Competition and Welfare. Main topics. Intermediate Microeconomics. Long-Run Average Costs (Figure 8.15 from Mansfield and Yohe)

Transcription

1 Competition and Welfare Intermediate Microeconomics Main topics Long run cost functions Four classes of market structure (review) Welfare analysis of market structures perfect competition monopolistic competition oligopoly monopoly If perfectly competitive markets are ideal, how common are they? Average cost A B S1 S3 S2 Long-Run Average Costs (Figure 8.1 from Mansfield and Yohe) C D S' 1 E S' 2 S' 3 0 Q Long-run average cost function R Quantity of output Figure 8.1 SHORT-RUN AVERAGE COST FUNCTIONS FOR 10/2/2001 VARIOUS SCALES OF PLANTS A. Dye Copyright 2000 by W.W. Norton & Company 1

2 Average cost L Long-Run Average Costs (Figure 8.16 from Mansfield and Yohe) Short-run average cost functions L' Long-run average cost function Quantity of output Figure 10/2/ LONG-RUN AVERAGE COST FUNCTION A. Dye Copyright 2000 by W.W. Norton & Company Long-Run Average Costs Long-run average costs may be upward sloping, downward sloping, flat. or U-shaped. U-shaped long-run average cost curves have regions of increasing and decreasing returns to scale. Costs per unit Constant long-run average costs mean constant returns to scale Costs per unit Increasing long-run average costs mean decreasing returns to scale Costs per unit LR LR LR Decreasing long-run average costs mean increasing returns to scale units of output units of output units of output Four Classes of Market Structure (from Lecture on Price Competition) Perfect competition: Firms are price-takers. They have no market power. (Perfectly) competitive market Unconcentrated, undifferentiated Imperfect competition: Firms are not price takers. They have some market power. Monopolistically competitive market Oligopoly Unconcentrated, differentiated Concentrated, product may or may not be differentiated Monopoly Concentrated, product may or may not be differentiated Many sellers, homogeneous product Many sellers, heterogeneous product few competitors or rivals (including possible entrants) a single seller (including possible entrants) 2

3 Which market structure is better for society? Firm with Market Power Price-taking Firm Price firm s demand Price firm s demand Economists argue that, when markets work properly, competition drives P = will produce maximum social welfare. Why? Consumer Surplus Market demand Price determined by market (any structure) A useful concept for analysis of social welfare outcomes is: Consumer surplus: the monetary difference between what consumers are willing to pay and what they must pay. If the good is not divisible, then it is the area shown. If the good is divisible, then it is the area below the demand curve and above the price. Consumer Surplus 10 consumer surplus Market demand Price determined by market (any structure) Consumer surplus: the monetary difference between what consumers are willing to pay and what they must pay. If the good is divisible, then it is the area below the demand curve and above the price. our usual assumption

4 Consumer and Producer Surplus in a Perfectly Competitive Market Market demand Market supply Consumer + producer surplus is at a maximum when P = P = millions of Market output A firm s output Perfectly Competitive Markets Proposition: Perfectly competitive markets produce optimal social welfare outcomes. Perfectly competitive markets their characteristics have a homogeneous product, many buyers and sellers, and easy entry and exit of firms in and out of the market. The classic argument has two parts: Firms willingly choose their output and price such that price equals marginal cost (P = ) Entry and exit of firms in the long run cause perfectly competitive firms to produce at minimum average costs. (P = = min in the long run) Profits and Entry 10 Long-run cost curves Normal and abnormal profits Suppose all firm owners pay themselves a normal rate of return and figure it into their costs. Then, normal profits = 0, and positive profits are abnormal profits. If firms in an industry earn abnormal profits, and entry is easy (costless), then new firms will enter. 4

5 Losses (Negative Profits) and Exit 10 Long-run cost curves Normal and abnormal profits Suppose all firm owners pay themselves a normal rate of return and figure it into their costs. Then, normal profits = 0, and positive profits are abnormal profits. If firms in an industry earn abnormal profits, and entry is easy (costless), then new firms will enter. Perfect Competition in the Long Run 10 Average cost is at a minimum when P = = This happens in the long run as long as firms enter and exit freely in pursuit of abnormal profits. Long-run cost curves How does a little market power change the outcome? Proposition: Monopolistically competitive markets produce near optimal social welfare outcomes. Monopolistically competitive markets their characteristics have a heterogeneous (differentiated) product, but otherwise, they resemble perfectly competitive markets -- many buyers and sellers, and easy entry and exit of firms in and out of the market. The classic argument has two parts: Firms have downwardly sloping demands, but because there are many differentiated substitutes, individual firms demand curves tend to be highly elastic. When they set MR =, the price they set is not too far above. Entry and exit of firms in the long run do not produce at minimum average costs. ( > min in the long run)

6 Consumer Surplus in a Monopolistically Competitive Market Monopolistically competitive firms face: elastic demands because there are many close substitutes but downward sloping demands because the product is differentiated. MR = millions of Market output A firm s output Monopolistic Competition in the Long Run 10 As in perfect competition If firms in an industry earn abnormal profits, and entry is easy (costless), then new firms will enter. MR 0 Monopolistic Competition in the Long Run Market price min 0 Market Demand 6

7 Monopoly Monopoly is a market structure in which a single firm supplies the entire market. There are two significant features that distinguish monopoly outcomes from monopolistic competition. Monopolies producer products that have no close substitutes. (Note I did not say no substitutes.) Therefore, the market demand for the monopolist s product will generally be more inelastic. What consequence will that have on the price? Either natural or artificial barriers to entry prevent entrants from eroding positive abnormal profits. Consumer Surplus in a Monopoly Relative to Monopolistic Competition consumer surplus Monopoly s demand and MR curves producer surplus the competitive ideal deadweight loss millions of The Market output same as The Firm s output millions of How does oligopoly differ from monopoly and monopolistic competition? The welfare outcome falls between the two. Entry barriers are not as high, but not high enough so that no competitors exist. When there are only few competitors, they are often referred to as rivals. How competitive rivals are depends on strategic factors that we will discuss later in the semester.

8 Summary Consumer surplus Competitive markets Perfect competition (an ideal) Monopolistic competition (a close second ) The social value of variety. Monopoly A worse outcome (But this is not the end of the story) Oligopoly ( Stay tuned We don t have enough tools in our basket yet.) 8