Market
Structures
ECON110-Principles of Economics
REVIEW: REVENUES, PROFIT
§ In general, total revenue is price x output (Q)
𝑇𝑅 = 𝑃𝑄
§ Total profit (Π ) is equal to total revenue minus total
cost.
Π=TR−TC
§ Like costs, profit and revenue can be expressed in
average (per output) units. Average profit (AP) is
average revenue minus average costs, or
equivalently:
Π 𝑇𝑅 𝑇𝐶
𝐴𝑃 = =
−
𝑄
𝑄
𝑄
§ Since 𝑇𝑅 = 𝑃𝑄,it follows that
𝑨𝑷 = 𝑷 − 𝑨𝑪
Therefore, AP, and total profits stays positive, as
long as P > AC.
PROFIT MAXIMIZATION: WHY
MR = MC?
Perfect Competition case:
• Discussion:
https://www.youtube.com/watch?v=w0H
bGX0KFFM&t=325s&ab_channel=JacobCli
fford
• Lecture:
https://www.youtube.com/watch?v=BQvt
njWZ0ig&ab_channel=JacobClifford
General case (optional but with calculus)
• See Canvas or classroom board notes
Market Structure:
Porter’s Five Forces
1.
Competition Rivalry
2.
Threat of New Entrants
3.
Threat of Substitutes
4.
Power of Suppliers
5.
Power of Buyers
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I. Competition
• Let’s
contrast two extreme
forms of market competition:
1.
Perfect Competition
2.
Monopoly
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Perfect Competition
In general, such competitive firms sell
homogeneous products and are price takers.
•
If you have prices t h at differ too much from
competitors, you lose if yours is too high
(obviously).
•
In addition, since firms are price-takers, P =MR.
(any further increase in output has the same
price)
Therefore, P =AR =MR.
•
Since MR = MC under profit maximization,
competitive firms will attempt to charge P=MC.
•
If there is initially a different P, other firms will
act depending on available incentives and
restore P=MC accordingly (think about shifts in
the market supply curve)
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Perfect Competition: Shutdown and
Exit Condition
• What if prices are too low?
• Recall: In the long run, there are no
fixed costs.
• Firms earn profits if TR > TC or P > AC
• On the other hand, if P cannot even cover AC,
firms exit the market.
• In the short run, firms need to
worry about variable costs (fixed
costs are a given an d cannot be
recovered).
• Firms may shutdown temporarily if TR < VC
or P < AVC. But they still pay fixed costs (i.e.
stay in the market, but produce Q = 0)
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Perfect Competition: Profits
•
Zero economic profit in the long-run.
Recall: Profits are positive if P > AC
• Positive economic profits attract
other firms to enter, which will
reduce prices until this condition
holds. In the long run, P=MC=AC
Zero economic profit applies if
• 𝑻𝒐𝒕𝒂𝒍 𝑹𝒆𝒗𝒆𝒏𝒖𝒆(𝑻𝑹) = 𝑻𝒐𝒕𝒂𝒍 𝑪𝒐𝒔𝒕
• 𝑻𝑹 = 𝑬𝒙𝒑𝒍𝒊𝒄𝒊𝒕𝑪𝒐𝒔𝒕 + 𝑰𝒎𝒑𝒍𝒊𝒄𝒊𝒕𝑪𝒐𝒔𝒕
But accounting profit may remain positive if
• 𝑻𝒐𝒕𝒂𝒍 𝑹𝒆𝒗𝒆𝒏𝒖𝒆 > 𝑻𝒐𝒕𝒂𝒍 𝑬𝒙𝒑𝒍𝒊𝒄𝒊𝒕 𝑪𝒐𝒔𝒕
Therefore, under competitive markets, firms earn
enough accounting profits to compensate for the
time and money invested to keep the business
going. No more, no less.
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Monopoly: Excess Market Power
§ One seller, multiple buyers.
§ Price Maker: I t can m a ke ou tp u t decisions
on its own, a n d it follows t h a t it can
influence t h e price on its own.
§ (Probably t he most famous
§ cartoon example: Krusty Krab)
§ As a n alternative, government may opt to
regulate price a n d ou tp u t decisions of
monopolies.
§ A monopolist has no supply curve since it is
powerful enough to choose a specific point
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II. Threat of New Entrants
•
Perfect Competition
• No barriers to entry, incentive to e a r n until
long r u n zero economic profit condition achieved
• Free entry or exit depending on how P
compares with AC
•
Monopoly
Strong Barriers to Entry
Natural barriers (e.g. economies of scale)
Small firms will find it very costly to compete
Legal barriers
•
Oligopoly
• ”In between case” – involves a few players selling
homogeneous products
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III. Threat of Substitutes
•
More substitutes decreases profitability of
an industry.
The more substitutes, the more ”competitors” and the
more pressure not to increase prices.
Recall: If the price of substitutes go down,
quantity demanded goes down. Also
consider: cross-price elasticity of demand.
•
Branding and product differentiation may
also play a role in the industry.
•
Monopolistic Competition:
Multiple sellers, but some monopoly power
present due to product differentiation
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IV. Suppliers
• If
suppliers have market power,
they can bring down the
profitability of an industry.
Shift costs downwards (from the supplier
industry to the incumbent industry).
• Example:
The profitability of
airlines gets affected by the nature
of aircraft manufacturing (BoeingAirbus duopoly)
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V. Buyers
•
We can say more about buyers in
consumer theory a n d marketing , b u t in
general, buyers m ay also affect t h e n a t u r e
of a n industry.
•
Some consumers a re more price sensitive
(consider: elasticity of demand)
•
Some capture more value t h a n others
•
Example 1: by social class?
•
Example 2: Sports a p p a re l i n d u str y =
depends on sports fans
•
A n o t h e r ca s e : I n l a b o r m a r ke t s , f i r m s a re b u ye rs ( t h i n k
a b o u t t h e i r m a r ke t p o w e r i n s o m e c a s e s / i n d u s t r i e s )
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Porter’s Five Forces:
Example (Airlines)
1.
Competition Rivalry
Oligopoly
2.
Threat of New Entrants
Easier to enter when LCC’s became popular
3.
Power of Suppliers
Aircraft manufacturers = duopoly, government / airport rules
4.
Power of Buyers
Business vs. Leisure Travelers
Branding, Marketing
5.
Threat of Substitutes
Road trips? Boats? Video conference instead of
travels.
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