FOUR TYPES OF MARKETS
• Perfect Competition --A market with a very large
number of firms, each of which
produces the same
standardized product and takes
the market price as given.
A price-taking firm.
FOUR TYPES OF MARKETS
• Monopolistic Competition --There are many firms, each sells a
differentiated product. Because
products sold by different firms are
not perfect substitutes, each firm
has some control over price. There
are no barriers to entering the
market.
FOUR TYPES OF MARKETS
• Oligopoly --- There are just a
few firms in the market, a result
of two sorts of barriers to entry:
• economies of scale,
• government may limit number
of firms in the market
FOUR TYPES OF MARKETS
• Monopoly --A single firm serves the entire
market. A monopoly occurs
when the barriers to entry are
very strong, which could result
from very large economies of
scale or a government limit on
the number of firms.
FOUR TYPES OF MARKETS
• Monopoly --EXAMPLES
large scale economies:
• local phone service,
• electric power generation,
established by government policy:
• drugs covered by patents,
• concessions in National Parks
Characteristics of Different Types of Markets
Number
Perfect
Monopolistic
Competition
Competition
very large
many
of firms
Type of
standardized differentiated
product
Control
none
slight
over price
Entry
no barriers
conditions
Examples wheat
soybeans
no barriers
restaurants
retail stores
clothing
Oligopoly
Monopoly
few
one
std or diff.
unique
considerable considerable
if not
regulated
large
large
barriers
barriers
automobiles local phone
air travel
and electric
breakfast
patented
cereal
drugs
TOTAL REVENUE
• The money the firm gets from selling its product and is equal
to price times quantity sold:Total Revenue = price * quantity
ECONOMIC PROFIT
Economic Profit = Total revenue - total economic cost
Total economic cost
= explicit costs
( firm’s actual cash payments for inputs )
+ implicit costs
( opportunity costs of non-purchased inputs, such as
entrepreneur’s time or money )
ECONOMIC PROFIT
Total revenue - total economic cost
Total economic cost
= explicit costs
( firm’s actual cash payments for inputs )
+ implicit costs
( opportunity costs of non-purchased inputs,
entrepreneur’s time or money )
such as
THE MARGINAL PRINCIPLE
Increase the level of an activity if its
marginal benefit exceeds its marginal
cost, but reduce the level if the
marginal cost exceeds the marginal
benefit. If possible, pick the level at
which the marginal benefit equals the
marginal cost.
Marginal Benefit of Firm’s Activity
Extra revenue earned by selling one more unit of
output.
Marginal Revenue
The change in total revenue that results from selling
one more unit of output.
For a perfectly-competitive firm, marginal revenue
equals market price.
EXAMPLE
Farmer sells 100 bushels of corn @ $200;
Farmer sells 101 bushels of corn @ $202;
Marginal revenue of 101st bushel is $2 (i.e., the same as price).
Applying Marginal Principle to Output Decision
The marginal principle suggests that the firm should pick the
quantity of output at which marginal revenue equals marginal
cost:
Marginal revenue = Marginal cost
Continue to increase output as long as extra revenue from one
unit of output exceeds extra cost.
