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Market Behaviour - Part 5

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What's going wrong? Equating marginal cost to marginal revenue doesn’t maximize profits. Demand curve for individual foirm can’t be horizontal. And lots more .. Individual firm demand curve can’t be horizontal (under assumptions of MArshallian model): Firms atomistic – doesn’t consider what other firms are doing; Market demand curve downward sloping; If individual firm increases own output, industry output rises by same amount; Slope of single firm demand curve identical to slope of market demand curve.
Fact tha dP/dq = dP/dQ known since 1957.
Stigler (1957) Perfect competition historically contemplated – Journal of Political Economy 65: 1 – 17.
The graphical intuition – If the market demand curve slopes down then any tiny part of it slopes down with the same slope.
It’s downward sloping all the way down.
Can’t we just assume price taking? Firm assumes can sell as much as it likes at market price; Sure but is this irrational behavior not rational; If the market demand curve slopes downwards, then any increase in output no matter how small must cause market price to fall however, infinitesimally.
Neoclassical result dependent upon irrational behavior.
Summing up so far: Marginal revenue for individual firm less than price; Demand curve for single atomistic firm can’t be horizontal; Introductory economics teaching a fallacy for over 40 years; Can standard tuition still be justified? Stigker 1957 – Yes! – Reworked marginal revenue for the ith firm in terms of the number of firms n and market elasticity of demand E.
Convergence to perfect competition argument. Profit maximisers equate marginal cost and marginal revenue. And this last term goes to zero as the number of sellers increases indefinitely.
Neoclassical argument: Equate your MC to your MR will maximize your profits. Mathematically solve ordinary differential. Find where derivative of your profit relative to your output is zero. But your profits don’t just depend on what you do. Also depend on what other firms do – Even if you can’t control what they do. So real profit-maximization rule is solve a total differential. Find where derivative of your profit relative to total industry output is zero.
But firms can’t know that – Yes they can. Problem is – Work out the output level that maximizes my profits. Economist: Easy – Equate MR and MC; Mathematician: Set total derivative of profit to zero.