(Perfect) Competition

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1 (Perfect) Competition

2 (Perfect) Competition The model of perfect competition is based on the following assumptions:

3 (Perfect) Competition The model of perfect competition is based on the following assumptions: Many small suppliers, small enough to not have no impact on other suppliers.

4 (Perfect) Competition The model of perfect competition is based on the following assumptions: Many small suppliers, small enough to not have no impact on other suppliers. Product homogeneity.

5 (Perfect) Competition The model of perfect competition is based on the following assumptions: Many small suppliers, small enough to not have no impact on other suppliers. Product homogeneity. Perfect information- all agents know prices set by all firms.

6 (Perfect) Competition The model of perfect competition is based on the following assumptions: Many small suppliers, small enough to not have no impact on other suppliers. Product homogeneity. Perfect information- all agents know prices set by all firms. Equal access- all firms have access to all production technologies.

7 (Perfect) Competition The model of perfect competition is based on the following assumptions: Many small suppliers, small enough to not have no impact on other suppliers. Product homogeneity. Perfect information- all agents know prices set by all firms. Equal access- all firms have access to all production technologies. Free access- any firm may enter or exit the market.

8 (Perfect) Competition

9 (Perfect) Competition As in the monopoly case, firms maximize profits by setting marginal revenue equal to marginal cost.

10 (Perfect) Competition As in the monopoly case, firms maximize profits by setting marginal revenue equal to marginal cost. However, unlike before, now marginal revenue=price.

11 (Perfect) Competition As in the monopoly case, firms maximize profits by setting marginal revenue equal to marginal cost. However, unlike before, now marginal revenue=price. We represent this as each firm facing a horizontal demand

12 (Perfect) Competition As in the monopoly case, firms maximize profits by setting marginal revenue equal to marginal cost. However, unlike before, now marginal revenue=price. We represent this as each firm facing a horizontal demand curve and acting like a price taker. Perfect competition is efficient in two senses:

13 (Perfect) Competition As in the monopoly case, firms maximize profits by setting marginal revenue equal to marginal cost. However, unlike before, now marginal revenue=price. We represent this as each firm facing a horizontal demand curve and acting like a price taker. Perfect competition is efficient in two senses:

14 (Perfect) Competition

15 (Perfect) Competition Each firm produces the efficient output level, where MR=MC.

16 (Perfect) Competition Each firm produces the efficient output level, where MR=MC. The set of firms active is efficient. where in the long run price equals AC.

17 (Perfect) Competition Each firm produces the efficient output level, where MR=MC. The set of firms active is efficient. where in the long run price equals AC. Note that this notion of efficiency is in a static sense.

18 Competitive Selection

19 Competitive Selection Here we will relax the last two assumptions.

20 Competitive Selection Here we will relax the last two assumptions. Now, instead of free entry, we will assume that firms pay a sunk cost in order to enter the industry.

21 Competitive Selection Here we will relax the last two assumptions. Now, instead of free entry, we will assume that firms pay a sunk cost in order to enter the industry. Not all firms have access to the same technologies.

22 Competitive Selection Here we will relax the last two assumptions. Now, instead of free entry, we will assume that firms pay a sunk cost in order to enter the industry. Not all firms have access to the same technologies. Specifically, each firm has a different cost function, and there is uncertainty about its own efficiency.

23 Competitive Selection Here we will relax the last two assumptions. Now, instead of free entry, we will assume that firms pay a sunk cost in order to enter the industry. Not all firms have access to the same technologies. Specifically, each firm has a different cost function, and there is uncertainty about its own efficiency. Consequently, firms choose optimal output based on priced being equated to expected marginal cost.

24 Monopolistic Competition Here we will maintain all of the assumptions of the perfectly competitive model except that of product homogeneity.

25 Monopolistic Competition Here we will maintain all of the assumptions of the perfectly competitive model except that of product homogeneity. To illustrate the differences we will consider short run and long run equilibria separately.

26 Monopolistic Competition Here we will maintain all of the assumptions of the perfectly competitive model except that of product homogeneity. To illustrate the differences we will consider short run and long run equilibria separately. In the sort run, we evaluate equilibrium taking the number of firms as given.

27 Monopolistic Competition Here we will maintain all of the assumptions of the perfectly competitive model except that of product homogeneity. To illustrate the differences we will consider short run and long run equilibria separately. In the sort run, we evaluate equilibrium taking the number of firms as given. Once again equating MR with MC, but this time the equilibrium price is greater than AC.

28 Monopolistic Competition Here we will maintain all of the assumptions of the perfectly competitive model except that of product homogeneity. To illustrate the differences we will consider short run and long run equilibria separately. In the sort run, we evaluate equilibrium taking the number of firms as given. Once again equating MR with MC, but this time the equilibrium price is greater than AC. This is referred to as short run because now outside firms are willing to enter the market.

29 Monopolistic Competition In contrast the long run equilibrium is characterized by MR=MC, but also P=AC (zero profits).

30 Monopolistic Competition In contrast the long run equilibrium is characterized by MR=MC, but also P=AC (zero profits). Common to the perfect competition model, profits are zero in the monopolistic competition model.

31 Monopolistic Competition In contrast the long run equilibrium is characterized by MR=MC, but also P=AC (zero profits). Common to the perfect competition model, profits are zero in the monopolistic competition model. In contrast, P=MC in the perfect competition model whereas P MC in the monopolistic competition model.

32 Monopolistic Competition In contrast the long run equilibrium is characterized by MR=MC, but also P=AC (zero profits). Common to the perfect competition model, profits are zero in the monopolistic competition model. In contrast, P=MC in the perfect competition model whereas P MC in the monopolistic competition model. Price is also greater than minimum average cost.

33 Monopolistic Competition In contrast the long run equilibrium is characterized by MR=MC, but also P=AC (zero profits). Common to the perfect competition model, profits are zero in the monopolistic competition model. In contrast, P=MC in the perfect competition model whereas P MC in the monopolistic competition model. Price is also greater than minimum average cost. This implies two sources of allocative inefficiency.

34 Monopolistic Competition

35 Monopolistic Competition Specifically, each firm produces too small an output.

36 Monopolistic Competition Specifically, each firm produces too small an output. Total costs would be lower if there were fewer firms each producing a higher level of output.

37 Monopolistic Competition Specifically, each firm produces too small an output. Total costs would be lower if there were fewer firms each producing a higher level of output. Total surplus can be increased by increasing output.

38 Monopolistic Competition Specifically, each firm produces too small an output. Total costs would be lower if there were fewer firms each producing a higher level of output. Total surplus can be increased by increasing output. Which is interesting, because even though monopolistic competition results in zero profits, that itself does not imply efficiency.

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