Four Market
Structures
1
FOUR MARKET STRUCTURES
Perfect
Competition
Monopolistic
Competition
Oligopoly
Pure
Monopoly
Every product falls somewhere on this spectrum
Examples:
1. Perfect Competition: Agricultural
Commodities (e.g. corn, wheat)
2. Monopolistic Competition: Mexican
Restaurants
3. Oligopolies: Wireless Service Providers
4. Monopolies: De Beers and diamonds
2
Perfect
Competition
3
FOUR MARKET STRUCTURES
Perfect
Competition
Monopolistic
Competition
Oligopoly
Pure
Monopoly
Imperfect Competition
Characteristics of Perfect Competition:
• 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.
Example of Perfect Competition: Candy bar
salesmen on the streets of Chile
4
5
Perfectly Competitive Firms
Example:
• Say you go out to buy a candy bar on the
streets of Viña del Mar, Chile.
• You quickly find that the price every street
vendor is charging is 500 pesos.
• This is the market price (where demand and
supply meet)
1. Why won’t any vendors sell them for 600?
2. Why won’t any vendors sell them at 400?
3. Do you think that vendors make a large profit off
of candy bars? Why?
These vendors are “price takers” because they
sell their products at a price set by the market.
6
Perfectly Competitive Firms
Why are they “price takers”?
•If a firm charges above the market price, NO
ONE will buy from them! Customers will simply
purchase from other firms.
•If one firm charges less, all firms will quickly
lower their prices to match that firm
•Therefore, at any given moment, perfectly
competitive firms are likely already charging as
little as they possibly can
•Since the price is the same at all quantities
demanded, the demand curve for each firm’s
product is… Perfectly Elastic
7
(A horizontal line)
The perfectly competitive firm is a
price taker
Price is determined by the industry
P
S
$15
P
Demand
$15
D
5000
Industry
Q
Firm
(price taker)
Q
8
Revenue
Revenue is simply the amount of money
that a firm makes by selling its output
Example:
A bakery only makes cookies and sells each
cookie for $3 each. If it sells 100 cookies,
$300
its revenue is _________________
If a firm sells only one good and charges every
customer the same price, revenue is simply:
Price (P) x Quantity (Q)
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?
1st unit
earns
$15 Competition:
In
Perfect
2nd unit earns $15
MR = is
D=
AR = P Demand
Marginal revenue
$15
constant at $15
MR=D=AR=P
Notice:
• Total revenue
increases at a
constant rate
• MR equal Average
Revenue
Q
Firm
(price taker)
11
Maximizing
PROFIT!
12
Profit Maximization
What is the primary goal of every business?
To Maximize Profit!
Profit = Total Revenue – Total Cost
• A profit-maximizing
firm will continue
Profit-maximizing
Rule:to
produce as long as the additional revenue
Produce
quantity
from the
next unit ofthe
output
is greaterof
than
the additional
cost of producing
output
at whichthat unit
Example (Assume
the=
price
MR
MCis $10)
Should the firm 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
Imagine that you worked hard all summer just to save
enough money to buy a front row ticket to a(n) (insert
your favorite musician here) concert. Twenty minutes
before leaving for the concert, you realize the Filiberto’s
chimichanga you ate earlier has given you food
poisoning. You’re in no mood to go anymore and you
really just want to lay in bed (or on the bathroom floor).
Unfortunately, it’s too late to sell the ticket, and you can’t
find anyone to go in your place. Do you still go the
concert? Or do you stay home?
Suppose that the demand for the
product decreases and the market
price falls 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!!!
16
•How much output should be produced?
•How much is Total Revenue? How much is Total Cost?
•Is there profit or loss? How much?
Price/Cost
MC
$9
8
7
6
5
4
3
2
1
ATC
Loss =$7
Total Cost = $42
AVC
MR=D=AR=P
Total
Revenue=$35
1 2 3 4 5 6 7 8 9 10 Q
17
Assume the market demand falls even
further. If the price decreases 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 can minimize its losses by
shutting down
•Why? If the price is below AVC the
firm is losing more money by
producing than they would if they shut
down altogether
18
SHUT DOWN! Produce Zero
Price/Cost
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
19
P<AVC: Firm should shut down
Cost and Revenue
Producing nothing is cheaper than staying
open.
