EFB223 Lecture Notes.docx

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Queensland University of Technology
Economics and Finance

Lecture 5  Remember, if the product is homogenous, and if there are many competitive selling the same product, and an individual firm or seller will have no control over the market price because remember once increase the price of Saturday Australia paper by even one cent, no will buy from you. Which means the demand curve you are facing will be horizontal in perfect market.  If you are selling a differentiated product- take coffee as an example: the coffee I sell and the coffee a different firm sells are substitutes but are they identical? NO, they are different in many ways  quality, location, service, decoration. Which means that if I raise the price of the coffee, will I lose customers to another coffee firm? NO which means that if I increase the price, I may lose SOME customers BUT not all. This means that I am facing a downward sloping demand curve.  If we have a coffee shop with a much steeper demand curve, D2 and another with a flatter demand curve, D1. In terms of elasticity, which one is more elastic? D1  If there are many competitions, what will happen to the demand curve facing a coffee shop? It will be flat  If you are facing a steeper demand curve, you have a greater market power. So if you have more market power, you are able to charge a higher price; conversely, if you have a smaller market power  Which firm, 1 or 2 has more market power? D2 because the curve is much steeper and can charge a higher price  Conclusion: Coffee shops in Sydney are more like firm, 1 or 2? Answer is 1  Market power in coffee shops determines the ability to charge a higher price and indicates Sydney because their market power is smaller because of keener competition there.  Because there are so many competitors and firms, entrepreneurs are free to enter or exit the market. It means that if firms in this market are making a profit and if they are making a profit, profit will be a signal for new entrepreneurs to enter. So if there are more competition because of entry of new firms, the yellow shaded area (profit) will eventually be competed away. The outcome is exactly the same as perfect competition;  Profit will only exist in short run. In the long run competition will erode the profits away.  How to model entry of new firms in perfect competition? When new firms enter the market, it will increase market supply  shifting of market supply curve can be used to model the entry of new firms when they are attracted to enter into the market because of profit  The supply curve of a perfectly competitive firm is MC curve above the minimum AVC  In an imperfect market, there is no stable relationship between price and quantity supplied, which means that there is no supply curve that we can establish for a firm in an imperfect market;  Why do we have to say this? The indication that to model the entry of new firm, we can not shift the market supply curve to the right because there is no market supply curve because there is no individual firm supply curve. So another way to go about it is simple: if there are more and more firms entering the market, the market share of an existing firm will be reduced;  How to model a reduced market share? We shift the demand curve of the firm to the left;  So, the output and price will be reduced. But the price is above the ATC, which means the firm still makes profit its just the profit is reduced;  If the firm makes profit, it will continue to attract new entries which mean that this is not the final long run equilibrium position!  So what is the final long run equilibrium position? If we shift the demand curve to the left [next slide] :::  ATC touches the demand curve  Demand curve tells you the price you charge at different level of output. There is only one output you can breakeven;  The yellow dot is the long run equilibrium. At the yellow dot, the price and ATC are equal which means you are breaking even – your profit is 0;  We should not only shift the demand curve, we have to also make it fatter!  Perfect competition long run - white dot is the minimum ATC point; demand is horizontal;  Output is good as it allows us to enjoy the output at its lowest possible cost;  Maximises social happiness  Monopolistic competition long run - the outcome is not desirable;  Yellow dot means that the price is higher than the white dot – means consumer PAYS MORE and enjoy less  The ‘excess capacity’ means the firm can produce more to achieve a lower cost of production but it chose not to so it produces at reduced capacity;  Excess capacity is associated with higher cost of production, higher prices and dead weight losses  Can eliminate dead weight loss and excess capacity by producing homogenous products – which will be boring  The advantage of product differentiation may outweigh dead weight loss and as a result it may not be an inferior outcome  We assume that the quality is unchanged; we assume the
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