Perfect Competition. ECON 212 Lecture 13. Tianyi Wang. Queen s Univeristy. Winter 2013
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1 Perfect Competition ECON 212 Lecture 13 Tianyi Wang Queen s Univeristy Winter 2013 Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
2 Intro We can analyze firm s supply decision. Firm faces two constraints: technology and market. Market constraint is summarized by the demand curve. Demand curve facing the firm differs from market demand curve. one firm, two firms,... see graphs later. We start with the simplest market enviroment: perfect competition. Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
3 Perfect Competittion Market is perfectly competititve if there are large number of firms so that each one is too small to influence market price. Firm s problem: how much to produce taken price as given. Strong assumption, works well. See class notes for graph of Deman facing a Competitive firm. Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
4 Supply Decision of a Competitive Firm Here we take the cost sturcture as given. Competitve firm s problem is max pq c(q) q Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
5 Supply Decision of a Competitive Firm Here we take the cost sturcture as given. Competitve firm s problem is max pq c(q) q Note we can backup input demands after solving for q. Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
6 Supply Decision of a Competitive Firm Here we take the cost sturcture as given. Competitve firm s problem is max pq c(q) q Note we can backup input demands after solving for q. FOC is p c (q) = 0 Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
7 Supply Decision of a Competitive Firm Here we take the cost sturcture as given. Competitve firm s problem is max pq c(q) q Note we can backup input demands after solving for q. FOC is p c (q) = 0 or p = MC (q) MR(q) = MC (q) Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
8 Supply Decision of a Competitive Firm Here we take the cost sturcture as given. Competitve firm s problem is max pq c(q) q Note we can backup input demands after solving for q. FOC is p c (q) = 0 or p = MC (q) MR(q) = MC (q) Competitive firm s supply curve is its MC curve. Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
9 Supply Decision of a Competitive Firm Here we take the cost sturcture as given. Competitve firm s problem is max pq c(q) q Note we can backup input demands after solving for q. FOC is p c (q) = 0 or p = MC (q) MR(q) = MC (q) Competitive firm s supply curve is its MC curve. However there are two issues. Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
10 Competitive Firm s Supply Curve We derived supply curve from FOC. It could either be a max or a min. See class notes graph where two output levels satisfy FOC. Note we can avoid q 1 by checking SOC. Graphically this happens on declining portion of MC. So firm s supply curve is only the upward sloping portion of MC. Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
11 Competitive Firm s Supply Curve (Con t) Second issue is if price is so low that not profitable to produce. See class notes for shutdown condtion. Note: shutdown is different from exit. So only upward sloping portion of MC above AVC is competitve firm s supply curve. Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
12 Long-run Supply of Competitive Firm Long-run curve intersects shrot-run curve at output q where fixed factor is optimal. See class notes for graph. Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
13 Long-run Supply of Competitive Firm Long-run curve intersects shrot-run curve at output q where fixed factor is optimal. See class notes for graph. LR curve is more responsive to price. Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
14 Long-run Supply of Competitive Firm Long-run curve intersects shrot-run curve at output q where fixed factor is optimal. See class notes for graph. LR curve is more responsive to price. Firm can exit in the long-run. Thus profit has to be greater than zero. pq c(q) 0 p c(q) q Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
15 Long-run Supply of Competitive Firm Long-run curve intersects shrot-run curve at output q where fixed factor is optimal. See class notes for graph. LR curve is more responsive to price. Firm can exit in the long-run. Thus profit has to be greater than zero. pq c(q) 0 p c(q) q Thus long-run supply curve is the upward sloping portion of LRMC above LRAC. Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
16 Long-run Supply of Competitive Firm Long-run curve intersects shrot-run curve at output q where fixed factor is optimal. See class notes for graph. LR curve is more responsive to price. Firm can exit in the long-run. Thus profit has to be greater than zero. pq c(q) 0 p c(q) q Thus long-run supply curve is the upward sloping portion of LRMC above LRAC. See class notes for constant returns to scale technology. Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
17 Short-run Industry Supply Suppose there are n firms, let S i (p) be firm i s supply curve. Then the industry/market supply is S(p) = If firms are identical, S(p) = ns i (p) n S i (p) i=1 Market demand and market supply determines equilibrium price and output level. Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
18 Long-run Industry Equilibrium If no barriers to entry, firms enter and exit in the long-run. Firms entry and exit affect output produced and therefore equilibrium price. We can get market supply by adding up individuals. Will get an approximation. See class notes. Note LR industry supply looks the same as firm supply with CRS technology. Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
19 Long-run Industry Equilibrium In Competitive Equilibrium, we have Demand = Supply and each firm max profit. 1. Firm max profit: p = LMC (q ) 2. Perfect competition: p = LAC (q ) 3. Market clears: Q D (p ) = Q S (p ) = n q Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
20 Opportunity Cost and Economic Rent Suppost entry is limited in some industries (Agriculture) due to limited fixed factors (Land). It might look like farmer earns positive profit π. Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
21 Opportunity Cost and Economic Rent Suppost entry is limited in some industries (Agriculture) due to limited fixed factors (Land). It might look like farmer earns positive profit π. This not correct, we do not measure opportunity cost of Land. Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
22 Opportunity Cost and Economic Rent Suppost entry is limited in some industries (Agriculture) due to limited fixed factors (Land). It might look like farmer earns positive profit π. This not correct, we do not measure opportunity cost of Land. Farmer can sell the Land for π. Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
23 Opportunity Cost and Economic Rent Suppost entry is limited in some industries (Agriculture) due to limited fixed factors (Land). It might look like farmer earns positive profit π. This not correct, we do not measure opportunity cost of Land. Farmer can sell the Land for π. Whenever a fixed factor is preventing entry, a rental rate for that factor exists. Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
24 Opportunity Cost and Economic Rent Suppost entry is limited in some industries (Agriculture) due to limited fixed factors (Land). It might look like farmer earns positive profit π. This not correct, we do not measure opportunity cost of Land. Farmer can sell the Land for π. Whenever a fixed factor is preventing entry, a rental rate for that factor exists. This is Economic Rent: payments to a factor of production in excess of the minimum necessary to have that factor supplied. Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
25 (Optional) Relationship b/w Cost-Min and Profit-Max Directly write profit max problem: max pq (wl + rk ) q s.t. q = Q(L, K ) How to solve? sub constraint into objective by eliminating q. FOC for K and L respectively are max pq(l, K ) (wl + rk ) K,L pq k = r pq L = w Take the ratio, we get the optimality cond t for cost-min. MP K MP L = r w Tianyi Wang (Queen s Univeristy) ECON 212 Lecture 13 Winter / 12
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