5. THEORY OF COMPETITION

How to survive in the market?

Competition is the process in which enterprises - influenced by their environment (rivals) - may set their quantity of supply and a price for a supplied commodity while maximizing their profits (neoclassical definition).

MARKET STRUCTURES (MODELS)

Market structure	Quantity of producers	Sort of product	Decision making	Market entry	Factors' mobility	Economic outcome in the long run
Perfect competition	A great deal (infinite)	homogenous	- quantity of output	Free entrance in a long run	complete	Normal profit
Monopolistic competition	A lot of	differentiated	- quantity of output - a price	Free in a long run	incomplete	Normal profit
Oligopoly	Several	homogenous or differentiated	- quantity of output - a price	Bounded or no entry	incomplete	Economic profit
Monopoly	One	homogenous	- quantity of output - a price	Entry is blockaded by definition	incomplete	Economic profit

No matter the market structure the firm's goal is maximizing the economic profit (short run) and maximizing the firm's value (long run). If a firm is unable to maximize the profit in the short run it should minimize its economic loss when founds are available to finance the loss (implicit assumption). It is impossible to operate in the market incurring economic loss in the long run. The goal is achieved for an output level when marginal revenue equals marginal cost, i.e. MR = MC, known as a golden rule.

For any firm (price taker or price maker), the rate at which total revenue changes with respect to output is called marginal revenue. It is defined by
.

Since a perfectly competitive firm is a price taker, it makes only a decision of setting the level of sales (custom made production).

In the short run a firm's the best economic position (its equilibrium point) dependent on a market situation can be as followed:

• The firm attains economic profit, if TR>TC or P>ATC,

a market an enterprise

P_X m.u.

MC

S

P_E P_E d=MR=AR ATC

D

0 Q_X 0 q_E q_x

m.u. TC TR

∏_E

0 q_e

• A firm attains normal profit, if TR=TC or P=ATC,

market enterprise

P_X jp.

MC

S

S₁ ATC

P_E P_E d=MR=AR

D

0 Q_X 0 q_E q_x

jp. TC

TR

0 q_e

• Minimises an economic loss, when TVC<TR<TC or AVC<P<ATC or L_e<TFC;

Market enterprise

P_X m.u.

MC

S

S₁ ATC

AVC

P_E P_E d=MR=AR

D

D₁

0 Q_X 0 q_E q_x

m.u. TC

TVC

TR

0 q_e

TVC=TR or AVC=P or L_e=TFC denotes a shut - down point,

market enterprise

P_X m.u.

MC

S

S₁ ATC

AVC

D

P_E D1 P_E d=MR=AR

D₂

0 Q_X 0 q_E q_x

TC

m.u.

TVC

L_E TR

0 q_e q_x

• for P <AVC or TR <TVC or L_e>TFC the firm will supply zero.

market enterprise

P_X m.u.

MC

S

S₁ ATC

S₂

AVC

D

P_E D₁ P_E d=MR=AR

D₂

0 Q_X 0 q_E q_x

TC

m.u.

TVC

L_E

TR

0 q_e q_x

MONOPOLY

In monopoly there is no supply curve, since a price is endogenous, what means, that the sales value does not respond on the price level directly; it is possible to sell various amount of output at the same price or the same amount of output at various prices.

Monopoly is able to discriminate the prices when the firm:

1. has got a market power (a diminishing demand function)

2. has got an information about various prices that customers are willing to pay for the commodity

3. is able to prevent from its product resale for the higher price.

Therefore monopoly, for the sake of monopoly power equaled
,

is capable to discriminate prices in three ways:

• first - degree price discrimination - the firm tries to price each unit at the consumer's reservation price (i.e. the consumer's maximum willingness to pay) for that unit

• under second - degree price discrimination, the firm offers consumers a quantity discount (the amount the consumer pays depends on the number of units he/she purchase)

• with third - degree price discrimination, the firm identifies different receiver groups or segments in the market because of various price elasticity of demand. The profit - maximizing firm sets a price for each segment of the market by setting marginal revenue equal to marginal cost.

TOTAL REVENUE AND TOTAL COST FUNCTIONS

• 
  a monopoly attains an economic profit if TR>TC or P>ATC

m.u.

36

zł

TR TC

12

TR

0 q_E output (sales)

D

MR

0
1 2 3 4 5 6 7 8 9 10 11 12

MC

P_E ATC

MR D=d=AR

P = 12-Q_X

0 q_E

P	Q	TR	MR
12	0	0	-
11	1	11	11
10	2	20	9
9	3	27	7
8	4	32	5
7	5	35	3
6	6	36	1
5	7	35	-1
4	8	32	-3
3	9	27	-5
2	10	20	-7
1	11	11	-9
0	12	0	-11

A monopoly minimizes an economic loss if TVC<TR<TC or AVC<P<ATC

or L_e<TFC

m.u.

MC

ATC

AVC

MR D=d=AR

0 q_E TC

m.u.

TVC

TR

q_E Q_x

- TVC=TR or AVC=P or L_e=TFC means a shut down point

m.u.

ATC

MC

AVC

MR D=d=AR

0 q_E

m.u. TC

TVC

TR

0 q_E Q_x

Gives up a production if TVC>TR or AVC>P or L_e>TFC

m.u.

MC ATC

AVC

MR D=d=AR

0 q_E Q_x

m.u. TC

TVC

TR

0 q_E Q_x

natural monopol

zł

P_E

P_max LAC

P_O LMC

0 q_E q_max q_O

First - degree price discrimination

m.u.

P₁

P₂ MC

P₃

P₄

P₅

P₆

P₇

P₈

P₉

P₁₀

P_E E

AR

D=d=MR

0 1 2 3 4 5 6 7 8 9 10 q_E Q_x

Second - degree price discrimination

m.u.

P₁

P₂

MC

P₃

D

0 q₁ q₂ q₃ Q

Subscription and a unit charge

P

p_r =0,29 MC

d

0 33 h

If consumer's surplus were bigger than subscription the consumer would be willing to purchase the subscription.

Third - degree price discrimination

segment I m.u. segment II

P_cl

P_cn

MC

D_I MR_I MR_II D_II

coal q_cl q_cn corn

Prof. Teresa Kamińska Microeconomics

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