal cost(makes intuitive sense, .P=100-Q, MC=10---Linear example 10
10 Profit maximization by the monopoly: Continued In maximizing profit the monopolist can choose either quantity or price (whichever is chosen the other follows from the demand curve: we will follow the convention that Monopolist chooses quantity) F.O.C. MCMR TC Q dQ d dQ dP Q dQ dQ P dQ d 0)( 0 Monopolist in order to maximize profits chooses an output such that marginal revenue is equal to marginal cost (makes intuitive sense) P = 100- Q, MC = 10 --- Linear example