Applying Marginal Principle to Perfect Competition
For a perfectly-competitive (price-taking) firm, marginal revenue
equals the market price, so the firm should pick quantity of
output at which price equals marginal cost:
Price = Marginal Cost
Picking the Profit-Maximizing
Output Level
Output
14
17
20
25
27
Marginal Revenue = Price
$36
$36
$36
$36
$36
Marginal Cost
$12
$18
$24
$36
$43
Profit Maximizing Output
COST / PRICE
Short-Run Marginal Cost
(SMC)
f
$45
$40
Short-Run Average
Total Cost (SATC)
e
PRICE = MR = $36
$35
$30
$25
$20
$15
$10
$5
5
10
15
20
25
30
35
40
OUTPUT
Profit Maximizing Output
COST / PRICE
Short-Run Marginal Cost
(SMC)
f
$45
$40
Short-Run Average
Total Cost (SATC)
e
PRICE = MR = $36
$35
$30
Profit = $250 per hour
$25
c
b
$20
$15
$10
$5
5
10
15
20
25
30
35
40
OUTPUT
ECONOMIC PROFIT AND
ACCOUNTING PROFIT
Total Profit = [Price - Average cost]
*
Quantity
If average cost of producing 25 chairs is $26:
firm’s average profit = $36 - $26 = $10
firm’s total profit = $10 • 25 chairs = $250
firm’s total profit = [$36 - $26] • 25 = $250
Profit Maximizing Output
COST / PRICE
Short-Run Marginal Cost
(SMC)
f
$45
$40
Short-Run Average
Total Cost (SATC)
e
$35
$30
$25
PRICE = MR = $24
b
$20
$15
$10
$5
5
10
15
20
25
30
35
40
OUTPUT
ECONOMIC PROFIT AND
ACCOUNTING PROFIT
Total Profit = (Price - Average Cost)
*
Quantity
If the Price is $24, the firm satisfies marginal
principle (price = marginal cost) at point b, with
20 chairs.
At this quantity, the price also equals average
cost, so economic profit is zero.
When a firm earns zero economic profit, it earns
a normal level of accounting profit.
ECONOMIC PROFIT AND ACCOUNTING PROFIT
Accounting Profit is equal to total revenue minus explicit costs;
Normal Accounting Profit is the accounting profit when economic
profit is zero;
(A firm’s implicit costs are covered).
If firm producing 20 chairs has an explicit cost of $400 and implicit
cost of $80, and
Total Revenue = $24 * 20 = $480;
while economic profit = 0,
Total Revenue - ( explicit costs + implicit costs ) = 0
accounting profit = $80,
Total Revenue - explicit costs = $480 - $400 = $80
The Shut-Down Decision
COST / PRICE
Short-Run Marginal Cost
(SMC)
$45
Short-Run Average
Total Cost (SATC)
$40
$35
$30
$25
$20
PRICE = MR = $18
z
$15
$10
$5
17
5
10
15
20
25
30
35
40
OUTPUT
The Shut-Down Decision
If market price of chairs drops to
$18, the firm will produce 17
chairs per hour (point z).
The Shut-Down Decision
COST / PRICE
Short-Run Marginal Cost
(SMC)
$45
Short-Run Average
Total Cost (SATC)
$40
$35
$30
t
$25
$20
PRICE = MR = $18
z
$15
$10
$5
17
5
10
15
20
25
30
35
40
OUTPUT
The Shut-Down Decision
At an output of 17 chairs per hour, the
average total cost becomes $26
(point t).
Since the average cost exceeds the
market price by $8, the firm will lose
$136 per hour.
$8 * 17 = $136
The Shut-Down Decision
COST / PRICE
Short-Run Marginal Cost
(SMC)
$45
Short-Run Average
Total Cost (SATC)
$40
$35
$30
t
$25
$20
Loss = $136 / Hr
PRICE = MR = $18
z
$15
$10
$5
17
5
10
15
20
25
30
35
40
OUTPUT
The Shut-Down Decision
The firm should continue to operate an
unprofitable facility if the benefit of
operating the facility exceeds the
cost.
The Shut-Down Decision
COST / PRICE
Short-Run Marginal Cost
(SMC)
$45
Short-Run Average
Total Cost (SATC)
$40
$35
Short-Run Average
Variable Cost (SAVC)
$30
t
$25
$20
Loss = $136 / Hr
PRICE = MR = $18
z
$15
$10
$5
17
5
10
15
20
25
30
35
40
OUTPUT
The Shut-Down Decision
The benefit equals the total revenue
generated by the facility.
