#### Transcript Price - Vidyarthiplus

```EQUILIBRIUM OF A FIRM
• Firm is said to be in equilibrium when it has no
tendency either to increase or to contract its
output.
• Firm’s equilibrium level of output will lie where
its money profits are maximum.
• Now profits are the difference between total
revenue and total cost.
• So in order to be in equilibrium, the firm will
attempt to maximise the difference between
total revenue and total cost.
• An old method of explaining the equilibrium
of the firm is to draw the total revenue and
total cost curves of the firm and locate the
maximum profit point.
• But, with the appearance of Marginalist
Revolution, equilibrium of the firm is
explained with the aid of marginal revenue
and marginal cost curves.
• Demand and supply are in equilibrium at
point E where two curves intersect each
other.
• It means that only at price of the quantity
demanded is equal to quantity supplied.
•
• OM is the equilibrium quantity which is
exchanged at price OP. If the price is greater
than the equilibrium price say OP”, the
quantity demanded by the buyers is P”L,
while the quantity offered to supply is P”K.
Thus LK is the excess supply which the buyers
will not take at the price OP”.
• Thus there will be a tendency for the price to
fall to the level of equilibrium price OP.
• At price OP’, which is less than the equilibrium
price, the buyers demand P’T, the sellers are
prepared to supply only P’H. HT represents excess
demand.
• The unsatisfied buyers will compete with each
other to obtain the limited supply of cloth and in
this effort they will bid up the price.
• Thus, we see that price is determined by the
equilibrium between demand and supply.
Nature of Revenue curves
• Under perfect competition, the market price
is determined by the market forces namely
the demand for and the supply of the
products.
• Hence there is uniform price in the market
and all the units of the output are sold at the
same price. As a result the average revenue is
perfectly elastic.
• The average revenue curve is horizontally
parallel to X-axis. Since the Average Revenue
is constant, Marginal Revenue is also
constant and coincides with Average
Revenue.
• AR curve of a firm represents the demand
curve for the product produced by that firm.
Short run equilibrium price and output
determination under perfect competition
1. Since a firm in the perfectly competitive market is a
price-taker, it has to adjust its level of output to
maximise its profit. The aim of any producer is to
maximise his profit.
• 2. The short run is a period in which the number and
plant size of the firms are fixed. In this period, the firm
can produce more only by increasing the variable
inputs
• 3. As the entry of new firms or exit of the existing
firms are not possible in the short-run, the firm in the
perfectly competitive market can either earn supernormal profit or normal profit or incur loss in the
short period
• In figure 8.1, output is measured along the x-axis
and price, revenue and cost along the y-axis. OP
is the prevailing price in the market. PL is the
demand curve or average and the marginal
revenue curve. SAC and SMC are the short run
average and marginal cost curves.
• The firm is in equilibrium at point ‘E’ where MR
= MC and MC curve cuts MR curve from below
at the point of equilibrium. Therefore the firm
will be producing OM level of output.
• At the OM level of output ME is the AR and
MF is the average cost. The profit per unit of
output is EF (the difference between ME and
MF).
• The total profits earned by the firm will be
equal to EF (profit per unit) multiplied by OM
or HF (total output). Thus the total profits
will be equal to the area HFEP. HFEP is the
supernormal profits earned by the firm.
Revenue of a Competitive Firm
Total revenue for a firm is the selling
price times the quantity sold.
TR = (P X Q)
Revenue of a Competitive Firm
Marginal revenue is the change in total
revenue from an additional unit sold.
MR =TR/ Q
Revenue of a Competitive Firm
For competitive firms, marginal
revenue equals the price of the
good.
Total, Average, and Marginal Revenue
for a Competitive Firm
Quantity
(Q)
1
2
3
4
5
6
7
8
Price
(P)
\$6.00
\$6.00
\$6.00
\$6.00
\$6.00
\$6.00
\$6.00
\$6.00
Total Revenue Average Revenue Marginal Revenue
(TR=PxQ)
(AR=TR/Q)
(MR=TR/ Q )
\$6.00
\$6.00
\$12.00
\$6.00
\$6.00
\$18.00
\$6.00
\$6.00
\$24.00
\$6.00
\$6.00
\$30.00
\$6.00
\$6.00
\$36.00
\$6.00
\$6.00
\$42.00
\$6.00
\$6.00
\$48.00
\$6.00
\$6.00
Profit Maximization for the
Competitive Firm
The goal of a competitive firm is to
maximize profit.
This means that the firm will want
to produce the quantity that
maximizes the difference between
total revenue and total cost.
Profit Maximization:
A Numerical Example
Price
(P)
\$6.00
\$6.00
\$6.00
\$6.00
\$6.00
\$6.00
\$6.00
\$6.00
Quantity
(Q)
0
1
2
3
4
5
6
7
8
Total Revenue
(TR=PxQ)
\$0.00
\$6.00
\$12.00
\$18.00
\$24.00
\$30.00
\$36.00
\$42.00
\$48.00
Total Cost
(TC)
\$3.00
\$5.00
\$8.00
\$12.00
\$17.00
\$23.00
\$30.00
\$38.00
\$47.00
Profit
(TR-TC)
-\$3.00
\$1.00
\$4.00
\$6.00
\$7.00
\$7.00
\$6.00
\$4.00
\$1.00
Marginal Revenue Marginal Cost
(MR= TR /  Q
) MC=  TC /  Q
\$6.00
\$6.00
\$6.00
\$6.00
\$6.00
\$6.00
\$6.00
\$6.00
\$2.00
\$3.00
\$4.00
\$5.00
\$6.00
\$7.00
\$8.00
\$9.00
Profit Maximization for the Competitive
Firm...
