Lecture 6 6

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Chapter 6

MARKET STRUCTURE

Chapter 6

MARKET STRUCTURE Upon completion this chapter, you should be able to :B Identify 4 types of market structureB Identify characteristics of each marketB Compare the supply and demand curve of each market

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Market structure depends on 2 main factors:B Quantity ProductB Price of the Product in the Market

How markets are organized :1. Types of product produced2. How many firms in the industry3. The freedom of entering and leaving the market4. The market price of the product5. The knowledge of sellers and buyers towards the product

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4 Types of Market 4 Types of Market Competitive / Perfect competition Market

B Many buyers and sellers in the market

Monopoly MarketB Only one sellers in the market

Monopolistic Competition MarketB Many sellers and buyers in the market but the competition is as high as in

the competitive market.

Oligopoly MarketB Only few sellers in the market

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Market Structure Market StructureNumber of firms ?

Identicalproducts

One firms Few firms Many firms

MONOPOLY water

electricity phone (house)

OLIGOPOLY oil / petrol

flighttyres

MONOPOLISTICCOMPETITION

movies

novelsmagazines

COMPETITIVEMARKET

instant noodle

pen canned drink

Differentiatedproducts

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COMPETITIVE / PERFECT

COMPETITION MARKET

COMPETITIVE / PERFECT

COMPETITION MARKET Characteristic of Perfect Competition

B Many buyers and sellers in the marketB Firms are PRICE TAKERS

Firms cannot influence the price of the goods andservices

B The product is homogeneous ( identical )B Both buyers and sellers have perfect knowledgeB

Freedom to enter or leave the industryB Perfectly elastic demand curve at the price set by themarket

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Revenue Concepts

in Perfect Competition Market

Revenue Concepts

in Perfect Competition Market Total Revenue (TR) = P x Q

B The value of the firms sale

Average Revenue (AR) = TR / Quantity soldB Revenue per unit sold

Marginal revenue (MR) = Change in TR Change inquantity

B The change in TR resulting from one unit change in the quantity sold.B In perfect competition, the price is constant. So the change in TR is

equal to price. ( MR = PRICE )

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Demand Curve, AR curve

and TC curveAR is always equal to Price

MR is equal to price only for firms in perfectly competitive market.

Price

Quantity sold

P = AR = MR3.00

Output PriceRM

TR RM

AR MR

1 3 3 3 3

2 3 6 3 3

3 3 9 3 3

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Profit Maximizing Output

Because the firm cannot affect the price of its product, to maximize profit it adjust the level of production.

Profit maximizing level of output can bedetermined using two approaches :

B TR and TC approachB Marginal Analysis

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Profit Max : The Smith Dairy FarmPrice(P)

Quantit(Q)

Tota l Reven(TR= PxQ)

Total Cost(TC)

Profit(TR-TC)

Marginal Rev e(MR=

Marginal CoMC=

0 $0 .00 $3 .00 -$3 .00

$6.00 1 $6 .00 $5 .00 $1 .00 $6 .00 $2 .00$6.00 2 $12 .00 $8 .00 $4 .00 $6 .00 $3 .00$6.00 3 $18 .00 $12.00 $6 .00 $6 .00 $4 .00$6.00 4 $24 .00 $17.00 $7 .00 $6 .00 $5 .00$6.00 5 $30 .00 $23.00 $7 .00 $6 .00 $6 .00$6.00 6 $36 .00 $30.00 $6 .00 $6 .00 $7 .00$6.00 7 $42 .00 $38.00 $4 .00 $6 .00 $8 .00$6.00 8 $48 .00 $47.00 $1 .00 $6 .00 $9 .00

QT R / QTC /

Profit is maximized if the farm produces 4 or 5 gallons of milk The profit-maximizing quantity can also be found by comparing marginal

revenue and marginal cost.As long as marginal revenue exceeds marginal cost, increasing output will raise

profit.If marginal revenue is less than marginal cost, the firm can increase profit by

decreasing output.Profit-maximization occurs where marginal revenue is equal to marginal cost.

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The Marginal-Cost Curve and the

Firms Supply Decision Cost curves have special features that are important

for our analysis.a.The marginal cost curve is upward-sloping.

b.The average total cost curve is u-shaped.c.The marginal cost curve crosses the average total costcurve at the minimum of average total cost.

Marginal and average revenue can be shown by ahorizontal line at the market price.

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P = AR =MR

P=MR 1

MC

Profit Maximization for the Competitive Firm...

Quantit0

Costsand

Revenue

The firmmaximizes profitby producing thequantity at whichmarginal costequals mar ginalrevenue.