The firm’s operating cost is the cost
incurred by operating -- as opposed
to shutting down:
The firm’s variable cost
(cost of labor and material)
The Shut-Down Decision
COST / PRICE
Short-Run Marginal Cost
(SMC)
$45
Short-Run Average
Total Cost (SATC)
$40
$35
Short-Run Average
Variable Cost (SAVC)
$30
t
$25
$20
$15
Loss = $136 / Hr
PRICE = MR = $18
z
14
u
$10
$5
17
5
10
15
20
25
30
35
40
The Shut-Down Decision
The benefit = Total Revenue:
Total Revenue = Price
quantity sold
*
Total Revenue = $18 17 = $306
*
The firm’s operating cost = variable cost:
Total variable cost = average variable cost
*
quantity sold
Total variable cost = $14
*
17 = $238
Since the benefit ($306) is greater than the
operating cost ($238), continue to operate
The Shut-Down Decision
COST / PRICE
Short-Run Marginal Cost
(SMC)
$45
Short-Run Average
Total Cost (SATC)
$40
$35
Short-Run Average
Variable Cost (SAVC)
$30
t
$25
$20
$15
$10
Loss = $136 / Hr
PRICE = MR = $18
z
14
12
s
u
$5
17
5
10
15
20
25
30
35
40
OUTPUT
The Shut-Down Decision
OPERATE:
Price > Average variable Cost
SHUTDOWN:
Price < Average Variable Cost
Why Operate an Unprofitable Facility ?
If Firm Shuts down:
• Although no longer paying for labor, it still pays for idle
production facility -- sunk cost.
• Because firm won’t sell any output, it will lose an amount of
money equal to fixed cost.
Why Operate an Unprofitable Facility ?
With 17 chairs:
Firm’s total cost = $442;
variable cost = $238, fixed cost = $204
If firm shuts down, firm loses $204;
If firm operates, it loses $136:
($8 * 17 chairs)
$68 left to cover fixed costs
The Shut-Down Price
The price at which the firm is indifferent between operating and shutting down:
point ‘s’ of the following diagram.
If the total revenue is less than variable cost, the benefit of operating the facility
is less than the cost; irrational to continue operating..
The Shut-Down Decision
COST / PRICE
Short-Run Marginal Cost
(SMC)
$45
Short-Run Average
Total Cost (SATC)
$40
$35
Short-Run Average
Variable Cost (SAVC)
$30
$25
$20
$15
$10
s
$5
Shut-Down Price
5
10
15
20
25
30
35
40
OUTPUT
Short-run Supply Curve of
The Firm
The part of the firm’s marginal
cost curve above the shut-down
price.
The Shut-Down Decision
COST / PRICE
Short-Run Marginal Cost
(SMC)
$45
Short-Run Average
Total Cost (SATC)
$40
$35
Short-Run Average
Variable Cost (SAVC)
$30
$25
$20
Firm’s Short-run Supply Curve
$15
$10
s
$5
Shut-Down Price
5
10
15
20
25
30
35
40
OUTPUT
The Market Supply Curve
The short-run market supply curve shows
relationship between market price and
quantity supplied by entire industry.
To compute market supply at particular
price, use individual supply curves to
determine how much output each firm
produces, then add quantities to get total
supply for industry.
Market Effects of Change in Demand
COST / REVENUE
(SMC) COST / REVENUE
Short-run
$45
market
(SATC)
supply
$40
$45
$40
$35
$35
$30
$30
$25
$20
$24
$24
$25
e
b
$20
$15
$15
$10
$10
$5
$5
20
CHAIRS PRODUCED / HOUR
Demand
1,000
CHAIRS PRODUCED / HOUR
Market Effects of Change In
Demand
• If market demand shifts to the right
and intersects the market supply at
$36 instead of $24, each firm
produces more output.
• The market price now exceeds the
average cost and an economic profit
now occurs.
Market Effects of Change in Demand
COST / REVENUE
$45
$40
$35
$30
$25
$20
$36
ECONOMIC
PROFIT
(SMC)
COST / REVENUE
$45
(SATC)
$40
$36
$35
$24
Short-run
market
supply
f
$30
$24
$25
b
e
New
Demand
$20
$15
$15
$10
$10
$5
$5
20
25
CHAIRS PRODUCED / HOUR
Original
Demand
1,000 1,250
CHAIRS PRODUCED / HOUR