Chapter 4 - Competition, Equilibrium, and Efficiency Flashcards
perfectly competitive industry is an industry with…
…no barriers to competition
main features of a competitive industry
- Atomistic firms
- Homogeneous products
- Perfect information
- Free entry
Atomistic firms
= there are many competitors, all small relative to the market and unable to affect the market price through their actions
Homogeneous products
competitors produce exactly the same product (compete head-to-head on price)
Perfect information
Everyone (firms and consumers) knows about prices and product characteristics
Free entry
there are no barrier to establishment of a new firm (other than “normal” entry costs). Imitation is possible: others can enter the business if they wish; and if they do, they incur the same costs as the incumbents do
if a firm has a sustainable competitive advantage, that advantage must lie in…
…the violation of one of the conditions of the perfect competition model
Each firm faces a … demand curve
flat
infinitely elastic demand: the firm can sell all it wants at market price and nothing at a higher price
Profit maximising condition
MC (q) = p
each firm’s supply decision is governed by its marginal cost curve. it supplies the quantity at which marginal cost equals price
industry supply curve
if we put all firms together, we sum their supply at each price, deriving the industry supply curve
S (p) = q1 + q2 + q3 + …
Market equilibrium
the point of intersection between the demand and supply curves
none of the market participants have an incentive to change their behaviour
excess supply
if price is above equilibrium, fewer people want to buy than sell
would drive the price down to equilibrium
excess demand
if price is below equilibrium, fewer people would want to sell than to buy
would drive the price up
law of supply and demand
price tends to move in the direction of the equilibrium price (where supply equals demand)
comparative statics
is used by economists to describe the exercise of looking at what happens to equilibrium if an exogenous factor changes
a rightward shift of the demand curve leads to an increase in quantity and a (1) in price
a rightward shift of the supply curve leads to an increase in quantity and a (2) in price
(1) increase
(2) decrease
the impact on price or quantity depends on the … of the supply and demand curves
slope
for shifts in demand, the impact depends on the slope of the supply curve (and the other way around)
short run
period when the number of firms is fixed
long run
consider the possibility of entry and exit
the short run equilibrium price might be above average cost
firms can make above normal profits in the short run
in the long-run equilibrium under perfect competition firms produce at the minimum average cost and make zero profits
if the price is greater than the average cost, we would expect new firms to enter the industry
market supply shifts to the right, driving down market price
ultimate effect: firm’s profit goes down to zero
if different firms have different cost structures, then in a long run competitive equilibrium, the marginal firm will be one for which p=…
p = MC = AC
rent
any payment in excess of the costs needed to bring that factor into production
firms that have cost advantages will be able to make a positive profit (=rent)
Model of competitive selection
same assumptions as perfect competition except
- firms must pay a sunk cost in order to enter
- not all firms have access to the same technology
different firms have different productivity levels, different cost functions, and each firm is uncertain about its own productivity level
variability of and uncertainty about firm efficiency reconciles the competitive model with empirical observation regarding simultaneous entry and exit; relative size of entrants/exiters vis-à-vis incumbents
θ = the firm’s estimate of its efficiency parameter
the profit for a type θ firm is given by:
q^2/θ is the variable cost of the firm
firm size is correlated with firm efficiency
Assumptions for monopolistic competition
- there is a large number of firms, so that the impact of each firm upon its rivals is negligible
- due to product differentiation, the demand curve faced by each firm is not horizontal, that is, each firm is a price setter, not a price taker
- there is free entry and free access to available technologies
maintains all of the assumptions of perfect competition except that of product homogeneity
long-run equilibrium in monopolistic competition
firms maximize profits, so that marginal revenue equals marginal cost
firms make zero profits (p=AC(q)), so that no active firm wishes to become inactive
-> equilibrium profits are zero, but firms do not produce at the minimum of their average cost
consumer surplus
difference between the demand curve and the market price
all area over price and under demand curve
producer surplus
difference between price and the supply curve
all area under price and over supply curve
allocative efficiency
requires that resources be allocated to their most efficient use - no DWL
productive efficiency
how close the actual production cost is to the lowest cost achievable
lower productivity of one firm to another in the same industry means higher costs, which lead to higher marginal cost
dynamic efficiency
the rate of introduction of new products, the improvements in the production techniques of existing ones
allocative efficiency requires that (1)
productive efficiency requires that (2)
dynamic efficiency refers to (3)
- output be at the right level
- such output be produced in the least expensive way given the available set of technologies
- the improvement over time of products and production techniques
the fundamental theorem
in a competitive market the equilibrium levels of output and price corresponds to the maximum total surplus
is about static efficiency