Costs
and
Revenue
The firm maximizes profit
by producing the quantity
at which marginal cost
equals marginal revenue.
MC
MC2
ATC
P=MR1
P = AR = MR
AVC
MC1
0
Q1
QMAX
Q2
Quantity
Profit Maximization for the
Competitive Firm
• Profit maximization occurs at
the quantity where marginal
revenue equals marginal cost.
Profit Maximization for the Competitive
Firm
When MR > MC  increase Q
When MR < MC  decrease Q
When MR = MC  Profit is maximized.
The firm produces up to the point where
MR=MC
Monopoly
• While a competitive firm is a
price taker, a monopoly firm is
a price maker.
Monopoly
•
A firm is considered a monopoly if . . .
it is the sole seller of its product.
its product does not have close
substitutes.
Characteristics of Monopoly
• 1. Single Seller: There is only one seller; he
can control either price or supply of his
product. But he cannot control demand for
the product, as there are many buyers.
• 2. No close Substitutes: There are no close
substitutes for the product. The buyers have
no alternatives or choice. Either they have to
buy the product or go without it.
3. Price:
• The monopolist has control over the supply so as
to increase the price. Sometimes he may adopt
price discrimination. He may fix different prices for
different sets of consumers.
• A monopolist can either fix the price or quantity of
output; but he cannot do both, at the same time.
4. No Entry:
• There is no freedom to other producers to enter
the market as the monopolist is enjoying
monopoly power. There are strong barriers for
new firms to enter.
• There are legal, technological, economic and
natural obstacles, which may block the entry of
new producers.
5. Firm and Industry:
• Under monopoly, there is no difference between a
firm and an industry. As there is only one firm, that
single firm constitutes the whole industry
Why Monopolies Arise
Barriers to entry have three sources:
• Ownership of a key resource.
– This tends to be rare. SCV is an example
• The government gives a single firm the exclusive right to
produce some good.
– Patents, Copyrights and Government Licensing.
• Costs of production make a single producer more
efficient than a large number of producers.
– Natural Monopolies
Economies of Scale as a Cause of
Monopoly...
Cost
Average
total cost
0
Quantity of Output
Monopoly versus Competition
Monopoly
Competitive Firm
 Is the sole producer
Is one of many
 Has a downward-sloping
producers
demand curve
Has a horizontal
 Is a price maker
demand curve
 Reduces price to
Is a price taker
increase sales
Sells as much or as
little at same price
Demand Curves for Competitive and
Monopoly Firms...
(a) A Competitive Firm’s
Demand Curve
Price
(b) A Monopolist’s
Demand Curve
Price
Demand
Demand
0
Quantity of
Output
0
Quantity of Output
A Monopoly’s Revenue
•
Total Revenue
P x Q = TR
•
Average Revenue
TR/Q = AR = P
•
Marginal Revenue
TR/Q = MR
A Monopoly’s Marginal Revenue
• A monopolist’s marginal revenue is
always less than the price of its good.
The
demand curve is downward sloping.
When a monopoly drops the price to sell one
more unit, the revenue received from
previously sold units also decreases.
A Monopoly’s Marginal Revenue
• A monopolist’s marginal revenue is
always less than the price of its good.
The
demand curve is downward sloping.
When a monopoly drops the price to sell one
more unit, the revenue received from
previously sold units also decreases.
A Monopoly’s Total, Average, and Marginal
Revenue
Quantity
(Q)
0
1
2
3
4
5
6
7
8
Price
(P)
\$11.00
\$10.00
\$9.00
\$8.00
\$7.00
\$6.00
\$5.00
\$4.00
\$3.00
Total Revenue
(TR=PxQ)
\$0.00
\$10.00
\$18.00
\$24.00
\$28.00
\$30.00
\$30.00
\$28.00
\$24.00
Average
Revenue
(AR=TR/Q)
\$10.00
\$9.00
\$8.00
\$7.00
\$6.00
\$5.00
\$4.00
\$3.00
Marginal Revenue
(MR= TR / 
)Q
\$10.00
\$8.00
\$6.00
\$4.00
\$2.00
\$0.00
-\$2.00
-\$4.00
A Monopoly’s Marginal Revenue
• When a monopoly increases the
amount it sells, it has two effects
on total revenue (P x Q).
The
output effect—more output is
sold, so Q is higher.
The price effect—price falls, so P is
lower.
A Monopoly’s Marginal Revenue
• When a monopoly increases the
amount it sells, it has two effects
on total revenue (P x Q).
The
output effect—more output is
sold, so Q is higher.
