4 Market
Structures
Candy Markets Simulation
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: Avocado farmers,
sunglass huts, and hammocks in Mexico
• 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
6
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 and
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
The Competitive Firm is a Price Taker
Price is set by the Industry
P
S
P
$15
Demand
$15
D
5000
Industry
Q
Q
Firm
(price taker)
9
The Competitive Firm is a Price Taker
Price is set by the Industry
What is the additional
revenue for selling an P
additional unit?
1st unit earns $15
2nd 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
Q
Firm
(price taker)
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? Competition:
For
Perfect
1st unit earns $15
= MR
2nd unit earnsDemand
$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
Q
Firm
(price taker)
11
Maximizing
PROFIT!
12
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
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
Profit Maximizing Rule
MR=MC
14
Lets put costs and revenue together
on a graph to calculate profit.
15
•How much output should be produced?
•How much is Total Revenue? How much is Total Cost?
•Is there profit or loss? How much?
P
$9
MC
8
7
6
5
4
3
2
1
MR=D=AR=P
Profit = $18
ATC
AVC
Total Cost=$45
Total Revenue =$63
1 2 3 4 5 6 7 8 9 10 Q
Don’t forget
that averages
show PER
UNIT COSTS
16
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!!!
17
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
2 Total Cost = $42
Total Revenue=$35
1
1 2 3 4 5 6 7 8 9 10 Q
18
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
•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.
19
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
20
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
AVC
TC=$35
MR=D=AR=P
TR=$20
1 2 3 4 5 6 7 8 9 10 Q
21
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)
22
Practice
23
#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
10
AVC
6
5
0
6 7
10
Q
24
#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
25
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
26