Market Structure

Market Structure

The selling environment in which a firm produces and sells its product is called a market structure.

Defined by three characteristics: The number of firms in the market The ease of entry and exit of firms The degree of product differentiation

Introduction

Perfect competition, with an infinite number of firms, and monopoly, with a single firm, are polar opposites.

Perfect Competition

A perfectly competitive market has the following characteristics:

There are many buyers and sellers in the market.The goods offered by the various sellers are largely the same.

Firms can freely enter or exit the market.

Perfect Competition

Profit-Maximizing Level of Output

The goal of the firm is to maximize profits. Profit is the difference between total revenue and total cost.

Revenue of a Competitive Firm

Total revenue for a firm is the selling price times the quantity sold.

TR = (P X Q)Marginal revenue is the change in total revenue from an additional

unit sold.

MR =TR/ Q

Total, Average, And Marginal Revenue For A Competitive Firm

Quantity(Q)

Price(P)

Total Revenue(TR=PxQ)

Average Revenue(AR=TR/ Q)

Marginal Revenue(MR= )

1 $6.00 $6.00 $6.002 $6.00 $12.00 $6.00 $6.003 $6.00 $18.00 $6.00 $6.004 $6.00 $24.00 $6.00 $6.005 $6.00 $30.00 $6.00 $6.006 $6.00 $36.00 $6.00 $6.007 $6.00 $42.00 $6.00 $6.008 $6.00 $48.00 $6.00 $6.00

QTR /

TC TR

0

Tota

l Cos

t, Re

venu

e $3853503152802452101751401057035

Quantity1 2 3 4 5 6 7 8 9

Profit Determination Using Total Cost and Revenue Curves

Maximum profit =$81

$130

Loss

Loss

Profit

Profit =$45

Profit Maximization Using Total Revenue and Total Cost

Profit is maximized where the vertical distance between total revenue and total cost is greatest.

At that output, MR (the slope of the total revenue curve) and MC (the slope of the total cost curve) are equal.

Marginal revenue (MR) – the change in total revenue associated with a change in quantity.Marginal cost (MC) – the change in total cost associated with a change in quantity.

*A firm maximizes profit when MC = MR.

Profit Maximization: Using MR and MC curves

Profit Maximization: The Numbers

Q P TR TC TR-TC MR MC ATC

0 $1 $0 $1.00 -$1.00 $11 $1 $1 $2.00 -$1.00 $1 $1.00 $2.002 $1 $2 $2.80 -$0.80 $1 $0.80 $1.403 $1 $3 $3.50 -$0.50 $1 $0.70 $1.174 $1 $4 $4.00 $0.00 $1 $0.50 $1.005 $1 $5 $4.50 $0.50 $1 $0.50 $0.906 $1 $6 $5.20 $0.80 $1 $0.70 $0.877 $1 $7 $6.00 $1.00 $1 $0.80 $0.868 $1 $8 $6.86 $1.14 $1 $0.86 $0.869 $1 $9 $7.86 $1.14 $1 $1.00 $0.87

10 $1 $10 $9.36 $0.64 $1 $1.50 $0.9411 $1 $11 $12.00 -$1.00 $1 $2.64 $1.09

MR=MCMR=MC

The Marginal Cost Curve Is the Supply Curve

The marginal cost curve is the firm's supply curve above the point where price exceeds average variable cost.

The MC curve tells the competitive firm how much it should produce at a given price.

The Interaction of Firms and Markets

FirmFirm MarketMarketPricePriceAndAnd

CostsCostsPricePrice

qqFF QQMM

aa

bb

cc

dd

AA

BB

qq11qq22qq33qq44 QQ11 QQ22

MCMC

P=MRP=MR00

ATCATC

P=MRP=MR11AVCAVC

SS11

SS22

DD00

$10$10

ATCATC=$7=$7

10 units10 units

The Marginal-Cost Curve and the Firm’s Supply Decision...

Quantity0

CostsandRevenueMC

ATC

AVC

Q1

P1

P2

Q2

This section of the firm’s MC curve is also the firm’s supply curve (long-run).

Determining Profit and Loss Find output where MC = MR.

The intersection of MC = MR (P) determines the quantity the firm will produce if it wishes to maximize profits.

Find profit per unit where MC = MR.

– Drop a line down from where MC equals MR, and then to the ATC curve.

– This is the profit per unit.– Extend a line back to the vertical

axis to identify total profit.

(a) Profit case (b) Zero profit case (c) Loss case

Determining Profits Graphically

Quantity Quantity Quantity

Price65 60 55 50 45 40 35 30 25 20 15 10

5 0

65 60 55 50 45 40 35 30 25 20 15 10

5 01 2 3 4 5 6 7 8 9 10 12 1 2 3 4 5 6 7 8 9 10 12

D

MC

A P = MR

B ATCAVCE

Profit

C

MC

ATC

AVC

MC

ATC

AVC

Loss

65 60 55 50 45 40 35 30 25 20 15 10 5 0 1 2 3 4 5 6 7 8 910 12

P = MRP = MR

Price Price

© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill

Loss MinimizationAverage cost of a unit of outputAverage cost of a unit of output

Revenue Revenue generated generated by a unit of by a unit of

outputoutput

Market Market price price fallsfalls

MC

P = MR

2 4 6 8 Quantity

Price

60

50

40

30

20

10

0

ATC

AVC

Loss

A$17.80

The Shutdown Decision

If total revenue is more than total variable cost, the firm’s best strategy is to temporarily produce at a loss

The Firm’s Long-Run Decision to Exit or Enter a Market

In the long-run, the firm exits if the revenue it would get from producing is less than its total cost.

Exit if TR < TCExit if TR/Q < TC/Q

Exit if P < ATC A firm will enter the industry if such an action

would be profitable. Enter if TR > TC

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