The price effect—price falls, so P is
lower.
Demand and Marginal Revenue Curves for a
Monopoly...
Price
\$11
10
9
8
7
6
5
4
3
2
1
0
-1
-2
-3
-4
Demand
(average revenue)
Marginal
revenue
1
2
3
4
5
6
7
8
Quantity of Water
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Profit-Maximization for a Monopoly...
2. ...and then the demand
curve shows the price
consistent with this quantity.
Costs and
Revenue
B
Monopoly
price
1. The intersection of the
marginal-revenue curve
and the marginal-cost
curve determines the
profit-maximizing
quantity...
Average total cost
A
Demand
Marginal
cost
Marginal revenue
0
QMAX
Quantity
Comparing Monopoly and Competition
• For a competitive firm, price equals
marginal cost.
P = MR = MC
• For a monopoly firm, price exceeds
marginal cost.
P > MR = MC
A Monopoly’s Profit
•
•
•
•
Profit equals total revenue minus total costs.
Profit = TR - TC
Profit = (TR/Q - TC/Q) x Q
Profit = (P - ATC) x Q
.
The Monopolist’s Profit...
Costs and
Revenue
Marginal cost
E
Monopoly
price
B
Average total cost
Average
total cost D
C
Demand
Marginal revenue
0
QMAX
Quantity
The Monopolist’s Profit
economic profits as long as price is
greater than average total cost.
Marginal-Cost Pricing for a Natural
Monopoly...
Price
Average
total cost
Loss
Regulated
price
Average total cost
Marginal cost
Demand
0
Quantity
Price Discrimination
• Price discrimination is the practice
of selling the same good at different
prices to different customers, even
though the costs for producing for
the two customers are the same. In
order to do this, the firm must have
market power.
Price Discrimination
•
•
Two
important
effects
of
price
discrimination:
It can increase the monopolist’s profits.
But in order to price discriminate, the firm
must
Be able to separate the customers on the
basis of willingness to pay.
Prevent the customers from reselling the
product.
The Early Bird Gets a Lower Price
• Early Bird Specials—
Restaurants charge
special, lower prices for
early diners.
• Matinees—Theaters
charge less for earlier
shows.
• Air Fares—Airlines charge
less for flyers willing to fly
“off peak,” i.e. early
morning and late night.
Is Price Discrimination Always
Undesirable?
• No, although sometimes justice appears to
demand different prices in different markets.
• In some cases, price discrimination may be
necessary for a firm to survive.
• In some cases, where there are significant
economies of scale, price discrimination may
THE ANATOMY OF FACTOR
MARKETS
–The four factors of production that
produce goods and services are:
• Labor
• Capital
• Land
• Entrepreneurship
THE ANATOMY OF FACTOR
MARKETS
– Factor price
– The price of a factor of production.
• The wage rate is the price of labor.
• The interest rate is the price of capital.
• Rent is the price of land.
– Factor market
– A market for labor, capital, or land.
THE ANATOMY OF FACTOR
MARKETS
• Labor Markets
–Labor market
–A collection of people and firms who are trading
labor services.
–Job
–A contract between a firm and a household to
provide labor services.
THE ANATOMY OF FACTOR
MARKETS
• Financial Markets
–Capital
–The tools, instruments, machines, and other
constructions that have been produced in the past
and that businesses use to produce goods and
services.
–Financial capital
–The funds that firms use to buy and operate
physical capital.
THE ANATOMY OF FACTOR
MARKETS
– Financial Market
–A collection of people and firms who are lending
and borrowing to finance the purchase of physical
capital.
–The two main types of financial market are
• Stock market
• Bond market
THE ANATOMY OF FACTOR
MARKETS
–Stock Market
–A stock market is a market in which the shares in
the stocks of companies are traded.
–Examples:
MSE CSE. SEBI
THE ANATOMY OF FACTOR
MARKETS
–Bond Market
–A bond market is a market in which bonds issued
by firms or governments are traded.
–Bond
–A promise to pay specified sums of money on
specified dates.
THE ANATOMY OF FACTOR
MARKETS
• Land Markets
–Land consists of all the gifts of nature.
–A market in which raw materials are traded are
called a commodity market.
• Competitive Factor Markets
–Most factor markets have many buyers and
sellers and are competitive markets.
DEMAND FOR A FACTOR OF PRODUCTION
– Derived demand
– The demand for a factor of production, which is
derived from the demand for the goods and
services it is used to produce.
– Value of marginal product
– The value to a firm of hiring one more unit of a
factor of production, which equals price of a unit
of output multiplied by the marginal product of
the factor of production.
DEMAND FOR A FACTOR OF
PRODUCTION
• Value of Marginal Product
–Table on the next slide walks
you through the calculation of
the value of marginal product.
DEMAND FOR A FACTOR OF PRODUCTION
The first two columns of
the table are the firm’s
total product schedule.
To
calculate
marginal
product, find the change
in total product as the
quantity of labor increases
by 1 worker.
DEMAND FOR A FACTOR OF PRODUCTION
To calculate the
value of marginal
product, multiply
the
marginal
product numbers
by the price of a
car wash, which
in this example
is Rs.3.