MC

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Occurs at quantity where :MC = MR

How ?B When MR > MC -----

increasing profit

B When MR < MC -----decreasing profit

B When MR = MC ----- profitis maximized

Q1 Q2

MC2

MC1

Quantity

(Q)

Profit

(TR-TC)

Marginal Revenue

(MR= )

Marginal Cost

MC=0 -$3.001 $1.00 $6.00 $2.002 $4.00 $6.00 $3.003 $6.00 $6.00 $4.004 $7.00 $6.00 $5.005 $7.00 $6.00 $6.006 $6.00 $6.00 $7.007 $4.00 $6.00 $8.008 $1.00 $6.00 $9.00

QTR / QTC /

P=AR=MR

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Short Run Equilibrium in

Perfect Competition

Short Run Equilibrium in

Perfect Competition 3 alternative situations :B

Situation A Economic ProfitB Situation B Break EvenB Situation C Economic Loss

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Measuring Profit in the Graph for theCompetitive Firm...

Why the firm gains an economic profits?Why the firm gains an economic profits?

1. Producing an output where MC=MR 1. Producing an output where MC=MR

2. P/MR/AR> ATC2. P/MR/AR> ATC

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Profit

Measuring Profit in the Graph for theCompetitive Firm... a. A Firm with Profits

(Economic Profits)Price

P

ATC

0

P = AR = MR

MC

QuantityQ

ATC

Profit-maximizing quantity

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Why the firm gains a break-event?Why the firm gains a break-event?

1. Producing an output where MC=MR 1. Producing an output where MC=MR 2. P/MR/AR= ATC, that means the firm2. P/MR/AR= ATC, that means the firm

still can cover its fixed cost.still can cover its fixed cost.3. Earns normal profit3. Earns normal profit

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P = AR = MR

Quantity

P=ATC

Price

0

MC

ATC

QBreak-even quantity

b. A Firm with break-even(Normal profit)

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Measuring Loss in the Graph for theCompetitive Firm...

Why the firm experience losses?Why the firm experience losses?

1. Producing an output where MC=MR 1. Producing an output where MC=MR 2. But P/MR/AR< ATC, that means2. But P/MR/AR< ATC, that means

the firm still can cover its fixed cost.the firm still can cover its fixed cost.3. Earns normal profit3. Earns normal profit

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Loss

Measuring Loss in the Graph for theCompetitive Firm... c. A Firm with Losses

Q

Price

ATC

P = AR = MR

MC ATC

P

Quantity0

Loss-minimizing quantity

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There are 2 types of losses?There are 2 types of losses?1.1. P > AVCP > AVC

can cover its AVC such as raw materials, wagescan cover its AVC such as raw materials, wagesand part of its fixed costsand part of its fixed costs

firm may continue to operate in short runfirm may continue to operate in short run

2. P < AVC2. P < AVC cant cover its AVC and ATCcant cover its AVC and ATC

the firm profit maximizing action is to shut downthe firm profit maximizing action is to shut downtemporarily at P=AVCtemporarily at P=AVC

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Loss


P = AR = MR

Quantity

Price/ Cost

P

Q

MC ATC

AVC ATC

AVC

0

c. A Firm with Losses

(P>AVC)


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Loss

Price/Cost

ATC

P P = AR = MR

Quantity0


MC ATC

Q

AVC

AVC

c. A Firm with Losses

(P

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The Marginal-Cost Curve and theFirms Supply Decision...

Quantity0

Costsand

RevenueMC

ATC

AVC

Q 1

P 1

P 2

Q 2

This section of thefirms MC curve isalso the firms supply curve .

Because of firms MC curve determinedhow much the firms is willing to supplyat any price

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The Firms Short-Run Decision to

Shut Down @ Exit x A shutdown refers to a short-run decision not to

produce anything during a specific period of

time because of current market conditions.

x Exit refers to a long-run decision to leave themarket.

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The Firms Short-Run Decision toShut Down

The firm considers its sunk costs when deciding to exit, but ignores them when deciding whether to shut down.B Sunk costs are costs that have already been committed

and cannot be recovered.

The firm shuts down if the revenue it gets from producing is less than the variable cost of production .Shut down if TR < VC

Shut down if TR/Q < VC/Q

Shut down if P < AVC

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The Firms Short-Run Decision to Shut Down...

Quantity

ATC

AVC

0

P/Costs

MC

If P < AVC, shut down.

If P > AVC,keep producingin the short run.

If P > ATC,keep producingat a profit.

Firms short-runsupply curve.

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The Firms Long-Run Decision to Exit

or Enter a Market x In the long-run, the firm

exits if the revenue itwould get from

producing is less thanits total cost.

Exit if TR < TC

Exit if TR/Q < TC/Q Exit if P < ATC

x A firm will enter theindustry if such an actionwould be profitable.

Enter if TR > TC

Enter if TR/Q > TC/Q Enter if P > ATC

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The Competitive Firms Long-Run Supply Curve...

Quantity

MC = Long-runS

ATC

AVC

0

Costs

Firm entersif P > ATC

Firmexitsif P

Lecture 6 6

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