Note to students:

The chapter on pure competition contains a lot of material. I will cover all of the chapter diagrams in lecture, in addition to the following material. As always, you are strongly advised to read the chapter before the lecture.

REMEMBER: The assigned reading for this lecture includes Section 4.6 (pages 106-111) of McConnell, Brue & Barbiero, Microeconomics, 11th edition. This sections deals with consumer and producer surplus.

CONSTRUCTION OF THE SUPPLY CURVE

Quantity supplied depends upon how firms in the market make price/quantity decisions.

We assume that all firms, regardless of the type of the market, seek to maximize profits. How they do this depends upon how the market is organized.

Market Organizations

STRUCTURE CONDUCT PERFORMANCE

Technical Number of Sellers Pricing Behaviour Efficiency

Allocative Number of Buyers Product Strategy Efficiency

Condition of Entry Dynamic Efficiency

& Exit (Progressiveness)

Product Equity Differentiation

We will deal with 4 market organizations:

• Perfect Competition • Monopoly • Oligopoly • Monopolistic Competition

For each, we will identify structure, conduct and performance

Demand facing industry is downward sloped Demand facing individual supplier is perfectly elastic

$131 $131

200 (max) 700,000

Individual Supplier Market (i.e., 5,000 Suppliers)

Important! There is a difference between market demand and individual supplier's demand.

In a perfectly competitive market, each supplier provides so little of the total that she can sell as much as she can produce at the going price.

This means the demand facing the individual supplier in a perfectly competitive market is perfectly elastic!

P MC ATC P S

D

Q Q Individual Supplier Market

OUTCOME OF COMPETITIVE MARKET

1) Allocative Efficiency

• P = Value to society of the last unit consumed

• MC = Cost to society of the last unit produced

• P = MC implies every unit whose value exceeds its cost is produced and consumed

2) Technical (or Productive) Efficiency

• All firms produce at the minimum point on their ATC curves (lowest average unit costs are achieved)

3) “Equity”

• P = ATC implies that the supplier is not obtaining economic profits (i.e., economic rent) The concept of Allocative Efficiency

Produce all units that add more to benefits than to costs.

P

Supply

P > MC P < MC

Demand Q each additional Qc each additonal unit unit is worth is worth less than its more than its resource cost resource cost

Net Benefits (Surplus)

$ 9 Marginal Social Cost = Supply 8

7

6

5

4

3

2 Marginal Social Benefit = Demand 1

1 2 3 4 5 6 7 8 9 10 11 12 13

Q = 4 units produced and consumed in a competitive market. P = $5. For consumers, every unit except the 4th is worth more than $5. Their surplus (net benefit) is the difference between what they pay ($5x4) and the total value of what they receive. Total value is the area under the demand curve up to 4 units. Consumer Surplus = (1/2)x($9-$5)x(4)

In the short run producers will produce any unit that adds more to revenue than to cost. Only the 4th unit adds $5 to costs. Producers would have produced each previous unit for a lower price. They receive $20. The difference between $20 and the sum of the marginal costs is the producer surplus. Producer surplus = (1/2)x($5-$1)x(4). In this example producer and consumer surplus are equal (BUT NOT ALWAYS - IT DEPENDS ON THE SHAPE AND PLACEMENT OF THE SUPPLY AND DEMAND CURVES).

PRODUCER SURPLUS ≠ ECONOMIC PROFITS

Marginal costs do not include fixed costs in the short run. In a perfectly competitive market the producer surplus actually equals the fixed costs.

Why is it a surplus then? Because, in the short run, the firm would have produced even if it didn't cover all fixed costs. So, in a sense, in the short run the firm is getting "more" than is required to induce it to produce 5 units.

Looks perfect, but things do go wrong (much, much more about this later)

• MARKET FAILURE: SPILLOVERS & PUBLIC GOODS

• MARKET FAILURE MEANS FAILURE TO ACHIEVE EFFICIENCY

• P ≠ MC

• ATC ≠ MINIMUM POSSIBLE

• ECONOMIES OF SCALE

• IMPOSSIBLE TO ACHIEVE P = MC AND ATC = MINIMUM AT THE SAME TIME

• TECHNOLOGICAL ADVANCE

FAILURE TO ACHIEVE DYNAMIC EFFICIENCY