Lecture10 - Lecture 10 Competition in the Short Run Perlo...

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Lecture 10: Competition in the Short Run Perlo/ Chapter 8 Vladimir Petkov VUW 19 April 2010 Vladimir Petkov (VUW) Lecture 10: Competition in the Short Run 19 April 2010 1 / 24
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Requirements for Perfect Competition 1 A high number of °rms in the market. The in±uence of an individual °rm on the whole industry is negligible. 2 Consumers believe that all °rms sell identical products . Goods are perfect substitutes: there are no di/erences in quality, brands are not important, etc. 3 Firms freely enter and exit the market (in the long run). There are no barriers to entry such as entry costs, legal obstacles, etc. 4 Buyers and sellers know the prices charged by all °rms. All agents have perfect information. 5 Transaction costs are low . The expenses of °nding a partner and making a trade are negligible. Examples of industries that satisfy these requirements: wheat, cement, etc. Vladimir Petkov (VUW) Lecture 10: Competition in the Short Run 19 April 2010 2 / 24
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Price Taking Behavior One of the most important features of perfect competition is that °rms take prices as given. Because of this, competitive °rms are often called price takers . There are many °rms operating in the industry. So each °rm alone is too ²small³ to a/ect the price. The total (industry) demand is usually downward sloping. However, from the viewpoint of any given °rm, its residual demand is horizontal Each °rm faces a perfectly elastic residual demand curve. No matter how much output a single °rm sells, it cannot change the price it faces! Vladimir Petkov (VUW) Lecture 10: Competition in the Short Run 19 April 2010 3 / 24
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Price Taking Behavior (Continued) The residual demand at any given price is the horizontal di/erence between market demand and the supply of all other °rms: D r ( p ) = D ( p ) ° S o ( p ) . If there are n identical °rms, °rm i ´s elasticity of demand is ε i = n ε ° ( n ° 1 ) η o , where ε is the elasticity of market demand and η o is the elasticity of supply of each of the other °rms. If n is big, ε i ± ° . For example, if n = 78 , ε = ° 1.1 and η o = 3.1 , then the elasticity of residual demand of each °rm is ε i = [ 78 ² ( ° 1.1 )] ° [ 77 ² 3.1 ] = ° 324.5 .
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