4 Market Structures 1 FOUR MARKET STRUCTURES Perfect

4 Market Structures 1

FOUR MARKET STRUCTURES Perfect Competition Monopolistic Competition Oligopoly Pure Monopoly Every product is sold in a market that can be considered one of the above market structures. For example: 1. Fast Food Market 2. The Market for Cars 3. Market for Operating Systems (Microsoft) 4. Strawberry Market 5. Cereal Market 2

Perfect Competition 3

FOUR MARKET STRUCTURES Perfect Competition Monopolistic Competition Oligopoly Pure Monopoly Imperfect Competition Characteristics of Perfect Competition: Examples of Perfect Competition: any agriculture, street food, open software, stock market • Many small firms • Identical products (perfect substitutes) • Easy for firms to enter and exit the industry • Seller has no need to advertise • Firms are “Price Takers” The seller has NO control over price. 4

Law of One Price In an efficient market, all identical goods must have only one price. Result: Each firm is a price taker. Firms have no control of the price Traffic Analogy When there is heavy traffic, why do all lanes seem to go the same speed? Cars leave slower lanes and enter faster lanes. Similarly, what happens in perfectly competitive markets if firms earn excessive profit? 5

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Perfectly Competitive Firms Example: • Say you go to Mexico to buy a hammock. • After visiting at few different shops you find that the buyers and sellers always agree on $15. • This is the market price (where demand supply meet) 1. Is it likely that any shop can sell hammocks for $20? 2. Is it likely that any shop will sell hammocks for $10? 3. What happens if a shop prices hammocks too high? 4. Do you think that these firms make a large profit off of hammocks? Why? These firms are “price takers” because the sell their products at a price set by the market. 7

Demand for Perfectly Competitive Firms Why are they Price Takers? • If a firm charges above the market price, NO ONE will buy. They will go to other firms • There is no reason to price low because consumers will buy just as much at the market price. Since the price is the same at all quantities demanded, the demand curve for each firm is… Perfectly Elastic (A Horizontal straight line) 8

Review 1. 2. 3. 4. 5. 6. 7. 8. Difference between fixed and variable resources Identify the three stages of returns and why each stage occurs Explain how to calculate AVC, AFC, ATC, and MC Identify the difference between the short run and the long run What are the 5 characteristics of perfect competition? Why is a perfectly competitive firm a ‘price taker’? Explain the traffic analogy for perfect competition Riddle: What flies without wings? 9

The Competitive Firm is a Price Taker Price is set by the Industry P S P $15 Demand $15 D 5000 Industry Q Firm (price taker) Q 10

The Competitive Firm is a Price Taker Price is set by the Industry What is the additional revenue for selling an P additional unit? 1 st unit earns $15 2 nd unit earns $15 Marginal revenue is $15 constant at $15 Notice: • Total revenue increases at a constant rate • MR equal Average Revenue Demand MR=D=AR=P Firm (price taker) Q 11

The Competitive Firm is a Price Taker Price is set by the Industry What is the additional revenue for selling an P additional unit? Competition: For Perfect 1 st unit earns $15 = MR 2 nd unit earns. Demand $15 Marginal revenue is $15 Demand (Marginal Revenue)MR=D=AR=P constant at $15 Notice: • Total revenue increases at a constant rate • MR equal Average Revenue Firm (price taker) Q 12

Maximizing PROFIT! 13

Short-Run Profit Maximization What is the goal of every business? To Maximize Profit!!!!!! • To maximum profit firms must make the right output • Firms should continue to produce until the additional revenue from each new output equals the additional cost. Example (Assume the price is $10) • Should you produce… …if the additional cost of another unit is $5 …if the additional cost of another unit is $9 …if the additional cost of another unit is $11 14