DEMAND FOR A FACTOR OF PRODUCTION
DEMAND FOR A FACTOR OF PRODUCTION
Figure shows the
value of the
marginal product
at Max’s Wash ’n’
Wax.
The blue bars show
the value of the
marginal product of
the labor that Max
hires based on the
numbers
in
the
table.
DEMAND FOR A FACTOR OF PRODUCTION
The orange line is
the firm’s value
of the marginal
product of labor
curve.
DEMAND FOR A FACTOR OF PRODUCTION
• A Firm’s Demand for Labor
– A firm hires labor up to the point at which the
value of marginal product equals the wage rate.
– If the value of marginal product of labor exceeds
the wage rate, a firm can increase its profit by
employing one more worker.
– If the wage rate exceeds the value of marginal
product of labor, a firm can increase its profit by
employing one fewer worker.
DEMAND FOR A FACTOR OF PRODUCTION
–A Firm’s Demand for Labor Curve
–A firm’s demand for labor curve is
also its value of marginal product
curve.
–If the wage rate falls, a firm hires
more workers.
DEMAND FOR A FACTOR OF PRODUCTION
Figure shows the demand for
labor at Max’s Wash’n’ Wax.
At a wage rate of
Rs10.50 an hour, Max
makes a profit on the
first 2 workers but
would incur a loss on
the third worker.
18.2 DEMAND FOR A FACTOR OF
PRODUCTION
Figure 18.2 shows the demand for
labor at Max’s Wash’n’ Wax.
At a wage rate of \$10.50 an hour, Max
makes a profit on the first 2 workers but
would incur a loss on the third worker.
So Max’s quantity of labor demanded is
2 workers.
Max’s demand for labor curve is
the same as the value of marginal
product curve.
DEMAND FOR A FACTOR OF PRODUCTION
The demand for labor
curve slopes downward
because the value of the
marginal product of labor
diminishes as the
quantity of labor
employed increases.
DEMAND FOR A FACTOR OF
PRODUCTION
–Changes in the Demand for Labor
–The demand for labor depends on:
•The price of the firm’s output
•The prices of other factors of
production
•Technology
DEMAND FOR A FACTOR OF
PRODUCTION
–The Price of the Firm’s Output
–The higher the price of a firm’s output, the
greater is its demand for labor.
–The Prices of Other Factors of Production
–If the price of using capital decreases relative to
the wage rate, a firm substitutes capital for labor
and increases the quantity of capital it uses.
–Usually, the demand for labor will decrease when
the price of using capital falls.
DEMAND IN FACTOR MARKET
–Technology
–New technologies decrease the demand for some
types of labor and increase the demand for other
types.
WAGES AND EMPLOYMENT
• The Supply of Labor
– People supply labor to earn an income. Many
factors influence the quantity of labor that a
person plans to provide, but the wage rate is a
key factor.
– Figure 18.3 on the next slide shows an
individual’s labor supply curve.
WAGES AND EMPLOYMENT
The table shows
Larry’s
labor
supply schedule,
which is plotted in
the
figure
as
Larry’s
labor
supply curve.
18.3 WAGES AND EMPLOYMENT
1. At a wage rate of
\$10.50 an hour,
Larry …
2. …supplies 30
hours of labor a
week.
18.3 WAGES AND EMPLOYMENT
3. As the wage rate
rises, Larry’s
quantity of labor
supplied …
4. …increases,
5. …reaches a
maximum, …
6. …then
decreases.
18.3 WAGES AND EMPLOYMENT
Larry’s labor supply
curve eventually
bends backward.
18.3 WAGES AND EMPLOYMENT
–Market Supply Curve
–A market supply curve shows the quantity of labor
supplied by all households in a particular job.
–It is found by adding together the quantities of
labor supplied by all households at each wage rate.
–Figure 18.4 on the next slide shows the supply of
car wash workers.
18.3 WAGES AND EMPLOYMENT
This supply curve
shows how the
quantity of car wash
workers supplied
changes when the
wage rate changes,
other things
remaining the same.
18.3 WAGES AND EMPLOYMENT
In a market for a
specific type of
labor, the
quantity supplied
increases as the
wage rate
increases, other
things remaining
the same.
18.3 WAGES AND EMPLOYMENT
• Influences on the Supply of Labor
– Three key factors influence the supply of labor:
• Preferences
• Time in school and training
18.3 WAGES AND EMPLOYMENT
–An increase in the adult population increases the
supply of labor.
–Preferences
–There has been a large increase in the supply of
female labor since 1960.
–The percentage of men with jobs has shrunk
slightly.
18.3 WAGES AND EMPLOYMENT
–Time in School and Training
–The more people who remain in school for fulltime education and training, the smaller is the
supply of low-skilled labor.
18.3 WAGES AND EMPLOYMENT
• Labor Market Equilibrium
– Labor market equilibrium determines the wage
rate and employment.
– Figure 18.5 on the next slide illustrates
equilibrium in the market for car wash workers.
18.3 WAGES AND EMPLOYMENT
1. The equilibrium wage rate is
\$10.50 an hour.
2. The equilibrium quantity of labor is
300 workers.