MC
$9
ATC
8
7
Fixed Costs=$10
AVC
6
5
TC=$35
4
MR=D=AR=P
3
2
TR=$20
1
1 2 3 4 5 6 7 8 9 10 Q
20
Review
• What are the characteristics of a
perfectly competitive market?
• What does the demand curve for a
perfectly competitive firm look like?
21
Mr. Darp
22
Review
•
•
•
•
•
•
•
What are the characteristics of a perfectly
competitive market?
What does the demand curve for a perfectly
competitive firm look like?
What is revenue?
What is the primary goal of every business?
What is profit?
What is the profit maximizing rule?
Under what circumstances would a perfectly
competitive firm continue to produce even
though it is losing money?
23
• How much output should be produced?
• How much is total revenue? How much is total cost?
• Is there profit or loss? How much?
Price/Cost
P
$9
8
7
6
5
4
3
2
1
MC
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
24
Practice
25
#1
Should the firm produce? Yes
What output should the firm produce? 10
What is TR at that output? What is TC? TR=$70
How much profit or loss? Profit=$20 TC=$50
$10
Cost and Revenue
MC
8
7
MR=D=AR= P
ATC
5
4
3
2
0
AVC
4
6 7
10
Q
26
$20
Price/Cost
#2
What output should the firm produce? Zero
What is TR where MR=MC? $45
What is TC where MR=MC? $55
How much profit or loss? Loss= $10
MC
ATC
AVC
15
11
10
9
MR=D=AR=P
0
5
7
Q
27
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
28
Where is the profit maximization point? How do you know?
What output should be produced? What is TR? What is TC?
How much is the profit or loss?Where is the Shutdown Point?
Cost and Revenue
$25
MC
20
Profit = $50
15
10
MR=P
ATC
AVC
Total Cost = $150
Total Revenue = $200
0
1 2 3 4 5 6 7 8 9 10
29
Side-by-side graph for a perfectly
competitive industry and firm.
Is the firm making a profit or a loss? How can you tell?
P
S
P
MC
ATC
$15
MR=D
$15
AVC
D
5000
Industry
Q
8
Q
Firm
(price taker)
30
Supply
Revisited
31
Marginal Cost and Supply
Cost and Revenue
As price increases, quantity
increases
$50
45
40
35
30
25
20
15
10
5
0
MC
ATC
MR5
AVC
MR4
MR3
MR2
MR1
1
2
3
4
5
6
7
9
Q
32
Marginal Cost and Supply
Cost and Revenue
When price increases, quantity increases
When price decreases, quantity decreases
$50
45
40
35
30
25
20
15
10
5
0
MC = Supply
ATC
MC above AVC is
the (short run)
AVC
Supply Curve!!!
1
2
3
4
5
6
7
9
Q
33
Marginal Cost and Supply
Cost and Revenue
What if variable costs increase (e.g. a per-unit tax)?
$50
45
40
35
30
25
20
15
10
5
0
MC2=Supply2
MC1=Supply1
AVC
AVC
When MC increases, SUPPLY decreases
1
2
3
4
5
6
7
9
Q
34
Marginal Cost and Supply
Cost and Revenue
What if variable costs decrease (e.g. a subsidy)?
$50
45
40
35
30
25
20
15
10
5
0
MC1=Supply1
MC2=Supply2
AVC
AVC
1
2
3
When MC decreases, SUPPLY
increases
Q
4
5
6
7
9
35
12
Price/Cost
Profit-maximizing quantity _________
Total revenue ______
$120
Total cost___________
$84
Profit/loss_______________
$36 profit
MC
11
10
MR=D=AR= P
ATC
7
6
5
4
AVC
5
8 9
12
Q
36
Perfect
Competition in the
Long-Run
Suppose you are a Chilean candy bar
street vendor. You learn that there is a
lot more profit in selling completos.
