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What is a Market?

Market( 市場 ) is a system governed by a set of rules or customs( 習俗 ) under which a well-defined good is exchanged.

Foreign exchange market, stock market

Food Market

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Four types of market

MonopolyMarket 完全壟斷

Oligopoly Market 寡頭壟斷

MonopolisticCompetition Market 壟斷性競爭

Perfect Competitive Market (Price-taker)受價者市場

Two extreme cases

Imperfect competitive Market (Price-searcher 尋價者市場 )

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Price-taker’s market ( 受價者市場 ) or(perfectly competitive market 完全競爭巿場 )

• A price-taker( 受價者 ) who cannot affect the market price and hence it must take whatever price that the market determines.

• Note: Because each seller only provides an insignificant part of the total market supply of some homogeneous goods ( 同類 / 同質的貨品 )

DefinitionDefinition

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Conditions of a Price-taking Market

1. A large number of sellers who are small in the market share 市場估有率 (relative to the market quantity).

2. Homogeneous goods ( 無異物品 ) are goods that are completely identical. E.g. no brand name, no advertisement. Any firm selling at a higher price would lose all its customers.

3. Perfect information; no transaction costs: buyers know the price charged by each sellers, no buyers would buy an identical product from sellers charging a higher price.

4. Free entry and exit: If market composed of a large number of small buyers and sellers, no one has the power to restrict the entry or exit of others

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Violation( 違反 ) of conditions

If any one of the first three conditions is violated, the market becomes price-searching ( 尋價者市場 ).

A market with only one seller is aA market dominated by a few large sellers is

anA market with a large number of small sellers but selling

heterogeneous goods or having imperfect information is a

monopoly ( 完全壟斷 ).

oligopoly ( 寡頭壟斷 ).

monopolistic competition. ( 壟斷性競爭 )

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Price-searching Market

Monopoly完全壟斷

Oligopoly 寡頭壟斷

Monopolistic competition 壟斷性競爭

尋價者市場

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Short Run Model of a Price-taker 受價者市場

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A Price-taker facing a horizontal Demand CurvesWhy?

Individual consumer demand curve

price-taker market/industry A price-taker

D1

P

Q=10

D

S

Q=10000

P1

*use the interception D and S to determine the market price at P1

*a price-taker do not have power to change P1

PP

Q=30

+ +

(ΣD)

(ΣS)

P1=d=horizontal demand curve

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A horizontal Demand Curve Facing a Price-taker (seller).

A. Horizontal demand curve: Reason: A price-taker cannot

influence the market price. If it charges a higher price, as market information is perfect and exists a large no.s of sellers supplying identical goods, it will lose all its customers. Quantity demanded drops to zero.

The demand is perfectly elastic A price-taker can sell whatever

quantity at the

Individual / A price-taker

P

Q

P1

0prevailing market

price ( 主要市場價值)

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Questions for discussion

Q2 “As the demand curved faced by a price-taker is horizontal, the market demand curve, which is the horizontal sum of all individual demand curves, must also be horizontal.” Discuss.

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Q2: Ans.

No, The market demand curve is the horizontal sum of

demand curves of all the consumers, not the horizontal sum of demand curves faced by all the price-takers.

Price-taker are not the buyers Price-taker are sellers. By the law of demand, as demand curves of

consumers are downward sloping, the market demand curve is also downward sloping.

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Marginal revenue (MR)&

Average revenue(AR)of a Price-taking firm

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(1) Equations Review

Revenue( 收入 ):

1. Total Revenue( 總收入 )=P*Q or AR*Q

2. Average Revenue=TR/Q

AR=P x Q

Q AR=P Marginal Revenue:( 邊際收入 )

1. MR= ▲TR/▲Q

or = (TR2-TR1) /(Q2-Q1)

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P Q Total Revenue(TR)

Marginal revenue (MR)

$5 10

$5 15

$5 20

$5 25

$5 30

Average revenue (AR)

Fill in the table

= P x Q

$50

$75

$100

$125

$150

$5

$5

$5

$5

$5

$5

$5

$5

$5

$5

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Explain the relationship between MR, AR and d curve

Price-taker cannot influence the market priceOutput is sold at the prevailing market priceSo the marginal revenue(MR) and average

revenue(AR) are equal the market price.