18.3 WAGES AND EMPLOYMENT
If the wage rate exceeds \$10.50 an
hour, the quantity demanded is less
than the quantity supplied and the
wage rate falls.
If the wage rate is below \$10.50 an
hour, the quantity demanded
exceeds the quantity supplied and
the wage rate rises.
18.4 FINANCIAL MARKETS
• The Demand for Financial Capital
– A firm’s demand for financial capital stems from
its demand for physical capital to produce goods
and services.
– The quantity of physical capital that a firm plans to
use depends on the price of financial capital—the
interest rate.
– Two factors that change the demand for captial
are:
• Population growth
• Technological change
18.4 FINANCIAL MARKETS
• The Supply of Financial Capital
– The quantity of financial capital supplied results
from people’s saving decisions.
– The higher the interest rate, the greater is the
quantity of saving supplied.
– The main influences on the supply of saving are:
• Population
• Average income
• Expected future income
18.4 FINANCIAL MARKETS
• Financial Market Equilibrium and the Interest
Rate
– Financial market equilibrium occurs when the
interest rate has adjusted to make the quantity of
capital demanded equal the quantity of capital
supplied.
– Figure 18.6 on the next slide illustrates financial
market equilibrium.
18.4 FINANCIAL MARKETS
The demand for financial capital is
KD, and the supply of financial
capital is KS.
1. The equilibrium interest rate is 6
percent a year.
2. The equilibrium quantity of
financial capital is \$200 billion.
18.5 LAND AND NATURAL RESOURCE MARKETS
– All natural resources are called land, and they fall
into two categories:
• Renewable
• Nonrenewable
– Renewable natural resources
– Natural resources that can be used repeatedly.
– Nonrenewable natural resources
– Natural resources that can be used only once and
that cannot be replaced once they have been
used.
18.5 LAND AND NATURAL RESOURCE MARKETS
• The Market for Land (Renewable Natural
Resources)
– The lower the rent, the greater is the quantity of
land demanded.
– The supply of a particular block of land is perfectly
inelastic.
– Figure 18.7 illustrates this market for land.
18.5 LAND AND NATURAL RESOURCE MARKETS
The demand curve for a 10-acre
block of land is D, and the supply
curve is S.
Equilibrium occurs at a rent of
\$1,000 an acre per day.
18.5 LAND AND NATURAL RESOURCE MARKETS
• Economic Rent and Opportunity Cost
– Economic rent
– The income received by any factor of production
over and above the amount required to induce a
given quantity of the factor to be supplied.
– The income that is required to induce the supply
of a given quantity of a factor of production is its
opportunity cost—the value of the factor of
production in its next best use.
18.5 LAND AND NATURAL RESOURCE MARKETS
Figure 18.8 shows how the
income of a factor of
production divides between
economic rent and
opportunity cost.
1. Part of the income is opportunity
cost (the red area).
2. Part is economic rent (the green
area).
18.5 LAND AND NATURAL RESOURCE MARKETS
• The Supply of a Nonrenewable Resource
– Over time, the quantity of a nonrenewable
resource decreases as it is used up.
– But the known quantity of a natural resource
increases because advances in technology enable
ever less accessible sources of the resource to be
discovered.
– Using a natural resource decreases its supply,
which causes price to rise.
– New discoveries increase supply, which cause
prices to fall.
Would you like to be a millionaire?
If so, it is in factor markets that you are going to make it happen.
You might come up with a \$1 million idea—borrow to finance capital
expenditure and hire labor.
But the surest way is by saving.
If, starting at age 25, you save \$66 a week and earn interest at 8 percent a
year, how will it take to accumulate \$1 million?
40 years! You’ll be a millionaire at age 65.
By making the capital market work for you, you can grow a few dollars a week
into \$1 million.
Market Structure
Market Structure
• Market structure – identifies how a market
is made up in terms of:
–
–
–
–
–
–
The number of firms in the industry
The nature of the product produced
The degree of monopoly power each firm has
The degree to which the firm can influence price
Profit levels
Firms’ behaviour – pricing strategies, non-price competition, output
levels
– The extent of barriers to entry
– The impact on efficiency
Market Structure
Perfect
Competition
Pure
Monopoly
More competitive (fewer imperfections)
Market Structure
Perfect
Competition
Pure
Monopoly
Less competitive (greater degree
of imperfection)
Market Structure
Pure
Monopoly
Perfect
Competition
Monopolistic Competition
Oligopoly
Duopoly Monopoly
The further right on the scale, the greater the degree
of monopoly power exercised by the firm.
Market Structure
• Importance:
• Degree of competition affects
the consumer – will it benefit
the consumer or not?
• Impacts on the performance
and behaviour of the company/companies
involved
Market Structure
• Models – a word of warning!
– Market structure deals with a number of economic ‘models’
– These models are a representation of reality to help us to understand
what may be happening in real life
– There are extremes to the model that are unlikely
to occur in reality
– They still have value as they enable us to draw comparisons and
contrasts with what is observed
in reality
– Models help therefore in analysing and evaluating – they offer a
benchmark
Market Structure
• Characteristics of each model:
– Number and size of firms that make up
the industry
– Control over price or output
– Freedom of entry and exit from the industry
– Nature of the product – degree of homogeneity (similarity)
of the products in the industry (extent to which products
can be regarded as substitutes for each other)
– Diagrammatic representation – the shape
of the demand curve, etc.