What do you do in the long run?
37
The Chilean Completo = A
Recipe for Profit
38
In the Long Run…
•New firms will enter profitable markets
•Existing firms will shut down if they
keep making losses
•Therefore, firms in perfectly
competitive markets tend to earn zero
economic profit in the long run
•This means that:
Accounting Profit =
Opportunity Cost
39
Example
• Suppose Tatiana turns down an
offer for a job that would have paid
her $100,000 per year and starts a
business instead
• If her business earns exactly
$100,000 in accounting
profit that first year,
Tatiana has earned $0 in
economic profit
Side-by-side graph for perfectly competitive
industry and firm in the LONG RUN
Is the firm making a profit or a loss? How can you tell?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000
Industry
Q
8
Q
Firm
(price taker)
41
Firm in Long-Run Equilibrium
Price = MC = Minimum ATC
Firm making a normal profit
P
MC
ATC
$15
MR=D
There is no incentive
to enter or leave the
industry
TC = TR
8
Q
42
Going from ShortRun
to Long-Run
43
1. Is this firm in long run equilibrium?
2. What will happen in the industry to bring
this firm into long run equilibrium?
P
S
P
MC
ATC
$15
MR=D
$15
D
5000 6000Q
Industry
8
Firm
Q
44
Potential Profit!
45
New firms enter the industry
supply increases
Price decreases and quantity increases
P
S
P
MC
S1
ATC
$15
MR=D
$15
$10
D
5000 6000Q
Industry
8
Firm
Q
46
Price falls for the firm because they
are price takers.
Price decreases and quantity decreases
P
S
P
MC
S1
ATC
$15
$15
MR=D
$10
$10
MR1=D1
D
5000 6000Q
Industry
5 8
Firm
Q
47
New Long Run Equilibrium at $10 Price
Zero Economic Profit
P
P
MC
S1
ATC
$10
MR1=D1
$10
D
5000 6000Q
Industry
5
Firm
Q
48
1. Is this the short or the long run? Why?
2. What will firms do in the long run?
3. What happens to P and Q in the industry?
4. What happens to P and Q in the firm?
P
S
$15
P
MC
ATC
MR=D
$15
D
4000 5000
Industry
Q
8
Firm
Q
49
Firms suffering losses leave the
industry; supply decreases
Price increases and quantity decreases
P
S1
S
P
MC
ATC
$20
$15
MR=D
$15
D
4000 5000
Industry
Q
8
Firm
Q
50
Price increase for the firm because
they are price takers.
Price increases and quantity increases
P
S1
S
$20
P
MC
$20
$15
$15
ATC
MR1=D1
MR=D
D
4000 5000
Industry
Q
89
Firm
Q
51
New Long Run Equilibrium at $20
Price
Zero Economic Profit
S1
P
P
$20
MC
$20
ATC
MR1=D1
D
4000
Industry
Q
9
Firm
Q
52
Going from LongRun to Long-Run
53
Currently in Long-Run Equilibrium
If demand increases, what happens in the short
run and the long run?
P
S
P
MC
ATC
MR1=D1
$15
MR=D
$15
D
5000
Industry
Q
8
Firm
Q
54
In The Short Run
Price increases and quantity increases
Firms earn profit
P
S
P
MC
ATC
$20
$20
$15
$15
MR1=D1
MR=D
D1
D
5000
Industry
Q
8 9
Firm
Q
55
In The Long Run
New firms enter the industry
Industry supply increases
Price Returns to $15
P
S S1
P
MC
ATC
$20
$20
$15
$15
MR1=D1
MR=D
D1
D
5000 7000 Q
Industry
8 9
Firm
Q
56
Back to Long-Run Equilibrium
The only thing that changed due to the demand
increase is the quantity sold in the industry
S1
P
P
MC
ATC
$15
MR=D
$15
D1
D
7000 Q
Industry
8
Firm
Q
57
1. Is this firm in long run equilibrium?
2. What will happen in the industry to bring
this firm into long run equilibrium?
