MARKET STRUCTURE

PERFECT COMPETITION

Perfect competition is an industry

structure in which there are many
firms, each small relative to the
industry, producing virtually identical
(or homogeneous) products and in
which no firm is large enough to have
any control over price, Perfect
knowledge.
 PERFECT COMPETITION

many firms, each small relative to the

industry,
producing virtually identical products
and
in which no firm is large enough to have
any control over prices.
In perfectly competitive industries, new
competitors can freely enter and exit
the market.
 HOMOGENEOUS PRODUCTS

Homogeneous products are

undifferentiated products; products
that are identical to, or
indistinguishable from, one another.
COMPETITIVE FIRMS ARE PRICE TAKERS

In a perfectly competitive market,

individual firms are price-takers.
This means that firms have no
control over price. Price is
determined by the interaction of
market supply and demand.
OUTPUT DECISIONS: REVENUES, COSTS,
AND PROFIT MAXIMIZATION
In the short run, a competitive firm faces a
demand curve that is simply a horizontal line
at the market equilibrium price.
 THE CONCEPT OF PROFIT

Profit is the dif ference between total revenue and total

cost.
The economic concept of profit takes into account the
opportunity cost of capital.
Total economic cost includes a normal rate of return. A
normal rate of return is the rate that is just sufficient to keep
current investors interested in the industry.
Breaking even is a situation in which a firm is earning
exactly a normal rate of return.
FIRM EARNING POSITIVE PROFITS IN THE
SHORT RUN

To maximize profit, the firm sets the level of

output where marginal revenue equals marginal
cost.
 MINIMIZING LOSSES

Operating profit (or loss) or net operating revenue

equals total revenue minus total variable cost (TR
T VC).
If revenues exceed variable costs, operating profit is
positive and can be used to offset fixed costs and reduce
losses, and it will pay the firm to keep operating.
 MINIMIZING LOSSES

Operating profit (or loss) or net

operating revenue equals total revenue
minus total variable cost (TR TVC).
If revenues are smaller than variable costs, the firm suffers
operating losses that push total losses above fixed costs.
In this case, the firm can minimize its losses by shutting
down.
 MINIMIZING LOSSES

When price equals $3.50, revenue is sufficient to

cover total variable cost but not total cost.
 MINIMIZING LOSSES

As long as price (which is equal to average revenue per

unit) is sufficient to cover average variable costs, the
firm stands to gain by operating instead of shutting
down.
 MINIMIZING LOSSES

The difference between ATC and AVC equals

AFC. Then, AFC q = TFC (the brown area).
 IMPERFECT COMPETITION
AND MARKET POWER

An imperfectly competitive industry

is an industry in which single firms
have some control over the price of
their output.
Market power is the imperfectly
competitive firms ability to raise
price without losing all demand for
its product .
 PURE MONOPOLY

A pure monopoly is an industry

with a single firm that produces
a product for which there are no
close substitutes and in which
significant barriers to entry
prevent other firms from
entering the industry to
compete for profits.
 BARRIERS TO ENTRY

Things that prevent new firms from

entering and competing in
imperfectly competitive industries
include:
1. Government franchises, or
firms that become monopolies
by virtue of a government
directive.
 BARRIERS TO ENTRY

Things that prevent new firms from

entering and competing in
imperfectly competitive industries
include:
2. Patents or barriers that grant
the exclusive use of the patented
product or process to the inventor.
 BARRIERS TO ENTRY

Things that prevent new firms

from entering and competing in
imperfectly competitive
industries include:
3. Economies of scale and other cost
advantages enjoyed by industries that have
large capital requirements. A large initial
investment, or the need to embark in an
expensive advertising campaign, deter
would-be entrants to the industry.
 BARRIERS TO ENTRY

Things that prevent new firms

from entering and competing in
imperfectly competitive
industries include:
4. Ownership of a scarce factor of
production: If production requires a
particular input, and one firm owns the entire
supply of that input, that firm will control the
industry.
MARGINAL REVENUE CURVE
FACING A MONOPOLIST

For a monopolist, an
increase in output
involves not just
producing more and
selling it, but also
reducing the price of its
output to sell it.
At every level of output
except one unit, a
monopolists marginal
revenue is below price.
MARGINAL REVENUE AND TOTAL
REVENUE

A monopolists marginal
revenue curve shows the
change in total revenue
that results as a firm
moves along the
segment of the demand
curve that lies exactly
above it.
PRICE AND OUTPUT CHOICE FOR A
PROFIT-MAXIMIZING MONOPOLIST

A profit-maximizing
monopolist will raise
output as long as
marginal revenue
exceeds marginal
cost (like any other
firm).
The profit-maximizing
level of output is the
one at which MR =
MC.
THE SOCIAL COSTS OF MONOPOLY

Monopoly leads to
an inefficient mix
of output.
Price is above
marginal cost,
which means that
the firm is
underproducing
from societys point
of view.
THE SOCIAL COSTS OF MONOPOLY

The triangle ABC

measures the net
social gain of
moving from
2,000 units to
4,000 units (or
welfare loss from
monopoly).
RENT-SEEKING BEHAVIOR

Rent-seeking behavior
refers to actions taken
by households or firms
to preserve positive
profits.
A rational owner would
be willing to pay any
amount less than the
entire rectangle P m ACP c
to prevent those
positive profits from
being eliminated as a
result of entry.
 NATURAL MONOPOLY

A natural monopoly is an
industry that realizes such
large economies of scale in
producing its product that
single-firm production of that
good or service is most
efficient.
NATURAL MONOPOLY

With one firm

producing
500,000 units,
average cost is $1
per unit. With five
firms each
producing
100,000 units,
average cost is $5
per unit.