How Does Industry Market
Structure Affect Price and
Output Decisions?
The example of an egg farm was used to illustrate costs and
revenues and how their behavior determines profits of the
firm. Other firms operate in industries that have different
market characteristics from those of the egg farm industry.
There are four types of industry market structures and,
although firms in each of the four types attempt to maximize
their profits, the results are different in the four types of
industries.
Pure competition Agriculture represents an industry that is
as close to pure competition as one can find. Purely competitive industries are those in which there are a large number
of producers supplying a standardized product. Firms in
such industries don't have any choice about what price they
charge. It is relatively easy for new producers to get into the
purely competitive industries or for existing producers to
drop out. If a wheat farmer tries to charge more for wheat than
the going price in the wheat market, he won't find any
buyers. Nor would it pay wheat farmers to set their price
below the market price because they can sell all of their
wheat at that price. Wheat farmers, therefore, because they
sell a standardized product in competition with many other
suppliers, have no control over price. The only choice they
have is how much wheat to sell at the going price. If wheat
pure competition a condition prevailing in
an industry in which there are such a large
number of firms producing a standardized
product that no single firm can noticeably
affect the market price by changing its
output; also an industry in which firms can
easily enter or leave.
If the market price of wheat is $5 a bushel, the farmer's total revenue rises by $5 for each additional bushel produced and sold.
In pure competition, the total revenue of the individual firm increases at a constant rate with increasing output.
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This combine can harvest enough
wheat in 9 seconds to provide flour to
make 70 loaves of bread. Wheat
farming is a purely competitive business, and wheat farmers cannot raise
prices to increase revenues.
is selling for $5 a bushel, their total revenue will be $5 multiplied by the number of bushels they sell, as shown by the
total revenue curve in Figure 3 on page 119.
The yearly quantity of wheat produced on the farm is
shown along the bottom axis. The revenue from sale of the
wheat is shown on the vertical axis. The total revenue is the
price per bushel times the number of bushels sold (TR = P
x Q). This is shown by the TR curve on the diagram. The
farmer's revenue, beginning at zero with zero output, would
rise at a constant rate with each additional bushel of wheat
produced and sold. At an output of 31,600 bushels the total
revenue is $158,000 ($5 x 31,600 bushels).
The wheat farmer's costs are shown in Figure 4. The fixed
costs are $62,000, whatever the level of output. This fixed
cost includes not only depreciation on the buildings and
equipment and interest on the borrowed capital, but also an
allowance for the normal rate of return on the farmer's own
capital invested in the farm and his management input. The
variable costs are added to the fixed costs, depending on how
much wheat is produced. They include seed, fertilizer, irrigation water, and hired labor costs. The total costs are the
sum of the fixed and variable costs. Total costs are $140,000
at an output of 31,600 bushels of wheat.
Notice that costs go up at an increasing rate, especially after
about 25,000 bushels, as shown by the TC curve rising more
and more steeply. Wheat farmers can increase wheat
production by using more seed, fertilizer, and irrigation and
by cultivating land more intensively. But if the amount of
land on which they are growing wheat is fixed, costs per
The total costs for each level of output are the fixed costs plus the variable costs. Variable costs go up at an increasing
rate because of diminishing returns.
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