Conclusion:

P=MR=AR=demand curve

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HKALE MC 98.29

Q.The demand curve facing a price-taker is perfectly elastic. This implies that

A. The market price will not change.B. The law of demand cannot be applied in the

price-takers’ industry.C. The market price will not decrease even

when a seller increases his output.D. All of the above

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HKALE MC98.29

Answer: C

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Example of a perfect competition Market (P-taker)?

In reality, no firm like perfect competition market. The very close one like is Gold Market.

(1) abundant buyer and seller

(2) Homogenous Goods e.g. 9999 gold bar

(2) Freedom of entry and exit the market

(3) It is easy to find information about the quantity and price in the market. But information is costly to obtain which is not a perfect information.

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Is there any market can fulfill ALL the condition of P-taker model in our economy?

No

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The conditions of p-taker’s market are not realistic. Is it still useful?

The model is still useful Use ideal( 完美 ) situation as a standard( 標準 )To analysis( 分析 ) competition in the real

world.Evaluate( 評估 ) and compare the efficiency of

other market structure.

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(2) Equations Review:Cost ( 成本 ): ( 總成本 )TC=TVC+TFC --------------------------------(1)

=Average Cost*Quantity ( 總可變成本 )TVC=AVC*Q----------------------------(2)

= Average Variable Cost*Quantity ( 總固定成本 )TFC=AFC*Q-----------------------------(3)

= Average Fixed Cost*QuantityMarginal Cost ( 邊際成本 ):MC= ▲TC/▲Q = --------------------------(4)(TC2-TC1)/ (Q2-Q1)

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(3) Equations Review

Profit=TR-TC ( 利潤 = 總收入 - 總成本 )

= Total revenue - Total Cost If profit =0 (normal profit or Breakeven) If profit =+Ve economic profit If Profit = -Ve Loss

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Determination of a wealth maximizing output

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Wealth-maximizing output of a P-taker ( 受價者市場 )

P

Q

MC

MR=P*=AR=d curve

Q’ Q*

P*

before Q’ MC>MR Loss

Between Q’ & Q* MR>MC Gain∴

At Q*, MR=MC Marginal Revenue can cover its marginal cost

MR>MC, you have to decide if the gain can cover the loss before Q*. Max-wealth at Q*, when MR=MC

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Q5 (a) At Q’, MR=MC. Explain why it is not wealth-maximizing?

(b) At Q*, MR>MC. The marginal gain is zero. Explain why it is wealth-maximizing?

Questions for Discussion

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Q5 Ans.: (a) & (b)

(a) At Q’, MR=MC it is wealth-minimizing. Because MC curve

cuts MR curve from above. At Q’, MC>MRLoss.

(b) At Q*, MR>MC marginal gain is positive, more units would be

produced even very small gain.MC curve cuts the MR curve from below at which marginal equal to zero.

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In short run: the no.s of firms is fixed. TC=TVC+TFC Maximizing-wealth output at MR=MC P or AR≧ AVC ( 收入≧可變成本 ) E.g labour

wage, monthly rent, water fees..etc.

Short Run of a P-taking Model

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SHORT-RUN OUTPUT DETERMINATION OF A PRICE-TAKER

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MCP

Q

AVC

ACP1

MR=AR=P1=d

Q1

AC1

Profit

Case A) In short-run, a price-taking firm is earning an

economic profit (P>AC) ref. P.158(4)

At P1: MR = MCProduce at Q1

Total Revenue = P x Q

Area =

Total Cost = AC x Q

Area =

Profit per unit =P-AC =

Total Profit = (P – AC) x Q

Area=O

A

BP1AQ1O

AC1BQ1OAB

P1ABAC1

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Case B) In short run, a Price-taker firm is earning a normal profit (Breakeven), if P=AC

ref. P.157(3)

MCP

Q

AVC

AC

P2 MR=AR=P=d

Q2

AC2=

At P2: MR = MCProduce at Q2

TR = P x Q

=

Total Cost = AC x Q

=

Since P = AC

Profit per unit =P-AC =

Total Profit = (P – AC) x Q

=

P2 CQ2 O

O

C

AC2CQ2O

0

0

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Case C) In short run, a Price-taker firm, continuing production, if P>AVC but not cover the AFC

ref. P.157(2) MCP

Q

AVC

AC

P3MR=AR=P=d

Q3

AC3

At P3: MR = MCProduce at Q3

TR = P x Q

=

Total Cost = AC x Q

=

Since AC>P

Loss per unit AC - P =

Total Loss = (AC - P) x Q

=

P3 EQ3 O

O

D

AC3DQ3O

DE

Loss

AC3DEP3

E

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Case D) In short run, a Price-taker firm is suspending production immediately, if P<AVC

ref. P.157(1)