Market Structure
Characteristics: Look at these everyday products – what type of
market structure are the producers of these products operating
in?
Mercedes CLK Coupe
Remember to
nature of the
product, entry and
exit, behaviour of
the firms, number
and size of the
firms in the
industry.
Canon
SLR Camera
Bananas
You might even
the industry is??
Electric
Guitar –
Jazz
VodkaBody
Perfect Competition
• One extreme of the market structure spectrum
• Characteristics:
– Large number of firms
– Products are homogenous (identical) – consumer
has no reason to express a preference for any firm
– Freedom of entry and exit into and out
of the industry
– Firms are price takers – have no control
over the price they charge for their product
– Each producer supplies a very small proportion
of total industry output
– Consumers and producers have perfect knowledge about the market
Perfect Competition
Diagrammatic representation
Cost/Revenue
MC
AC
Given
The
average
The
the
MC
industry
assumption
is the
costcost
price
curve
of
ofisprofit
isfirm
the
AtThe
this
output
the
maximisation,
standard
producing
determined
the
shaped
by
firm
theproduces
curve.
demand
making
normal
atis
MC
an
(marginal)
cuts
output
and supply
thewhere
AC
units
of
curve
MC
of
theoutput.
industry
=
atMR
its It
profit.
This
is
a
long
(Q1).
lowest
falls
as
This
at
point
a first
whole.
output
because
(due
level
The
to firm
the
of
is athe
law
is a of
fraction
mathematical
diminishing
very
of
the
small
total
relationship
returns)
supplier
industry
then
within
rises
run equilibrium
supply.
between
asthe
output
industry
marginal
rises.and
andhas
average
no
position.
values.
control over price. They will
sell each extra unit for the
same price. Price therefore
= MR and AR
P = MR = AR
Q1
Output/Sales
Perfect Competition
Diagrammatic representation
Cost/Revenue
MC
MC1
AC
AC1
AC1
abnormal profit. If new firms
enter
the the
industry,
will
Nowlower
The
Because
assume
ACmodel
aand
firmsupply
MC
assumes
makes
would
increase,
price
will isfall
and
the
some that
imply
perfect
form
knowledge,
the
of modification
firm
the
now
firmto
firm
will
leftgains
making
its product
earning
gains
theabnormal
or
profit
some
fornormal
only
form
profit
once
again.
ofshort
(AR>AC)
a
time
represented
before(say
others
by
a new
the
production
grey
copy
area.
the idea
method).
or are attracted
What
would
to
the industry
happen?by the
existence of Average and
Marginal costs could be
expected to be lower but
price, in the short run,
remains the same.
P = MR = AR
Abnormal profit
P1 = MR1 = AR1
Q1
Q2
Output/Sales
Monopolistic or Imperfect Competition
• Where the conditions of perfect competition do
not hold, ‘imperfect competition’ will exist
• Varying degrees of imperfection give rise to
varying market structures
• Monopolistic competition is one of these – not to
be confused with monopoly!
Monopolistic or Imperfect Competition
• Characteristics:
– Large number of firms in the industry
– May have some element of control over price due to the
fact that they are able to differentiate their product in
some way from their rivals – products are therefore close,
but not perfect, substitutes
– Entry and exit from the industry is relatively easy – few
barriers to entry and exit
– Consumer and producer knowledge imperfect
Monopolistic or Imperfect Competition
Implications for the diagram:
MC
Cost/Revenue
AC
£1.00
Abnormal Profit
£0.60
MR
Q1
D (AR)
Output / Sales
We
Marginal
assume
Cost
that
and
the
firmand
This
IfSince
The
the
is
demand
firm
a the
short
produces
run
curve
equilibrium
Q1
facing
produces
Average
where
Cost
will
MR
be
the
position
sells
the firm
revenue
each
forwill
a
unit
firm
befor
downward
in£1.00
from
a = MC
on
(profit
same
maximising
shape.
However,
output).
monopolistic
average
sloping
each
unit
with
and
sold
market
represents
thefalls,
costthe
(onthe
At
because
this
output
level,
products
AR>AC
structure.
average)
AR
MR
earned
curve
forthe
lies
from
each
under
sales.
unit
the
being
and
are
the
differentiated
firm
makes
in
60p,
AR curve.
the firm will make 40p x
abnormal
way,
profit
the(the
firmgrey
will
Q1some
in abnormal
profit.
only be
area).
able to sell extra
output by lowering
price.
Monopolistic or Imperfect
Competition
Implications for the diagram:
Cost/Revenue
MC
AC
MR1
MR
Q1
AR1
D (AR)
Output / Sales
Because there is relative
freedom of entry and exit
into the market, new
firms will enter
encouraged by the
existence of abnormal
profits. New entrants will
increase supply causing
price to fall. As price falls,
the AR and MR curves
shift inwards as revenue
from each sale is now
less.