Short-Run Profit Maximization What is the goal of every business? To Maximize Profit!!!!!! • To maximum profit firms must make the right output • Firms should continue to produce until the additional revenue from each new output equals the additional cost. Example (Assume the price is $10) • Should you produce… …if the additional cost of another unit is $5 …if the additional cost of another unit is $9 …if the additional cost of another unit is $11 Profit Maximizing Rule MR=MC 15

Lets put costs and revenue together on a graph to calculate profit. 16

• How much output should be produced? • How much is Total Revenue? How much is Total Cost? • Is there profit or loss? How much? P MC $9 8 7 6 5 4 3 2 1 Profit = $18 Total Cost=$45 Total Revenue =$63 MR=D=AR=P ATC AVC Don’t forget that averages show PER UNIT COSTS 1 2 3 4 5 6 7 8 9 10 Q 17

Suppose the market demand falls. What would happen if the price is lowered from $7 to $5? The MR=MC rule still applies but now the firm will make an economic loss. The profit maximizing rule is also the loss minimizing rule!!! 18

Cost and Revenue • How much output should be produced? • How much is Total Revenue? How much is Total Cost? • Is there profit or loss? How much? MC $9 8 ATC 7 6 AVC Loss =$7 5 MR=D=AR=P 4 3 Total Cost = $42 2 Total Revenue=$35 1 1 2 3 4 5 6 7 8 9 10 Q 19

Assume the market demand falls even more. If the price is lowered from $5 to $4 the firm should stop producing. Shut Down Rule: • A firm should continue to produce as long as the price is above the AVC (you’re still making $$ for every unit sold) • When the price falls below AVC then the firm should minimize its losses by shutting down • Why? If the price is below AVC the firm is losing more money by producing than they would have to pay to shut down. • Exit vs shutdown : leave completely vs stop production 20

Cost and Revenue SHUT DOWN! Produce Zero MC $9 8 7 6 5 4 3 2 1 ATC AVC Minimum AVC is shut down point 1 2 3 4 5 6 7 8 9 10 Q 21

P<AVC. They should shut down Cost and Revenue Producing nothing is cheaper than staying open. MC $9 8 7 6 5 4 3 2 1 ATC Fixed Costs=$10 TC=$35 AVC MR=D=AR=P TR=$20 1 2 3 4 5 6 7 8 9 10 Q 22

Profit Maximizing Rule MR = MC Three Characteristics of MR=MC Rule: 1. Rule applies to ALL markets structures (PC, Monopolies, etc. ) 2. The rule applies only if price is above AVC 3. Rule can be restated P = MC for perfectly competitive firms (because MR = P) 23

Review 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. Difference between fixed and variable resources Identify the three stages of returns and why each stage occurs Identify the difference between the short run and the long run What are the 3 stages of the LRATC Why does ‘economies of scale’ occur? Why does ‘constant returns to scale occur? What are the 5 characteristics of perfect competition? Explain the traffic analogy for perf. Comp. profits Draw a perfectly competitive firm & industry making a profit Draw a perfectly competitive firm & industry making a loss What is the ‘shut down rule’ and when is it applicable? Would you like to go to a small university, or a big university? Why? 24

Practice 25

#1 Should the firm produce? Yes What output should the firm produce? 10 What is TR at that output? What is TC? TR=$140 TC=$100 How much profit or loss? Profit=$40 $20 Cost and Revenue MC 15 14 MR=D=AR= P ATC AVC 10 6 5 0 6 7 10 Q 26

#2 What output should the firm produce? Zero Shutdown (Price below AVC) What is TR at MR=MC point? $45 What is TC at MR=MC point? $55 How much profit or loss? Loss=Only Fixed Cost $5 Cost and Revenue $20 MC ATC AVC 15 11 10 9 MR=D=AR=P 5 0 5 7 Q 27

What output should the firm produce? 6 What is TR at that output? $90 What is TC? $120 How much profit or loss? Loss= $30 #3 $40 Cost and Revenue MC 30 ATC 20 19 15 10 0 AVC MR=D=AR=P 6 8 Q 28

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