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2 example, even if there are many gas sellers in Istanbul, the price of gas is not exactly same everywhere. Why? B/c (i) quality of gas may not be the same across different sellers, (ii) price information is not perfect, buyers do not know all current prices in all stations, (iii) Location matters; gas sold in Mecidiyekoy is not the same good as gas sold in Hadimkoy.
3 go down. For example, assume when Metin increases production from 3 to 4 gallons, price goes down from 6 to 5 liras/gallon. DRAW a demand curve TO ILLUSTRATE the difference. Then, TR1=18 liras and TR2=20 liras, MR=2 liras/gallon which is less than both 5 liras and 6 liras. In markets that are not p. competitive, MR < price. For perfectly competitive markets, MR = price.
4 All firms pick their profit maximizing output at a quantity where MR = MC. This principle holds in all types of markets. Draw graph of profit. Give the intuition that profit maximization implies finding the peak of the profit function. This is where slope of the profit function is zero. Profit = TR - TC, Take the change (derivative) of both sides divided by the change in the output quantity: (Change in profit / change in Q) = (change in TR / change in Q) (change in TC / change in Q) LHS is the slope of the profit function, RHS first term is the slope of TR, which we defined above as MR, RHS second term is the slope of TC function which we defined as MC. Then, (Change in profit / change in Q) = Slope of Profit Ft. = MR - MC So, the quantity of output where slope of the profit function is zero can be found by equating RHS to zero: 0 = MR MC => MR = MC is the principle of profit maximization. Since for a p. competitive firm, MR = price, a competitive firm picks its optimal output at where price = MC. For markets that are not competitive, price > MR = MC at the optimal output chosen by the firm. Show Figure 1. Now we want to apply profit maximization to the cost curves of last chapter. For profit maximization, we need the output that satisfies MR = MC condition. This is simply the point where MC curve intersects the MR curve.
5 Illustrate why the firm does not pick Q1 or Q2, instead picks Qmax. Notice that it does not matter where the firm starts searching for profit maximizing output. Show Figure 2. Now what happens if the market price rises from P1 to P2? Then the firm chooses the quantity Q2 at which MR2 = P2 intersects the MC curve. Now think what happens in all other possible prices. You can realize that given price, the supply curve of a p. competitive firm is its MC curve. In other words, height of the supply curve shows the marginal cost of production. Note that all the supply curves that we have drawn in this class have assumed p. competitive markets.
12.3 Exceptions to the rule of Supply = MC : 1. Firms Short-run decision to Shut Down:
If the price is too low, a competitive firm may choose to shut down production temporarily. We differentiate between a temporary, short-run shut-down decision and a permanent, long-run exit the market decision. Example: Consider a tomato farmer that observes that the total revenue from 1 ton of tomatoes does not even cover the variable cost of transporting 1 ton to the marketplace. Then naturally she would rather not plant tomatoes next season. Would she sell her land? No, maybe she would wait for a year to see if the price will be any higher. In the short term of one year, by leaving the land empty, she can save the variable cost of transportation, but she still incurs the fixed cost of maintaining the land. In the decision whether to leave the land empty this year or not, fixed cost is irrelevant, i.e. fixed cost is a sunk cost. Sunk costs cannot be
6 recovered. She shuts down if the net benefit of a shutdown is positive: If she shuts down, she gets the following net benefits: Loses revenue from sales, -TR Saves variable costs, +VC Cannot save fixed costs, 0 (no change) Net Benefit of Shut Down = -TR + VC, Shutdown if -TR + VC > 0 VC > TR . divide both sides by Q, Shutdown if AVC > price show figure 3: short-run supply of a competitive firm is equal to zero if price < AVC, and supply is equal to MC otherwise.
