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4 Market Structures

4 Market Structures. Candy Markets Simulation. FOUR MARKET STRUCTURES. Pure Monopoly. Perfect Competition. Monopolistic Competition. Oligopoly. Every product is sold in a market that can be considered one of the above market structures. For example: Market for wheat

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4 Market Structures

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  1. 4 Market Structures Candy Markets Simulation

  2. FOUR MARKET STRUCTURES Pure Monopoly Perfect Competition Monopolistic Competition Oligopoly • Every product is sold in a market that can be considered one of the above market structures. • For example: • Market for wheat • The Market for Cars • Market for electricity • Strawberry Market • Cereal Market

  3. Perfect Competition

  4. FOUR MARKET STRUCTURES Pure Monopoly Perfect Competition Monopolistic Competition Oligopoly Imperfect Competition Characteristics of Perfect Competition: Examples of Perfect Competition: Avocado farmers, sunglass huts, and hammocks in Mexico • Many small firms • Identical products (perfect substitutes) • Easy for firms to enter and exit the industry • Seller has no need to advertise • Firms are “Price Takers” • The seller has NO control over price.

  5. Law of One Price In an efficient market, all identical goods must have only one price. Result: Each firm is a price taker. Firms have no control of the price Traffic Analogy When there is heavy traffic, why do all lanes seem to go the same speed? Cars leave slower lanes and enter faster lanes. Similarly, what happens in perfectly competitive markets if firms earn excessive profit? 5

  6. Perfectly Competitive Firms • Example: • Say you go to Mexico to buy a hammock. • After visiting at few different shops you find that the buyers and sellers always agree on $15. • This is the market price (where demand and supply meet) • Is it likely that any shop can sell hammocks for $20? • Is it likely that any shop will sell hammocks for $10? • What happens if a shop prices hammocks too high? • Do you think that these firms make a large profit off of hammocks? Why? • These firms are “price takers” because the sell their products at a price set by the market.

  7. Demand for Perfectly Competitive Firms • Why are they Price Takers? • If a firm charges above the market price, NO ONE will buy. They will go to other firms • There is no reason to price low because consumers will buy just as much at the market price. • Since the price is the same at all quantities demanded, the demand curve for each firm is… • Perfectly Elastic • (A Horizontal straight line)

  8. The Competitive Firm is a Price Taker Price is set by the Industry P S P Demand $15 $15 D Q Q 5000 Firm (price taker) Industry

  9. The Competitive Firm is a Price Taker Price is set by the Industry • What is the additional revenue for selling an additional unit? • 1st unit earns $15 • 2nd unit earns $15 • Marginal revenue is constant at $15 • Notice: • Total revenue increases at a constant rate • MR equal Average Revenue P Demand $15 MR=D=AR=P Q Firm (price taker) 10 10

  10. For Perfect Competition: Demand = MR (Marginal Revenue) The Competitive Firm is a Price Taker Price is set by the Industry • What is the additional revenue for selling an additional unit? • 1st unit earns $15 • 2nd unit earns $15 • Marginal revenue is constant at $15 • Notice: • Total revenue increases at a constant rate • MR equal Average Revenue P Demand $15 MR=D=AR=P Q Firm (price taker) 11 11

  11. MaximizingPROFIT! 12

  12. Short-Run Profit Maximization What is the goal of every business? To Maximize Profit!!!!!! • To maximum profit firms must make the right output • Firms should continue to produce until the additional revenue from each new output equals the additional cost. • Example (Assume the price is $10) • Should you produce… • …if the additional cost of another unit is $5 • …if the additional cost of another unit is $9 • …if the additional cost of another unit is $11

  13. Profit Maximizing Rule MR=MC Short-Run Profit Maximization What is the goal of every business? To Maximize Profit!!!!!! • To maximum profit firms must make the right output • Firms should continue to produce until the additional revenue from each new output equals the additional cost. • Example (Assume the price is $10) • Should you produce… • …if the additional cost of another unit is $5 • …if the additional cost of another unit is $9 • …if the additional cost of another unit is $11 14

  14. Lets put costs and revenue together on a graph to calculate profit.

  15. How much output should be produced? • How much is Total Revenue? How much is Total Cost? • Is there profit or loss? How much? P MC $9 8 7 6 5 4 3 2 1 MR=D=AR=P ATC Profit = $18 AVC Don’t forget that averages show PER UNIT COSTS Total Cost=$45 Total Revenue =$63 Q 1 2 3 4 5 6 7 8 9 10

  16. Suppose the market demand falls. What would happen if the price is lowered from $7 to $5? The MR=MC rule still applies but now the firm will make an economic loss. The profit maximizing rule is also the loss minimizing rule!!!

  17. How much output should be produced? • How much is Total Revenue? How much is Total Cost? • Is there profit or loss? How much? MC $9 8 7 6 5 4 3 2 1 ATC Cost and Revenue AVC Loss =$7 MR=D=AR=P Total Cost = $42 Total Revenue=$35 Q 1 2 3 4 5 6 7 8 9 10

  18. Assume the market demand falls even more. If the price is lowered from $5 to $4 the firm should stop producing. • Shut Down Rule: • A firm should continue to produce as long as the price is above the AVC • When the price falls below AVC then the firm should minimize its losses by shutting down • Why? If the price is below AVC the firm is losing more money by producing than they would have to pay to shut down.

  19. SHUT DOWN! Produce Zero MC $9 8 7 6 5 4 3 2 1 ATC Cost and Revenue AVC Minimum AVC is shut down point Q 1 2 3 4 5 6 7 8 9 10

  20. P<AVC. They should shut down Producing nothing is cheaper than staying open. MC $9 8 7 6 5 4 3 2 1 ATC Cost and Revenue Fixed Costs=$10 AVC TC=$35 MR=D=AR=P TR=$20 Q 1 2 3 4 5 6 7 8 9 10

  21. Profit Maximizing Rule MR = MC • Three Characteristics of MR=MC Rule: • Rule applies to ALL markets structures (PC, Monopolies, etc.) • The rule applies only if price is above AVC • Rule can be restated P = MC for perfectly competitive firms (because MR = P)

  22. Practice 23

  23. #1 Should the firm produce? What output should the firm produce? What is TR at that output? What is TC? How much profit or loss? Yes 10 TR=$140 TC=$100 Profit=$40 $20 15 10 5 0 MC MR=D=AR= P 14 ATC Cost and Revenue AVC 6 Q 6 7 10

  24. #2 What output should the firm produce? What is TR at MR=MC point? What is TC at MR=MC point? How much profit or loss? Zero Shutdown (Price below AVC) $45 $55 Loss=Only Fixed Cost $5 $20 15 10 5 0 MC ATC AVC 11 Cost and Revenue MR=D=AR=P 9 Q 5 7

  25. #3 What output should the firm produce? What is TR at that output? What is TC? How much profit or loss? 6 $90 $120 Loss= $30 $40 30 20 10 0 MC ATC Cost and Revenue AVC 19 MR=D=AR=P 15 Q 6 8

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