Monopolistic or Imperfect
Competition
Implications for the diagram:
Cost/Revenue
MC
AC
AR = AC
MR1
Q2
MR
Q1
AR1
D (AR)
Output / Sales
Notice that the existence
of more substitutes makes
the new AR (D) curve
more price elastic. The
firm reduces output to a
point where MC = MR
(Q2). At this output AR =
AC and the firm will make
normal profit.
Monopolistic or Imperfect
Competition
Implications for the diagram:
Cost/Revenue
MC
AC
AR = AC
MR1
Q2
AR1
Output / Sales
This is the long run
equilibrium position
of a firm in monopolistic
competition.
Monopolistic or Imperfect Competition
• Some important points about monopolistic
competition:
– May reflect a wide range of markets
– Not just one point on a scale – reflects many
degrees
of ‘imperfection’
– Examples?
•
•
•
•
•
•
•
•
•
•
•
Monopolistic or Imperfect Competition
Restaurants
Plumbers/electricians/local builders
Solicitors
Private schools
Plant hire firms
Insurance brokers
Health clubs
Hairdressers
Funeral directors
Estate agents
Damp proofing control firms
Monopolistic or Imperfect Competition
• In each case there are many firms
in the industry
• Each can try to differentiate its product
in some way
• Entry and exit to the industry is relatively free
• Consumers and producers do not have perfect knowledge of
the market – the market may indeed be relatively localised.
Can you imagine trying to search out the details, prices,
reliability, quality of service, etc for every plumber in the UK in
the event of an emergency??
Oligopoly
• Competition between the few
– May be a large number of firms in the industry but the
industry is dominated
by a small number of very large producers
• Concentration Ratio – the proportion of total market
sales (share) held by the top 3,4,5, etc firms:
– A 4 firm concentration ratio of 75% means the top 4 firms
account for 75% of all
the sales in the industry
Oligopoly
• Example:
• Music sales –
The music industry has
a 5-firm concentration
ratio of 75%.
Independents make up
25% of the market but
there could be many
thousands of firms that
make up this
‘independents’ group.
An oligopolistic market
structure therefore
may have many firms
in the industry but it is
dominated by a few
large sellers.
Market Share of the Music Industry 2002. Source IFPI: http://www.ifpi.org/site-content/press/20030909.html
Oligopoly
• Features of an oligopolistic market structure:
– Price may be relatively stable across the industry –
kinked demand curve?
– Potential for collusion
– Behaviour of firms affected by what they believe their rivals
might do – interdependence of firms
– Goods could be homogenous or highly differentiated
– Branding and brand loyalty may be a potent source of competitive advantage
– Non-price competition may be prevalent
– Game theory can be used to explain some behaviour
– AC curve may be saucer shaped – minimum efficient scale
could occur over large range of output
– High barriers to entry
Oligopoly
Price
The kinked demand curve - an explanation for price stability?
The
Assume
If
The
thefirm
principle
firmthe
therefore,
seeks
firm
ofto
is
the
lower
charging
effectively
kinked
its price
demand
a faces
price
to of
£5‘kinked
gain
a
and
a curve
competitive
producing
demand
rests on
an
curve’
the
output
principle
forcing
of 100.
itsit rivals
to
will follow
maintain
that:
asuit.
stable
Anyorgains
rigid pricing
it makes will
If it chose to raise price above £5, its
quickly beOligopolistic
structure.
lost and the firms
% change
may in
rivals
a. would
If a firm
not
raises
followitssuit
price,
andits
the firm
demand will
overcome
this
beby
smaller
engaging
thaninthe
non%
effectively
rivalsfaces
will not
an follow
elasticsuit
demand
reduction
price
competition.
in price – total revenue
curve for its product (consumers would
would
b. Ifagain
a firm
fall
lowers
as theitsfirm
price,
nowitsfaces
buy from the cheaper rivals). The %
a relatively
rivalsinelastic
will all dodemand
the same
curve.
change in demand would be greater
than the % change in price and TR
would fall.
£5
Total
Revenue B
Total Revenue A
Kinked D Curve
Total Revenue B
D = elastic
D = Inelastic
100
Quantity
Duopoly
• Market structure where the industry is dominated
by two large producers
– Collusion may be a possible feature
– Price leadership by the larger of the two firms may exist – the
smaller firm follows the price lead
of the larger one
– Highly interdependent
– High barriers to entry
– Cournot Model – French economist – analysed duopoly –
suggested long run equilibrium would see equal market share and
– In reality, local duopolies may exist
Monopoly
• Pure monopoly – where only
one producer exists in the industry
• In reality, rarely exists – always
some form of substitute available!
• Monopoly exists, therefore,
where one firm dominates the market
• Firms may be investigated for examples of
monopoly power when market share exceeds
25%
• Use term ‘monopoly power’ with care!