7 In other words, a firm exits a market if TR < TC, TR TC < 0, Profit < 0. This means if its making a loss. SIMILARLY, a new firm that was not in the market before ENTERS THE MARKET if Profit > 0 in that market. New firms enter the market if profit > 0, if TR > TC, divide by Q, if price > ATC. SHOW this on Figure 4. Free entry/ exit means that whenever there is positive profit in the tomato sector, there will be new firms entering, and whenever profits go negative, existing firms will exit the market. show figure 5, illustrate area representing profits and losses. We know that profit = TR TC. since TR = Q x P and TC = Q x ATC, we can write profit = Q x (P - ATC) The amount of profits can be shown as the shaded area on Figure 5(a). Even if a firm is maximizing profits, it might be making losses. Maximizing profits is the same as minimizing losses since +losses = -profits. SHOW Figure 5(b) as an example of a firm minimizing its losses. The amount of losses is given by the shaded area, and this amount is equal to again profit = Q x (P - ATC) which is a negative number b/c P < ATC. Question: Answer: Why does such a firm not exit the market? It does exit, but it exits in the long run. Before the long-run comes, it
might stay in the market to wait for the conditions to get better. We assume number of firms is fixed in the short-run. Number of firms changes in the long-run.
12.4 Firm versus Market Supply Short-Run Market Supply with a Fixed Number of Firms:
Show figure 6. In short-run, before entry/exit happens, we want to know how market supply looks like. Market supply equals the sum of the quantities supplied by the individual firms in the market. Assume there are 1,000 identical firms in the market. These firms have the same cost structure (cost curves). At a price of 1 lira, an individual firm wants to supply 100 units. This is because firm picks Q according to price = MC , assuming price is greater than AVC (otherwise, the firm supplies zero amount). Then, the market supply is equal to 1,000 times the supply of an individual firm, which is 100,000 units. This is because all firms are identical to each other. Remember this is the short-run supply curve.
9 are no more entries into the industry. We are at long run equilibrium. Properties of the Long Run Equilibrium are: 12Competitive firms make zero profit in the long run, The LONG RUN MARKET SUPPLY CURVE IS HORIZONTAL at a price equal to the minimum of the ATC curve. Because this is THE ONLY PRICE THAT MAKES PROFITS EQUAL TO ZERO since Profit = (Price-ATC)*Q, 3Firms produce at their efficient scale. This is the qty at which average costs are minimum. Does it make sense to make zero economic (not accounting) profits? Remember that we are not talking about zero accounting profits. Consider following example: I have spent 200,000 YTL from my own money to buy a farm and started producing tomatoes. I can also work as a university professor for 30,000 YTL a year. At zero economic profits, my accounting profits from tomato business must be equal to 200,000 x 0.05 + 30,000 = 40,000 YTL a year, assuming an annual 5% interest on bank deposits. 40,000 YTL is the amount of money I could have made by just staying in the university. I will stay in tomatoes business in the long-run only if my accounting profits from planting tomatoes is at least 40,000 TL. Remember that economic profits include all opportunity costs, including benefits of an alternative job I could have. This is the difference between the common accounting profit and economic profit. An Example of a demand change Consider the following EXAMPLE about the market for milk: DRAW Figure 8 (a)
10 Suppose that initially the market is in long run equilibrium as in the Figure. Suppose American Medical Association announced that drinking milk reduces chances of heart attack among men by 10 %. What happens to milk market in the short-run and in the long-run? First the market demand for milk shifts right. In the short-run, number of firms is fixed, so price of milk goes up, existing firms produce more milk according to their MC curves. Firms will make positive profits. DRAW short-run response as on FIGURE 8 (b) In the long run, new firms observe the positive profits and enter the milk industry. When these new firms start producing milk, short-run market supply curve shifts rightwards. This causes the milk price to decrease. The decrease of price continues until profit becomes equal to zero. The new long-run equilibrium will be at point C. SHOW long-run response on Figure 8 (c). We come to a new point on the long-run supply curve. This is why the long-run supply curve is horizontal. The total milk output have increased compared to initial position. However, amount of milk produced by each firm did NOT increase, it is constant. Every firm produces at the efficient scale. But the NUMBER OF FIRMS in the industry has increased. This has increased industry output.
