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8 _ 9 _ 10 - MARKET STRUCTURE

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8 _ 9 _ 10 - MARKET STRUCTURE Powered By Docstoc
					      Market Structures:

Perfect Competition, Monopoly,
   Monopolistic Competition
      What Is Perfect Competition?
  (Characteristics of perfect competition)
– Perfect competition is an industry in which
 Many firms sell identical /homogoneous/same products to many buyers-
  Each firm’s output is a perfect substitute for the output of the other firms,
  so the demand for each firm’s output is perfectly elastic.
 There are no restrictions to entry into the industry- When minimum cost
  of starting up the firm/business is small, easier for the firms to enter the
  industry.
 Each firm is a price taker- No single firm can influence/change the price—
  it must “take” the equilibrium market price - Established firms have no
  advantages over new ones. To increase firms profit, the firm can increase
  quantity or decrease cost of porduction but cannot increase the price.
 Sellers and buyers are well informed about prices – Everybody knows the
  market price and whichever firms charge higher price than market
  equilibrium price will not be able to sell their products/ buyers will buy
  from other firms.
   What Is Perfect Competition?
• How Perfect Competition Arises
– Perfect competition arises:
 When firm’s minimum efficient scale is small relative
  to market demand so there is room for many firms in
  the industry.
 And when each firm is perceived to produce a good
  or service that has no unique characteristics, so
  consumers don’t care which firm they buy from.
        The goal of firms in Perfect
              Competition.
• Economic Profit and Revenue
  – The goal of each firm is to maximize economic profit,
    which equals total revenue minus total cost.
  – Total cost is the opportunity cost of production, which
    includes normal profit.
  – A firm’s total revenue (TR) equals price, P, multiplied by
    quantity sold, Q, or          TR= P  Q.
  – A firm’s marginal revenue (MR) is the change in total
    revenue that results from a one-unit increase in the
    quantity sold.
  –                           MR = ∆TR/∆Q
     Demand, Price Total Revenue, Marginal Revenue in
                   Perfect Competition
Quantity (Q)   Price (P)   Total Revenue (TR) =   Marginal Revenue (MR)
                           Price X Quantity       = ∆TR/∆Q
0              25          0                      0
1              25          25                     25
2              25          50                     25
3              25          75                     25
4              25          100                    25
5              25          125                    25
6              25          150                    25
7              25          175                    25
8              25          200                    25
9              25          225                    25
10             25          250                    25
11             25          275                    25
12             25          300                    25
13             25          325                    25
 What Is Perfect Competition? (Graph
               analysis)
Plotting the data from the previous table, we get the following
figures on the next slide:

Figure 11.1 Part (a) shows that market demand and market
supply determine the market price that the firm must take.

Figure 11.1(b) shows the firm’s total revenue curve (TR)—the
relationship between total revenue and quantity sold.

Figure 11.1(c) shows the marginal revenue curve (MR).
   What Is Perfect Competition?
– Figure 11.1 illustrates a firm’s revenue concepts (TR and MR).
    What Is Perfect Competition?
• The firm in a perfectly competitive market has no
  power to determine price .
• Cindy must sell the sweaters at sweater market
  price=25 dollars per sweater.
   Why the demand curve is perfecly elastic?
Figure 11.1(c) shows the marginal
revenue curve (MR).

The demand for the firm’s product is
perfectly elastic because one of Cindy’s
sweaters is a perfect substitute for the
sweater of another firm.                   =Dd

The firm can sell any quantity it
chooses at the market price, so MR=
price and the demand curve for the
firm’s product is horizontal at the
market price.

If the firm increase the price more
than RM25, people will go to other
firms to buy the same product.
 Why the demand curve is perfecly
            elastic?
• In perfect competition, if one firm raises its
  price, that firm will not increase its revenues.
• If the firm increase the price more than market price, people
  will go to other firms to buy the same product. Their number
  of customers will decrease and thus, their total revenue will
  decrease.
      Total Revenue, Total Cost and Economic Profit

Q    Price   TR   MR   Total       MC= ∆TC/∆Q   Economic Profit
                       Cost (TC)                =(TR-TC)
0    25      0    0    22                       -22
1    25      25   25   45          23           -20
2    25      50   25   66          21           -16
3    25      75   25   85          19           -10
4    25      100 25    100         15           0
5    25      125 25    114         14           11
6    25      150 25    126         12           24
7    25      175 25    141         15           34
8    25      200 25    158         17           42
9    25      225 25    183         25           42
10   25      250 25    210         27           40
11   25      275 25    245         35           30
12   25      300 25    300         55           0
13   25      325 25    360         60           -35
The Firm’s Decisions in Perfect Competition
(Choosing profit maximizing output)
–After plotting the data from the
 table, we get the for TC, TR and
 Profit curves.

From the graphs, we can
 conclude that,
–At high output levels, the firm
 again incurs an economic loss—
 now the firm faces steeply rising
 costs because of diminishing
 returns.

