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Market Structure

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14 views26 pages

Market Structure

Uploaded by

imittesaf
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Market Structure

What will we cover today?


Learning Objectives
■ Identify the characteristics of the four market structures
■ Analyse the profit maximising position in the four market structures
■ Examine short run and long run profit outcomes in the three market
structures.
Recap: The profit maximising
rule!
Last week we saw that firms will maximise their profit
when

Marginal Cost = Marginal Revenue


MC = MR

■ When MR>MC, firms should increase output.


■ When MR<MC, firms should decrease output.
Recap: Profit outcomes

■ When a firm produces a quantity where MR=MC, there are


three possible outcomes:
■ Outcomes will depend on the market structure the firm is in, and its
ability to influence price

■ Normal profit/Break Even: TR = TC​


■ Economic profit: TR > TC​
■ Economic loss: TR < TC​
Market Structures
• Market structures lie on a spectrum:

Perfect
Competition

Monopolistic
Monopoly
Competition

• Most • Least
competitive competitive
• Most efficient • Most inefficien
Perfect Competition
Number of Many small firms
sellers
Product Homogenous (identical) product
characterist
ics
Market No market power. “Price Takers”
power
Barriers to No barriers. Easy to enter/exit the market
entry
Efficiency Most efficient The examples above
come close to perfect
competition. However
Examples? Lawn mowing, house cleaning perfect competition is
more a theoretical
concept, and doesn't
really exist in
Price, Demand and Revenue
Total Revenue (TR)
■ Total Revenue (TR) = Price (P) x Quantity (Q)
■ Therefore TR increases by price for each
additional unit sold
■ An upward sloping line

Average Revenue (AR)


■ Average Revenue (AR) = Total Revenue per Unit
(=PRICE)

Marginal Revenue (MR)


■ Additional revenue from the sale of one more
unit (= PRICE)
Price, Demand and Revenue
Market demand versus
an individual firm’s
demand
■ A firm in perfect
competition is a ‘price
taker’ (no ability to
influence price)
■ Price is set by the
market
■ Therefore a firm faces
a perfectly elastic
demand curve (at
market price)
Economic profit in perfect
competition
If P>ATC, the firm will
make economic profit

This will encourage new


firms to enter the
market

Market supply will


increase

Market price will fall

The firm’s economic


profit will decrease (no
Economic loss in perfect
competition
If P<ATC, firms will make an
economic loss

Some firms will exit the market

Market supply decreases

Market price increases

The economic loss of remaining


firms decreases (no economic
loss is possible in the long run)
Short Run Profit Outcome:
Perfect Competition
In the short run we have three (3) possible outcomes:

#1 Normal Profit (Break Even) P = ATC

#2 Economic Profit (Supernormal) P > ATC


– Firms will ENTER industry causing a shift in supply curve to the right (increase in
supply) which drives down price
– Economic profit of existing firms decreases

#3 Economic Loss P < ATC


– Firms will EXIT industry causing a shift in supply curve to the left (decrease in supply)
which drives up price
– Economic profit of existing firms increases
Long Run Profit Outcome:
Perfect Competition
■ In perfect competition there are no barriers to entry or exit

■ Firms will enter and leave the industry based on profits

■ In the long run firms will only be able to make NORMAL PROFIT (break
even)
■ Economic profit is impossible in perfect competition in the long run
Monopoly
Market structures lie on a
spectrum
Perfect Oligopoly
Competition

Monopolistic
Competition Monopoly
What is a Monopoly?
Number of One large firm
sellers:
Product Unique. No close substitutes
characterist
ics:
Market Firm has complete control over price.
power: Price maker

Barriers to Very high. Almost impossible to enter


entry: the market

Efficiency: The most inefficient market structure

Examples: WASA, Defense, Electricity, Railway


Why do
monopolies arise?
■ Because a single firm owns a key
resource e.g. water supply
■ Because the government gives the
seller the exclusive right to sell a
good or service through patent and
copyright laws, e.g.
pharmaceuticals
■ Because in some markets, a single
firm can supply the market at a
lower average total cost, compared
to many firms. E.g. broadband
networks, electricity distribution.
Monopoly versus Perfect
Competition Perfect competition
Key difference:
– Monopoly firms can influence the
price of their output (price makers)
– Competitive firms are price takers
and have no influence over price

■ Competitive firms face a Monopoly


perfectly elastic demand curve as
there are many alternate sellers
available in the market.
■ A monopoly has a downward
sloping demand curve– the
monopolist is the market.
Maximising Monopoly Profit
A monopoly maximises profit by
choosing the quantity at which
marginal revenue equals
marginal cost
MR = MC

It then uses the demand curve


to find the price that
consumers are willing to pay
Profit = (P – ATC) x Q
Short run outcomes
for a Monopoly firm
■ Normal Profit if P = ATC
■ Economic profit if P > ATC
■ Economic loss if P < ATC

■ Will a monopoly make an economic profit in


the long run?
■ Will a monopoly make an economic loss in
the long run?
Long run outcomes for a
Monopoly firm
■ Normal profit
■ Economic profit is possible, as barriers to entry stop new firms from
entering the market

■ A monopoly firm won’t continue to make a loss in the long run – it will
exit the market
Other Imperfect Markets

Perfect
Competition Oligopoly

Monopolistic Monopoly
Competition
Monopolistic Competition
Number of Many small firms
sellers:
Product Differentiated – products are similar
characterist and substitutable, but not identical
ics:

Market Firms have a small amount of


power: influence over price.
Barriers to Low. Easy to enter the market
entry:
Efficiency: Fairly efficient market structure

Examples: Most products available to


consumers
Outcomes in the Short Run
• A monopolistically competitive firm faces highly (but not perfectly) elastic
demand along much of its demand curve, as there are many substitutes.
• Short run profit maximisation will be where MR = MC
• Possible outcomes:
• economic profit,
• economic loss,
• normal profit (break even)
• The variable that allows for economic profit is product differentiation, which
gives the firm some influence over price
Economic Profit P Loss P <
> ATC ATC

Normal profit: P =
ATC
Outcome in the Long Run
In the long run only normal profit is attainable
If a firm is making economic profit in the short run…
• New firms will enter
• Competition will increase driving down the price
• The market supply curve will shift to the right, driving equilibrium price down

If a firm is making a loss in the long run…


• Firms will leave
• Competition will decrease leaving remaining firms with grater share of total
demand
• The market supply curve will shift to the left, driving the equilibrium price
upwards
Required reading

■ Textbook Gans et. al. pp. 304 – 314, 327-340, 357-61.

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