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Market is generally understood to means particular place of locality where goods are bought and sold. However in any particular place or locality does not mean market where goods are bought and sold. The buyers and sellers need not assemble at a particular locality for the buying and selling. The goods can be bought and sold without the direct contact between the buyers and sellers. Now a day the contact can be made through wireless and cables. In Economics market refers to the market for a commodity. Thus the essential features of a market are (a) a commodity which is bought and sold (b) existence of buyers and sellers, (c) a place (d) The contact between buyers and sellers. According to John. F.Dve "market as a group of buyers and sellers in sufficiently close contact with one another, that exchange takes place among them". Market consists of different forms like perfect competition, imperfect competitions, etc. Below are given some of the important characteristic features of a perfectly competitive market. Perfect competition, is said to prevail when the following conditions are found in the market. (1) Large number of buyers and sellers: Under perfectly competitive market there is large number of buyers and sellers. The position of a single seller in the market is just like a drop in the ocean. Each buyer purchases only a small quantity of the total amount. Each buyer and seller has no ability to influence the ruling price by their independent action. The price under perfect competition is given and each seller adjusts its sale to earn maximum profits. Under perfect competition the sellers of a commodity is the price taker and output adjuster and not price makers. They take the market price as a given datum. (2) Homogeneous Products: The second condition of perfect competition is that the products sold by the suppliers are fully homogeneous. The commodities available everywhere are the same. The products of various sellers are indistinguishable from each other. They are perfect substitutes for one another. The cross elasticity between the products is infinite. The commodities are perfectly similar in quality, quantity, size and shape. The buyers are indifferent to any commodity sold in the market. If the commodities sold in the market were differentiated, each seller would influence over the price of his own variety.
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The control over price is removed only when all the sellers are producing homogenous products. Thus in a perfectly competitive market, buyers have no other basis of attaching to one seller for purchasing a product other than price. (3) Uniform price: Under perfect competition the ruling market price is the same. Price is uniform as the products in the market are identical. Price is fixed by all the buyers and sellers in the market. No Individual effort of a buyer or seller goes to determine price. If any miller sells at the price less than prevailing price, the demand for his commodity will be so high that he will not be able to supply the commodities at low price to the increased demand. On the other hand if a seller sells at a price higher than the ruling market mice, he will lose by doing so as most of his customers will leave him for his higher price. (4) Tree entry and free exit: Under perfect competition buyers and sellers are absolutely free to enter and leave the market. No restriction is imposed on their entry and exit. Under perfect competition firms get only normal profit. At this normal profit there is no tendency on the part of the existing firms to leave the market or the new firms to leave market. But at abnormal profit and abnormal loss, firms tend to enter and leave the market according" to their will. Thus on the basis of profit and loss firms are at liberty to enter or quit the market. (5) Perfect knowledge about the market: One of the most pre-requisite of perfect competition is that both buyers and-sellers must have perfect knowledge about the conditions of the market. Sellers must know the ruling market price charged by other sellers from the buyers. Similarly buyers It in know the prices charged by different sellers. This condition is highly essential for a competitive market. Single price and homogeneous commodity can not prevail if the buyers remain ignorant of the market. When all the buyers can know the price fend the uniform quality of the commodity, nobody will offer more fend therefore single price prevails in the "market, (6) Perfect mobility: Under perfect competition it is understood that various factors of production are perfectly mobile within the industry. Factors of production can freely move from one occupation to another and from one place to another. There is no barrier on their movement. Factors move from place to place in search of higher wage. There should not be any kind of imposition on the mobility of resources. (7) Absence of transport cost: In a perfectly competitive market there is single unit price. Price being charged by the firms is free of transportation cost. Price is not affected by the cost of transportation of goods. The market price charged by different sellers does not differ due to location of different sellers in the market. No seller is near or distant to any buyers. Thus there is no transportation cost from one part of the market to the other. Perfectly competitive market is a myth. Such a market is never
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found in the real world. It is an ideal. As an ideal market it compares the price and profit condition in imperfect market.