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Chapters 11 – 14 Market Structures

Chapters 11 – 14 Market Structures. Perfect Competition Monopolistic Competition Oligopoly Monopoly. Structures:. Based on: The Number of Firms in the Industry Similarity of goods/services produced The ease with which new firm can enter the industry. Market Structure.

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Chapters 11 – 14 Market Structures

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  1. Chapters 11 – 14Market Structures • Perfect Competition • Monopolistic Competition • Oligopoly • Monopoly

  2. Structures: • Based on: • The Number of Firms in the Industry • Similarity of goods/services produced • The ease with which new firm can enter the industry

  3. Market Structure

  4. PERFECT COMPETITION • Assumptions of the model: 1)There exist many sellers and buyers in the market 2) Identical (Homogeneous) product being sold 3) Freedom of entry/exit by firms 4) Perfect information for all involved in the market 5) Each firm has a very small market share

  5. the firms are price takers; that is, each firm cannot • individually affect market price • This leads to the following characteristics of the market: 2) products are perfect substitutes - demand is perfectly elastic 3) Price is uniform across suppliers This leads us to conclude that, in perfect competition, MR = AR = P

  6. PRODUCE OR NOT TO PRODUCE? • Recall, the firm in the Short Run has two questions to answer: 1) Produce or Shut-down? 2) If produce, how much should we produce? Recall economic profit = TR - TC Profits depend upon market price - 4 scenarios

  7. Produce or Not to Produce • Case I - - P > AC Profit/unit = (P-AC) Total Profit = (P-AC)Q So, if (P-AC) > 0, firm will earn positive economic profit How much does it produce? Where MR=MC

  8. Produce or Not to Produce • Case II - - P = min AC Profit/unit = (P-AC) Total Profit = (P-AC)Q Economic Profit = 0 =====>> Firm earns normal profit How much does it produce? Where MR=MC

  9. Produce or Not to Produce? CASE III - - P < minimum AC but P> minimum AVC (P-AC) < 0 =====> Economic Loss Should the firm shutdown? NO. Firms can cover variable costs, so would lose more by shutting Down than they are by producing Profit maximization (MR=MC) also minimizes losses

  10. Produce or Not to Produce? Economic Loss - should we shutdown? • CASE 4 P  minimum of AVC If Economic Loss = Fixed Cost , continue to produce with losses equal to fixed cost If Economic Loss > Fixed Cost, SHUTDOWN SHUTDOWN POINT The output/ price where firms are just able to cover its variable costs. At a lower price, it cannot cover variable cost and should shutdown

  11. SR Supply Curve • Using what we have just done, can we explain why the supply curve is upward sloping SR industry supply curve - the quantity supplied by the industry at a given price - Horizontal sum of all individual firms Price is still determined by Supply and Demand, but now we know more about why firms will produce/not produce at that level

  12. LONG-RUN SUPPLY • Long-run signals by firm: 1) If positive economic profit exists, firms will enter the market. 2) If economic losses exist, firms will leave the market. 3) If normal profits for the firms exist, no motivation to either enter or leave the market.

  13. Firm Entry/Exit • FIRM ENTRY - As firms enter the market, market supply rises, and the economic profit of the firms drops • FIRM EXIT - As firms leave the market, market supply • falls, and the economic profit of the firms that remains • increases (economic loss decreases) Summary In Long Run, entry and exit of firms yields an equilibrium where the firms earn NORMAL PROFIT (economic profit = 0)

  14. LR Industry Supply Curve • Relationship between quantity supplied and price when the industry is in LR competitive equilibrium. 3 Possible scenarios: 1) Constant cost industry 2) Increasing cost industry (External diseconomies) 3) Decreasing cost industry (External economies)

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