Transcript 2nd Ed Chapter 4x

Chapter 4
Firms and Market Structures
4.1 What is a Firm?
4.2 Types of Firm
4.3 Different Types of Market
4.4 Perfect Competition
4.5 Monopoly
4.6 Oligopoly
4.7 Monopolistic Competition
4.8 Profit
4.9 Revenue
4.10 Costs
4.11 Profit Maximisation for a Perfectly Competitive Firm
4.12 Profit Maximisation for a Monopolist
4.13 Break Even Analysis
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What is a Firm?
An institution that hires the factors of production to produce
and/or sell goods and services.
A firms’ goal is to maximise profit.
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Sole Proprietorships
Firms with one owner.
The owner has unlimited liability for the firm.
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Partnerships
Firms with 2 to 20 owners.
Each owner has unlimited liability for the firm.
By pooling resources individuals can come together to create a
much larger firm than they could have on their own
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Companies
Firms owned by shareholders who
each own part of the company.
Shareholders have limited liability
for the company’s debts, only
legally liable up to the value of the
capital contributed.
Run by managers and staff who
may not be shareholders - creates
an incentive conflict.
Dutch East India Company Share
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Different Types of Market
The main market structures are:
– Perfect Competition
– Monopoly
– Oligopoly
– Monopolistic competition
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Perfect Competition
Characterised by:
– The market is very large
– Firms all sell an identical or very similar product
– There are very low barriers to enter the market
– Established firms have no advantage over new entrants.
– Firms are price takers.
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Perfect Competition
Firms make zero economic profit. (just enough profit to pay the bills, stay in business.)
Competition drives firms to charge the equilibrium price.
–If a higher price is charged firms will be undercut by a competitor and lose market share
and profit.
–If a lower price is charged firms will make a loss as revenue will not cover costs.
–Therefore all firms charge the equilibrium price. Equilibrium price is the lowest possible
price firms can charge and stay in business (hence zero economic profit).
Perfect competition creates an efficient outcome.
A hypothetical model, there is no such thing as a perfectly competitive market in the real
world (but some markets come close i.e. world markets for commodities like grain or wool).
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Competitive Markets in Australia
Natural tendency in a modern market economy to move towards
less competition and greater concentration of ownership.
Larger firms can take advantage of economies of scale – cost
cutting efficiencies of large businesses.
Governments attempt to increase competition to create a more
efficient outcome.
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Monopoly
Characterised by:
– Very high barriers to entry
– No close substitute goods
– Monopolies are price makers
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Monopoly
Monopolies arise because of the ownership of some key resource (water,
land, new patent etc.)
A natural monopolist is a firm that can provide a good or service more
efficiently than two or more other firms could (rail network, water supply
etc.)
As monopolies have the entire market for a good, they cannot be undercut in
price by a competitor.
A monopolist will charge a higher price than would have prevailed in a
competitive market.
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Is a Monopoly Efficient?
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Is a Monopoly Efficient?
Producer surplus (monopoly surplus) is higher than in a perfectly
competitive market.
Consumer surplus is much lower than in a perfectly competitive
market due to the higher price.
A monopoly creates a deadweight loss, therefore, a monopoly
does not create an efficient outcome
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Public Ownership vs. Private
Ownership of Monopolies
Governments own and operate monopolies in order to service
the public interest.
Industries such as public transport are often government owned
to ensure that their use is kept cheap enough for the public to
access.
Privately run monopolies may charge exorbitantly high prices.
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Oligopoly
Characterised by:
– Few firms selling very similar to identical products
– High barriers to entry
– No close substitutes outside the Oligopoly
– Significant market power and price making ability
Rupert
Murdoch’s
Daily
Telegraph
operates in an
Oligopoly.
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Oligopoly
Oligopoly firms behave strategically as prices and quantities sold
by competitors will affect their profits.
Have incentives to collude with other oligopolists to act as a
monopoly to maximise profit.
Governments try to stop this from happening as it creates a
socially unbeneficial outcome due to higher prices. Collusion
between oligopolists is illegal in Australia.
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Oligopolies in Australia
The banking industry.
The domestic airline
industry.
Supermarket industry.
