Topic 4:

Market Structures
Perfect Competition

The Four Market Structures

Economists have identified four
market structures in which firms
operate:
perfect competition
monopoly
monopolistic competition
oligopoly

The characteristics of Perfect

Competition
A large number of buyers and sellers
Price takers (price and quantity are
determined by demand and supply)
Selling homogeneous (standardized)
product
Free market entry and exit
No advertising

Near perfect
competition
Examples

Gold

Eggs
Nasi Lemak

An Individual Price Takers

Demand Curve
Perfectly competitive firms are
price takers, selling at the
market-determined price.
In other words, the demand is
perfectly elastic
(horizontal) at the market
price.

A Change In Market Price And

The Firms Demand Curve

Sellers are provided with

current information
about market demand
and supply conditions as
a result of price
changes.

DD= Price = MR = AR

Profit maximizing Output

Decision

Maximize Revenue :
Minimize
cost

MR = MC

Based on the table above, which output level

should be produced at in order to maximize
the profits?

Short-Run
There are 3 possibilities:
earning profits

generating losses
breaking even

Perfect Competition
Diagrammatic representation
Cost/Revenue

MC
AC

Given
The
average
the
MC
assumption
is the
cost
cost
curve
of
ofisis
The
industry
price
AtThe
this
output
the
profit
the
producing
standard
determined
maximisation,
additional
U by
shaped
the
the firm
firm
produces
curve.
(marginal)
demand
MC
atcuts
an
and
units
output
the
supply
of
AC
output.
where
curve
of
is
making
normal
MC
atItits
=
the
falls
MR
lowest
industry
at
(Q1).
first
point
This
(due
asbecause
output
a to
whole.
the
level
of
law
the
is
of
mathematical
a
fraction
diminishing
of
the
returns)
total
The
firm
is
a
very
small
profit. This is a long
industry
relationship
then
supplier
rises
supply.
between
as
within
output
therises.
run
equilibrium
marginal
industry
andand
average
has no
position.
values.
control over price. They
will sell each extra unit
for the same price. Price
therefore = MR and AR

P = MR = AR

Q1

Output/Sales

Perfect Competition

Diagrammatic representation
Cost/Revenue

MC
MC1
AC
AC1

AC1

Because the model assumes

perfect
knowledge,
the firm
Average
Now
The
lower
assume
and
ACMarginal
aand
firm
MC
makes
gains
the
advantage
costs
some could
would
form
implyof
be
that
modification
expected
the for
firmonly
a
timebut
before
others
to
is short
now
be
its product
lower
earning
orabnormal
price,
gains
in
copy
the
idea
or
are
the
some
profit
short
(AR>AC)
form
run,
of cost
remains the
attracted
the
same.
advantageto(say
represented
by the
aindustry
new
grey by
the
existence
of
abnormal
production method). What
area.
profit.
new firms enter the
would If
happen?
industry, supply will
increase, price will fall and
the firm will be left making
normal profit once again.

P = MR = AR

Abnormal profit

P1 = MR1 = AR1

Q1

Q2

Output/Sales

Evaluating Economic Losses In

The Short Run

A firm generating an
economic loss faces a tough
choice.
Should it:
Continue to produce or
Shut-down its operation?

Cont
To make this decision, we
need to consider average
variable costs (AVC).

Shutdown decision
rule
P < min AVC
Shutdown
P min AVC
Continue
operating

Long-Run
Equilibrium
Since there is no barriers to enter
and exit the market (free market
entry and exit),
PROFIT
Entry of new players

loss
LOSS

Exit players

SS

SS

Price

Price TR

TR

Economic Profits And Losses

Disappear In The Long Run

In longrun equilibrium,
perfectly competitive firms
make zero economic
profits, earning a normal
return on the use of their
capital.

Reference
Chapter 8
Tucker