Monopoly
• Monopoly power – refers to cases where firms influence
the market in some way through their behaviour –
determined by the degree
of concentration in the industry
–
–
–
–
–
Influencing prices
Influencing output
Erecting barriers to entry
Pricing strategies to prevent or stifle competition
May not pursue profit maximisation – encourages unwanted
entrants to the market
– Sometimes seen as a case of market failure
Monopoly
• Origins of monopoly:
– Through growth of the firm
– Through amalgamation, merger
or takeover
– Through acquiring patent or license
– Through legal means – Royal charter,
nationalisation, wholly owned plc
Monopoly
• Summary of characteristics of firms exercising
monopoly power:
– Price – could be deemed too high, may be set to destroy
competition (destroyer or predatory pricing), price
discrimination possible.
– Efficiency – could be inefficient due to lack of competition
(X- inefficiency) or…
• could be higher due to availability of high profits
Monopoly
• Innovation - could be high because
of the promise of high profits, Possibly encourages
high investment in research and development (R&D)
• Collusion – possible to maintain monopoly power of
key firms
in industry
• High levels of branding, advertising
and non-price competition
Monopoly
• Problems with models – a reminder:
– Often difficult to distinguish between a monopoly
and an oligopoly – both may exhibit behaviour
that reflects monopoly power
– Monopolies and oligopolies do not necessarily aim
for traditional assumption of profit maximisation
– Degree of contestability of the market may influence behaviour
– Monopolies not always ‘bad’ – may be desirable
in some cases but may need strong regulation
– Monopolies do not have to be big – could exist locally
Monopoly
Costs / Revenue
MC
£7.00
AC
Monopoly
Profit
This(D)
AR
Given
isthe
both
curve
barriers
the
forshort
a to
monopolist
entry,
run and
likely
the
long
monopolist
run
to be
equilibrium
relatively
will be
position
price
able to
inelastic.
exploit
for
a monopoly
abnormal
Output assumed
profits in the
to
be atrun
long
profit
as maximising
entry to the output
(note caution
market
is restricted.
here – not all
monopolists may aim
for profit maximisation!)
£3.00
MR
Q1
AR
Output / Sales
Monopoly
Welfare
implications of
monopolies
Costs / Revenue
MC
£7
AC
Loss of consumer
surplus
£3
AR
MR
Q2
A
look
back
at
the
for
The
The
higher
price
monopoly
in
price
a competitive
price
anddiagram
lower
would be
perfect
competition
will
reveal
output
market
£7
permeans
unit
would
with
that
beoutput
£3
consumer
with
levels
that
inat
equilibrium,
price will by
be
surplus
output
lower
is
levels
Q2.
reduced,
at Q1.indicated
equal
to
the
MC
of
production.
On the face of it, consumers
We
lookprices
therefore
a
facecan
higher
and at
less
comparison
of
the
differences
choice in monopoly conditions
between price and output in a
compared to more competitive
competitive
situation compared
environments.
to a monopoly.
Q1
Output / Sales
Monopoly
Welfare
implications of
monopolies
Costs / Revenue
MC
£7
AC
Gain in producer
surplus
The monopolist will benefit
be
affected
from
by a loss
producer
of producer
surplus equal
showntobythe
thegrey
grey
triangle rectangle.
but……..
£3
AR
MR
Q2
Q1
Output / Sales
Monopoly
Welfare
implications of
monopolies
Costs / Revenue
MC
£7
AC
The value of the grey shaded
triangle represents the total
welfare loss to society –
sometimes referred to as
£3
AR
MR
Q2
Q1
Output / Sales
Contestable Markets
• Theory developed by William J. Baumol,
John Panzar and Robert Willig (1982)
• Helped to fill important gaps in market
structure theory
• Perfectly contestable market – the
pure form – not common in reality but a
benchmark to explain firms’ behaviours
Contestable Markets
• Key characteristics:
– Firms’ behaviour influenced by the threat
of new entrants to the industry
– No barriers to entry or exit
– No sunk costs
– Firms may deliberately limit profits made
to discourage new entrants – entry limit pricing
– Firms may attempt to erect artificial barriers to entry –
e.g…
Contestable Markets
• Over capacity – provides the
opportunity to flood the market
and drive down price in the event
of a threat of entry
• Aggressive marketing and branding
strategies to ‘tighten’ up the market
• Potential for predatory
or destroyer pricing
• Find ways of reducing costs and
increasing efficiency to gain competitive
Contestable Markets
• ‘Hit and Run’ tactics – enter the
industry, take the profit and get
out quickly (possible because of
the freedom of entry and exit)
• Cream-skimming – identifying
parts of the market that are high
those markets
Contestable Markets
• Examples of markets exhibiting
contestability characteristics:
– Financial services
– Airlines – especially flights
on domestic routes
– Computer industry – ISPs, software,
web development
– Energy supplies
– The postal service?
Market Structures
• Final reminders:
•
•
•
•
•
Models can be used as a comparison – they are not necessarily meant to BE
reality!
When looking at real world examples, focus on the behaviour of the firm in
relation to what the model predicts would happen – that gives the basis for
analysis and evaluation of the real world situation.
Regulation – or the threat of regulation may well affect
the way a firm behaves.
Remember that these models are based on certain assumptions – in the real world
some of these assumptions may not be valid, this allows us to draw comparisons
and contrasts.
The way that governments deal with firms may be based on a general assumption
that more competition is better than less!
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