MCP

Q

AVC

AC

P4

MR=AR=P=d

Q4

AC4

At P4: MR = MCProduce at Q3

TR = P x Q

=

Total Cost = AC x Q

=

Since AC>P

Loss per unit AC - P =

Total Loss = (AC - P) x Q

=

P4 GQ4 O

O

F

AC4FQ4O

FG

Loss

AC4FGP4

G

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Short Run Supply Curve of a P-taker

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Short Run Supply curve of a P-taker

The S.R. supply curve:

1. Q* at MC=MR

2. P greater than or equal to AVC in Short Run.

3. The supply curve coincides with the MC curve.

Q

AVC

AC

MR=AR=P*=d

Q*

PMC

P*

S.R. supply curve of a P-taker’s

Min AVC

TR=TVC

P-taker’s supply curve

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The market equilibrium Price (Peq)

+…+

+…+

Q Q

QQQ

PP

P P

P

P*

Individual A’ Individual B’

Firm A’ Firm B’

Market/Industry

Q*

D(=Σd)

S(=Σs)

Peq is determined by the intersection of market D and S

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Long Run Model of a P-taker

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Long Run Model(L.R) of a P-taker L.R, Freedom of entry and exist L.R, TC=TVCL.R, max-wealth output at MR=LRMC,

P or AR LRAC≧ ( 收入≧總成本 )Profitnew firm entry (S↑) supply curve to the right

forcing P↓until Profit =0

D

SS’

P↓

Q

P

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Long Run Supply Response: If P>LRACProfit existEntry of new firm

QQ*

AC2

P*

P

LRAC

LRMCP

Profit (1)MR=P=AR=d

Individual P-taker firm

D

S

S’

P1=AC2

(2)

P-taker market

TC=TVC MR=MC

Profit is a signal for entry of new firms in L.R.

Forcing Price↓until the profit = 0. Then no more new firm entry

New firm entry(S↑)

(3)

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Long Run (1) Entry of new firms: When P>LRAC

In Long run, if P>LRACProfitSupplyPrice until profit fall toFinally, all firms just earn profit in the

long run. (Breakeven)

S ↑P↓ zero.

normal

new firm entry

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Long Run (2) Exit of firms: When LRAC>P

QQ*

AC2

P*

LRACLRMC

Individual P-taker firm

D

SS’

P↑

P-taker market

MR=MC

Loss is a signal for exit of existing firms in L.R.

S↓ Forcing P↑, the P< LRAC. no more firms exit∴

New firm exit (S↓)

(3)

(2)

TC=AC ＊Q

Loss(1)

P

P

Q

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Long Run: (2) Exit of firms

In L.R.: If LRAC>PLoss occurSupply Price driving marketFirm , only the firm who has a

lower LRAC can survive

(S ) Supply curve to the left

PExit

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(2) No entry and exit: When P=LRAC

QQ*

P*=AC

LRAC

LRMC

Individual P-taker firm

D

SP-taker market

MR=MC

Zero Profitin L.R.TR just cover TC and earning no more than their highest-valued alternative.(Breakeven)

Profit = 0 no firm entry or exit

TC=AC ＊ Q =TR=P* ＊ Q*

P

P

Q

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Why Profit is Zero in the Long Run

MCP

Q

PAC

AC’AC ↑due to the increase in factor price, raising the firm’s total cost

AC1

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Under ‘competitive conditions’ always pressure on

Profit exists

S output in the industry price of the good move an existing firm’s total

revenue

Factor price total cost Profit is squeezed from above and from below

firm will enter the marketshare the existing profit

increase expand

downward

Profit

Lowering increase increase

Why Profit is Zero in the Long Run?

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How profit is eliminated by an increase in factor price?

Factor price Cost of ProductionIn reality, factors of production are

heterogeneous. Different firms produce with different production cost.