See case studies pg. 137-140
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Duopoly
• A form of oligopoly where the market is dominated by two firms.
• Competition exists, making efficiency higher than in a monopoly.
• A duopoly needs to be closely watched by a Government as price
collusion can easily occur between the businesses to create a
monopoly.
Examples:
• Pepsi and Coca-Cola,
• Woolworths and Coles,
• Boeing and Airbus.
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Monopolistic Competition
Characterised by:
– Many sellers
– Low barriers to entry into the market
– Differentiated Product
– Some market power over price
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Monopolistic Competition
Difference between monopolistic competition and perfect
competition is that the product is slightly differentiated.
The difference can be real or perceived by the consumer,
achieved by branding and marketing.
Examples include:
– Restaurant industry
– Toiletries (toilet paper, soap etc.)
– Clothing
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Profit
Profit = Total Revenue (TR) – Total Costs(TC)
Economic Profit includes opportunity cost in the total cost
calculation (includes explicit and implicit costs).
Accounting Profit simply measures dollars and cents (includes
explicit costs only).
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Revenue
Total Revenue (TR) = Quantity of goods sold (Q) x Price of each good (P)
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Costs
Total Costs (TC) = Fixed Costs (FC) + Variable Costs (VC)
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Fixed Costs
Fixed costs are costs that do not change with output and
must be paid even if the company is not producing any
output (i.e. rent).
In the short-run a firm faces both fixed and variable costs.
In the long run no costs are fixed, all costs are variable.
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Variable Costs
Variable costs are the costs that vary with the number of units of
a good that are produced.
The higher the output the higher the variable costs.
All inputs of production are variable costs, materials, wages,
electricity etc.
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Average Cost
TC/Q = FC/Q + VC/Q
By dividing each cost measure by the quantity of units produced
we get average cost per unit.
FC/Q = Average fixed cost per unit
VC/Q = Average variable cost per unit
TC/Q = Average total cost per unit
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Marginal Cost
Marginal cost (MC) is the increase in total cost that results
from a one unit increase in output.
Marginal Cost (MC) =
change in total cost
________________
change in output
Marginal cost shows how variable costs change as the level of
output changes.
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Marginal Revenue
Marginal Revenue (MR) =
change in total revenue
_____________________
change in output
The change in revenue that comes from a one unit change in output.
Tells the firm how much extra income they will receive by producing an
extra unit of output.
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Profit Maximisation for a Perfectly
Competitive Firm
• A perfectly competitive firm can only change its number of
units sold, not its price, as it must charge the market price.
• If it charges over the market price it will be undercut be
competitors and sell no units.
• If it charges under the market price it will make a loss on each
unit sold and go out of business.
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Profit Maximisation for a Perfectly
Competitive Firm
At the market price the perfectly competitive firm can sell as many
units as it likes. It will sell the quantity of units where:
marginal revenue = marginal cost.
• If marginal revenue > marginal cost the firm can make a higher
profit by selling more units, and will keep selling until marginal
revenue = marginal cost.
• If marginal revenue < marginal cost the firm can make more profit
by selling fewer units. So it will sell less and less until marginal
revenue = marginal cost.
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Profit Maximisation for a Monopolist
• A monopoly will also produce the level of units where marginal
revenue = marginal cost for the exact same reason as the perfectly
competitive firm does.
• However, the perfectly competitive firm faces a flat marginal
revenue curve as price is always constant and equal to the market
price.
• The monopolist faces a downward sloping marginal revenue curve
because it is a price maker and can charge a high price without fear
of being undercut by competitors (there aren’t any).
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Profit Maximisation for a Monopolist
• Because the monopolist faces a downward sloping demand
curve rather than a flat one, the higher price the monopolist
charges the less units it sells.
• Selling the quantity where marginal revenue = marginal cost
will result in the monopolist charging a higher price and in less
units being sold than in the perfectly competitive equilibrium.
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Monopoly vs Perfect Competition
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Break-Even Analysis
• The break-even point is the level of production at which total
cost and total revenue are equal.
• Break-even analysis is used to inform managers of how many
units the business needs to sell before it will begin to make a
profit.
• It is an essential tool for business planning.
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