P
S
P
MC
ATC
$15
$15
D
5000 6000Q
Industry
8
Firm
Q
58
Potential Profit!
59
New firms enter the industry
supply increases
Price decreases and quantity increases
P
S
P
MC
S1
ATC
$15
$15
$10
D
5000 6000Q
Industry
8
Firm
Q
60
Price falls for the firm because they
are price takers.
Price decreases and quantity decreases
P
S
P
MC
S1
ATC
$15
$15
$10
$10
D
5000 6000Q
Industry
5 8
Firm
Q
61
New Long Run Equilibrium at $10 Price
Zero Economic Profit
P
P
MC
S1
ATC
$10
$10
D
5000 6000Q
Industry
5
Firm
Q
62
1. Is this firm in long run equilibrium?
2. What will happen in the industry to bring
this firm into long run equilibrium?
P
S
$15
P
MC
ATC
$15
D
4000 5000
Industry
Q
8
Firm
Q
63
Firms suffering losses leave the industry
Supply decreases
Price increases and quantity decreases
P
S1
S
P
MC
ATC
$20
$15
$15
D
4000 5000
Industry
Q
8
Firm
Q
64
Price increases for the firm because
they are price takers
Price increases and quantity increases
P
S1
S
$20
P
MC
ATC
$20
$15
$15
D
4000 5000
Industry
Q
89
Firm
Q
65
New Long Run Equilibrium at $20
Price
Zero Economic Profit
S1
P
P
$20
MC
ATC
$20
D
4000
Industry
Q
9
Firm
Q
66
Efficiency
67
Perfect Competition and Efficiency
Efficiency refers to the optimal use
of society’s scarce resources
•Perfect Competition forces producers to use
limited resources to their fullest.
•Inefficient firms have higher costs and are
the first to leave the industry.
•Perfectly competitive industries are
extremely efficient
There are two kinds of efficiency:
1. Productive Efficiency
2. Allocative Efficiency
68
Efficiency Revisited
Which points are productively efficient?
Which are allocatively efficient?
14
A
B
Bikes
12
G
10
8
C
E
6
4
F
2
Productive Efficient
combinations are A
through D
(they are produced at the
lowest cost)
Allocative Efficient
combinations depend
on the wants of
D
society
0
0
2
4
6
8
10
Computers
69
Productive Efficiency
The production of a good in the
least costly way. (Minimum
amount of resources are being
used)
Graphically, it is the lowest point
on the ATC curve
70
Short-Run
MC
Price
ATC
Profit
P
Notice that the product is NOT being
made at the lowest possible cost per unit
(ATC not at lowest point).
Q
Quantity
71
Short-Run
MC
Price
ATC
P
Loss
Notice that the product is NOT being made at the lowest
possible cost per unit (ATC not at lowest point).
Q
Quantity
72
Long-Run Equilibrium
MC
Price
ATC
P
Notice that the product is being made at the
lowest possible cost per unit (Minimum ATC)
Q
Quantity
73
Allocative Efficiency
Producers are allocating
resources to make the products
most wanted by society
Graphically it is where…
MC = Demand (Price)
Why? Price represents the benefit
people get from a product
74
What if the firm makes 15
units?
Price
MC
$5
The marginal benefit to
society is greater than
marginal cost
Not enough produced
Society wants more
$3
15 20
Quantity
Underallocation
of resources
75
What if the firm makes 22
units?
MC
Price
$7
$5
The marginal benefit to
society is less than the
marginal cost
Too much produced
Society wants less
20 22
Quantity
Overallocation of
resources
76
Long-Run Equilibrium
Price
MC
P
Optimal amount
being produced
Q
The marginal benefit to
society (as measured by the
price) equals the marginal
cost.
Quantity
77
Long-Run Equilibrium
MC
Price
ATC
P
P = Minimum ATC = MC
EXTREMELY EFFICIENT!!!!
Q
Quantity
78