In long run, market price of good to the minimum point of the LRAC curve (marginal firm) firm’s with superior factors by offering extra payment (imputed rent)

increase increase

Fall

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Distinguish between three types of firm

1. Marginal firm or fringe firm

2. Intra-marginal firm

3. Extra-marginal firm

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Marginal firm (P=AC)

With the highest average cost curveLowest productive power or efficiencyOnly cover its full costs (TVC+TFC)Earn only negligibly more within the

industry than outsideFirst to leave the industry if the price

increase

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Marginal firm (P=AC)

MC=MR

P=d=AR=MR

AC

P*Q*=AC*Q*

TR=TC

Just cover its full cost

MC

P=AC

Q*

Q

P

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Intra-marginal firm (P>AC)

Earning an amount of rent in excess of the initial cost of fixed factor (TR>TC)

Lower cost in the industry (P>AC)Poor alternative elsewheresurvive at a lower priceOnly a larger fall in price will force it to

exit

profit

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Intra-Marginal firm (P>AC)

Profit: Earning excess of initial cost

P

P1

Q*

AC

MC

Q

AC1

TC

Profit P=MR=AR=d

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Extra-marginal firm(AC>P)AC>P

AC>PThe firm has a higher costBetter alternative elsewhereSo it is not enter the industry

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P

Q

MC

AC

P1

Extra-Marginal firm(AC>P) Loss, not

enter the industry

P=d=AR=MR

Total Cost

AC1

Q1

Loss

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Q: Explain why in a competitive industry like farming, some farmers are able to earn a much higher income than other competitors?

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Ans.

First comers of the industry are able to earn a much higher income.

They usually own more fertile lands and save other variable costs. E.g. costs of pesticide of fertilizer.

Late comers, earn less income. E.g. lands are usually poorer quality and higher variable cost

Late comers can only incomes close to or equal to the costs of providing other inputs.

They earn smaller amounts of rents, or even no rent at all.

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Review

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Short Run Model (S.R.)≠ Long Run Model(L.R)

L.R, Freedom of entry and exist L.R, TC=TVCL.R, max-wealth output at

MR=LRMC, AR LRAC≧ ( 收入≧總成本 )

Profitnew firm entry (S↑) P↓until Profit =0

D

SS’

P↓

QDD’

S

Q

P↑

P

S.R, the no. of firms is fixed.

S.R, TC=TVC+TFCS.R, max-wealth output at

MR=MC, AR≧ AVC ( 收入≧可變成本 )

Price↑(caused by D↑) induce the existing firms to produce more and enjoy profit.

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Wealth-maximizing Output of a P-taker firmin S.R and L.R.

P

Q

MCAC

AVC

MR=AR=P1=d curve

SR-Q*

MR=AR=P2=d curve

Q*-LR

P2

P1 1.MR=MC Maximize wealth output

2.S.RP AVC Produce≧ ∴

1.MR=MC

2.L.RP AC ≧Produce∴

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Vilfredo Pareto identified a condition of resource allocation p.154

Which is now know as the Pareto condition.

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The meaning of Pareto Efficiency in Allocation

Definition: A state where it is no longer possible

reallocate the use of resources so that one individual will gain without loss to another.

P

Q

MC

P* MR=AR=P=d

Q*

P = MR=MC=MUV

P-taker model

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Functions of Pareto Efficiency

1. The Pareto condition forms the basis for an evaluation of the efficiency of resources allocation.

2. If the market is not function well, it may not attain the Pareto EfficiencyMarket failure

3. Government intervention is called for to correct this situation.

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Resource Allocation Efficiency

1) Production Efficiency: Revenue cover the cost:P = MC

2) Consumption Efficiency: P=MUV, the market price is equal to the marginal use value

3) Allocation Efficiency: P =MC =MUV

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It is no longer be possible to ↑or↓output to improve social welfare.P

Q

MC

P* MR=AR=P=d Curve

Q*

Efficiency in Resource Allocation (P=MC=MUV)

↑or↓ output will decrease social welfare.

Social cost > benefit∴

P=MC=MUV

Q1

dead weight loss

dead weight loss

Q2

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Pareto condition in Price-taking Market

In a perfectly competitive market, the coordination of

production is not the role of aThere is an in the marketWhich coordinates

And to achieve the maximum for the whole economy

single individual

‘invisible hand’

consumption, production, and allocation

benefit

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Economics notes & past paper collection