Market Structure and
Equilibrium
We will consider the two extreme cases
Perfect Competition
Monopoly
Market Efficiency
• Decision makers in a market behave
rationally and have full access to all
relevant behavior.
• Consumer and producer surplus is
maximized
Determinants of Market Structure
• Number and size of buyers, sellers, and
potential entrants,
• Degree of product differentiation
• Amount and cost information about product
price and quality, and
• Conditions for entry into and exit from a
market
Market Equilibrium
Perfect Competition
• Supply forces (producers) P
and demand forces
(consumers) seek a
balance
• Price below perceived
Pe
value increases demand
• Price above ATC
provides pure profit, an
incentive to increase
supply
Demand
curve
Supply
curve
Q
Individual Firm’s Demand
and MR Curve
P
Highly elastic demand
One firm’s change in Q has little effect on price
Pe
∆P
∆Q
Q
Market Equilibrium
Perfect Competition
Individual Firm
Price (P)
ATC
MC
P1
P2
Q2 Q1
• Price above ATC
provides pure profit,
an incentive to
increase output
• Pure profit equals
(P1 x Q1) – (P2 x Q2)
Market Equilibrium
Perfect Competition
Individual Firm
Price (P)
ATC
P1
P2
Q2 Q1
MC
• All firms are price takers
• Market price (P1) equals
marginal revenue (MR) and
average revenue (AR)
• Optimal level of output is
where MR = MC = P1
• In long-run P will go to P2
where pure profit is
eliminated
Market Supply Curve
Summation of supply curves for individual firms
Q
Demand
Market supply curve
=
Qm
Sum vertically
Qj
Qt
Qp
Qj
Janet’s sawmill
+
+
Tracy’s sawmill
Pete’s sawmill
+
Joe’s sawmill
Pm (same P for all firms and market)
P
Perfect Competition - Example
• Given supply and demand functions,
Qs = 30 + 55 P
Qd = 230 – 45 P
• Determine marginal revenue, MR, i.e. Pe, from supply and
demand curves for total market. Calculate Pe from market
supply equals demand equilibrium condition,
Qs = Qd
30 + 55 P = 230 – 45 P
100 P = 200
P = 2 = MR
• Use P to get equilibrium quantity, Qe
Qe = 230 – 45 x 2 = 230 –90 = 140
Apply Market Price to Individual
Firm – “Pete’s Sawmill”
P = $2 from market equilibrium
Determine quantity Pete should produce
from Pete’s marginal cost (MC) curve,
which is,
Qs = 5 + 5.8 P
= 5 + 5.8 x 2
= 16.6
Market Equilibrium
Monopoly
• Only one producer
– Producer is a price “setter”, not a price
taker
• Demand curve restricts ability to set price
– Demand curve determines marginal
revenue (MR)
• Only way to change quantity sold is to
change market price
• Marginal revenue (MR) is not constant
• What forces lead to a monopoly
Market Equilibrium
Monopoly
P
Monopolists
MC curve
Pe
Up & over to
get P
MC = MR to max. profit
Down
to
get
Q
e stands for
equilibrium
Monopolists
MR curve
Market
demand curve
Q
Qe determine fist, then get P from demand curve
Marginal Revenue Curve
• TR = P x Q
• Demand curve – P = a – bQ
• TR = (a – bQ ) x Q
= aQ – bQ2
• MR = dTR/dQ = a – 2b Q
• Same intercept and 2x slope of demand
curve
Market Equilibrium
Monopoly compared to competitive equilibrium
P
Monopolists
MC curve
Pm
Pc
m – monopoly equilibrium
c – competitive equilibrium
Monopolists
MR curve
Qm Qc
Market
demand curve
Q
Market Equilibrium
Monopoly
Compared to competitive
market equilibrium –
Monopolist produces (sells)
smaller quantity at higher price
Monopoly – Example
Given, same supply and demand curves as in
competitive example,
Qd = 230 – 45 P (given), or
P = 5.11 – 1/45 Q
Qs = 30 + 55 P (given), or
P = 0.545 + 1/55 Q
Determine marginal revenue curve:
Revenue = P x Q
= Q (5.11 – 0.022 Q)
= 5.11 Q – 0.022 Q2
MR = 5.11 – 0.044 Q
Monopoly – Example, cont.
Equate MC and MR to determine Q:
5.11 – 0.044 Q = 0.545 + 0.018 Q
4.57 = 0.062 Q
Q = 74
Substitute Q into demand curve to get P,
P = 5.11 – 0.022 x 74 = 3.48
Compare the solutions for the two types of markets,
Competition: P = 2.00, Q = 130
Monopoly: P = 3.48, Q = 74
Monopsony
• One buyer and many sellers
• Common in forest products markets
– Bulky and heavy commodity
– High transportation cost
– Limits haul distance
• How can sellers gain market power?