Transcript Market Structure

Market Structure
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The Degree of
Competition
• The four market structures
– perfect competition
– monopoly
– monopolistic competition
– oligopoly
• Classifying markets
– number of firms
– freedom of entry to industry
– nature of product
– nature of demand curve
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Market Structures
Type of
market
Number
of firms
Freedom of
entry
Nature of
product
Examples
Implications for
demand curve
faced by firm
Perfect
competition
Very
many
Unrestricted
Homogeneous
(undifferentiated)
Cabbages, carrots
(approximately)
Horizontal:
firm is a price taker
Monopolistic
competition
Many /
several
Unrestricted
Differentiated
Builders,
restaurants
Downward sloping,
but relatively elastic
Undifferentiated
Cement
or differentiated
cars, electrical
appliances
Downward sloping.
Relatively inelastic
(shape depends on
reactions of rivals)
Oligopoly
Monopoly
Few
One
Restricted
Restricted or
completely
blocked
Unique
Local water
company, train
operators (over
particular routes)
Downward sloping:
more inelastic than
oligopoly. Firm has
considerable
control over price
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Perfect Competition
• Assumptions
– firms are price takers
– freedom of entry
– identical products
– perfect knowledge
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The Revenue of
Competitive Firm
• Total revenue (TR)
– How much does the firm receive for the sale of the
total output?
TR = P × Q
• Average revenue (AR)
– How much does the firm receive for the sale of one
typical unit of output?
AR = TR/Q
• Marginal revenue (MR)
– How much does the firm receive for the sale of one
additional unit of output?
MR = ΔTR/ΔQ
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Cost of Production
• Includes all the opportunity costs of
making its output of goods and services.
– Explicit costs: input costs that require a
direct outlay of money by the firm (e.g.
opportunity cost of $100 electricity fee)
– Implicit costs: input costs that do not require
an outlay of money by the firm (e.g.
opportunity cost of renting out building)
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Profit
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Profit Maximization
• The firm will want to produce the quantity
that maximizes the difference between
total revenue and total cost.
• Occurs at the quantity where marginal
revenue equals marginal cost (MR=MC).
• Why don’t the firm just produce the
maximum quantity?
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Marginal Analysis
Q
0
1
2
3
4
5
6
7
P=AR
6
6
6
6
6
6
6
6
TC
3
5
8
12
17
23
30
38
TR
18
24
30
36
42
Profit MR
-3
1
6
4
6
6
6
7
6
7
6
6
6
4
6
MC
 Profit
2
3
4
5
6
7
8
4
3
2
1
0
-1
-2
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Marginal Analysis
Q
0
1
2
3
4
5
6
7
P=AR
6
6
6
6
6
6
6
6
TC
3
5
8
12
17
23
30
38
TR
0
6
12
18
24
30
36
42
Profit MR
-3
1
6
4
6
6
6
7
6
7
6
6
6
4
6
MC
 Profit
2
3
4
5
6
7
8
4
3
2
1
0
-1
-2
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Short-run equilibrium of industry and firm
under perfect competition
Firm is a price taker. Price
is given by the market.
P
£
MC
S
Pe
AC
D = AR
= MR
AR
AC
D
O
O
Q (millions)
(a) Industry
Qe
Q (thousands)
(b) Firmwww.lrjj.cn
Profit Maximization
• When MR > MC, increase Q
• When MR < MC, decrease Q
• When MR = MC, profit is maximized
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Long-run equilibrium
Profits return
to normal
New firms enter
P
£
Supernormal profits
S1
Se
LRAC
P1
AR1
D1
PL
ARL
DL
D
O
O
Q (millions)
(a) Industry
QL
Q (thousands)
(b) Firm
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Produce or shut down –
the short-run
• Shut down (short-run decision)
• Exit (long-run decision)
• Which costs are relevant?
– If the firm shuts down, it only incurs fixed cost,
which is sunk and cannot be recovered.
– Relevant cost in the short run is variable cost.
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Produce or shut down
- the short-run
• The firm shuts down if the revenue it gets
from producing is less than the variable
cost of production.
– Shut down if TR < VC
– Shut down if TR/Q < VC/Q
– Shut down if P < AVC
• As long as P ≥ AVC (or TR ≥ TVC), the
firm should operate even if it is losing
money (loss-minimizing)
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Enter or exit
– the long run
• In the long run, the firm exits if the revenue
it would get from producing is less than its
total cost.
– Exit if TR < TC
– Exit if TR/Q < TC/Q
– Exit if P < ATC
• A firm will enter the industry if such an
action would be profitable.
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Monopoly
• A firm that is the sole seller of a product
for which no close substitutes exist.
• The firm is protected from competitors by
barriers that prevent entry from other
firms
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Barriers to entry
•
•
•
•
•
•
Monopoly resources
Government-created monopolies
Natural monopolies (economies of scale)
Product differentiation and brand loyalty
Aggressive tactics
Lower costs for an established firm
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Profit maximising under monopoly
£
MC
Total profit
AC
AR
Profit maximised
at output of Qm
(where MC = MR)
AC
AR
MR
O
Qm
Q
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Profit Maximization
under Monopoly
• MR = MC (true for all firms!)
• In a competitive firm, P = MR
– Profit maximization leads to P = MC → P =
MC = MR
• For a monopoly, P > MR
– Profit maximization leads to P > MC
• Why?
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Equilibrium under PC &
Monopoly – the same MC curve
£
MC ( = supply under
perfect competition)
Comparison with
Perfect competition
P1
P2
AR = D
MR
O
Q1
Q2
Q
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Monopolistic Competition
• A situation where there are a lot of firms
competing with their own market segment
• Each firm has some discretion as to what
price to charge for its products
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Monopolistic Competition
• Assumptions
– Independence
– Freedom of entry
– Product differentiation
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£
Monopolistic Competition –
Short run equilibrium
MC
AC
Ps
ACs
AR = D
MR
O
Qs
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Q
£
Monopolistic Competition –
Long run equilibrium
New firms entering
the industry reduce
demand for each
individual firm.
LRMC
Price falls to PL
LRAC
PL
ARL = DL
MRL
O
QL
Q
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Oligopoly
• A few firms share a large proportion of the
market
• Key features of oligopoly
– barriers to entry
– interdependence of firms
• Competition versus collusion
• Collusive oligopoly: cartels
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Profit-maximising cartel
£
Industry profit
maximised at
Q1 and P1.
Industry MC
P1
Members must
agree to restrict
total output to Q1.
Industry D = AR
Industry MR
O
Q1
Q
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Factors favoring collusion
•
•
•
•
•
•
•
•
Few firms
Open with each other
Similar production methods and average costs
Similar products
Dominant firm
Significant entry barriers
Stable market
No government measures to curb collusion
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