-Firms always try to
maximize profit, and the
firm maximizes its
economic profit when it
produces 9 sweaters a day.
   The Firm’s Decisions in Perfect
           Competition
• Marginal Analysis
  • The firm can use marginal analysis to determine
    the profit-maximizing output.
  • profit is maximized by producing the output at
    which marginal revenue, MR, equals marginal
    cost, MC. (MR=MC)
  – Figure 11.3 on the next slide shows the marginal
    analysis that determines the profit-maximizing
    output.
   The Firm’s Decisions in Perfect
           Competition
•If MR > MC, economic
profit increases if output
increases.
•If MR < MC, economic profit
decreases if output
increases.
•If MR = MC, economic
profit decreases if output
changes in either direction,
so economic profit is
maximized.
      The Firm’s Decisions in Perfect
        Competition (Profit/Loss)
• Profits and Losses in the Short Run
   – Maximum profit is not always a positive economic profit.
   – To determine whether a firm is making an economic profit
     or incurring an economic loss, we compare the firm’s
     average total cost at the profit-maximizing output with the
     market price.
   – Figure 11.4 on the next slide shows the three possible
     profit outcomes.
   P>ATC =Economic Profit
   P<ATC = Economic Loss
   P=ATC = 0 economic profit /normal profit
The Firm’s Decisions in Perfect
        Competition
– In part (a) price equals average total cost and the
  firm makes zero economic profit (breaks even).
The Firm’s Decisions in Perfect
        Competition
– In part (b), price exceeds average total cost and
  the firm makes a positive economic profit.
The Firm’s Decisions in Perfect
  Competition (Profit/Loss)
– In part (c) price is less than average total cost and
  the firm incurs an economic loss—economic profit
  is negative.
The Firm’s Decisions in Perfect
        Competition
– Short-Run Decisions
– In the short run, the firm must decide:
– 1. Whether to produce or to shut down
  temporarily.
– 2. If the decision is to produce, what quantity to
  produce.
– Long-Run Decisions
– In the long run, the firm must decide:
– 1. Whether to increase or decrease its plant size.
– 2. Whether to stay in the industry or leave it.
   The Firm’s Decisions in Perfect
     Competition (Profit/Loss)
• In the short run, perfectly competitive firms
  earn economic profit or economic loss.

• But in the long run in perfect competition, no
  firm can earn economic profit.
Output, Price, and Profit in Perfect
           Competition
• Long-Run Adjustments
  – In short-run equilibrium, a firm may make an
    economic profit, break even, or incur an economic
    loss.
• In the long run, many firms enter and exit the
  market, no firm can earn economic profit.
  – New firms enter an industry in which existing firms make an economic
    profit.
  – Firms exit an industry in which they incur an economic loss.
  – There will be no new firms enter/exit the industry if there is no
    economic profit/no economic loss,
  – In other words, in the long run no firm can earn economic profit.
Output, Price, and Profit in Perfect
           Competition
• Entry and Exit
  – New firms enter an industry in which existing
    firms make an economic profit.
  – Firms exit an industry in which they incur an
    economic loss.
  – Figure 11.8 on the next slide shows the effects of
    entry and exit.
The Firm’s Decisions in Perfect Competition
   (Shut Down or Continue Production)
  – The shutdown point is the output and price at
    which the firm just covers its total variable cost.
  – This point is where average variable cost is at its
    minimum.
  – It is also the point at which the marginal cost
    curve crosses the average variable cost curve.
  – At the shutdown point, the firm is indifferent
    between producing and shutting down
    temporarily.
  – It incurs a loss equal to total fixed cost from either
    action.
The Firm’s Decisions in Perfect
 Competition (Shut Down or
    Continue Production)
– If the price exceeds minimum average variable
  cost, the firm produces the quantity at which
  marginal cost equals price.
– Price exceeds average variable cost, and the firm
  covers all its variable cost and at least part of its
  fixed cost.
P>AVC=continue production
P<AVC=shut down production
P=AVC= indifferent toshut down / to continue
The Firm’s Decisions
in Perfect Competition
  – Short-Run Supply Curve
  – Figure 11.5 shows how the
    firm’s short-run supply
    curve is constructed.
  – If price equals minimum
    average variable cost, $17
    in this example, the firm is
    indifferent between
    producing nothing and
    producing at the shutdown
    point, T.
Monopoly
       Characteristics of Monopoly
1.   One seller - many buyers
2.   One product (no good substitutes)- no other firms are selling the same
     products.
3.   High Barriers to entry- It is difficult for new firms to enter the market
     because of a very high cost for a new firm to start up the business
     (natural monopoly) and because of government regulation (legal
     monopoly).
–              Natural monopoly: an industry in which one firm can supply
     the whole market at a lower price than two or more firms can. It is
     because of economics of scale- producing larger quantity at a decreasing
     average cost. Selling larger quantity to as many buyers as possible
     enable firm to generate more revenue to cover the high fixed cost.
–              Legal monopoly: Government sometimes gives license to only
     one firm to sell certain products.

4.   Price Maker- the firm has the power to determine price. Thus, beside
     determining the quantity it sells, it must choose the appropriate price to
     meet demand and to maximize profit. A monopolist has complete
     control over both price and quantity of output.
Natural Monopoly


In a natural monopoly,
economies of scale are so
powerful that they are still
being achieved even when
the entire market demand
is met.
The LRAC curve is still
sloping downward when it
meets the demand curve.
    Total Revenue, Total Cost and Economic Profit

Q   Price   TR   MR   Total Cost   MC= ∆TC/∆Q   Economic Profit =(TR-
                      (TC)                      TC)
0   20      0    0    21
1   18      18   18   24           3            -6
2   16      32   14   30           6            2
3   14      42   10   40           10           2
4   12      48   6    55           15           -7
5   10      50   2    75           20           -25
6   8
7   6
  Total, Marginal, and Average Revenue




Chapter 10         31
  Demand curve and Marginal Revenue
         curve in monopoly
From the table, we can see that
• For sales to increase, price must fall
   In order to sell an additional unit of its product, a monopoly
   must decrease price on all units (for a single price monopoly).

• Thus demand curve for monopolist is downward sloping.

• Since marginal revenue is always less than price, A
  monopolist's marginal revenue curve is below than its
  demand curve.

 • A monopolist's marginal revenue curve is flatter than its
     demand curve.
Chapter 10                    32
                Average and Marginal Revenue

       $ per    7
      unit of
      output
                6

                5

                4                      Average Revenue (Demand)

                3

                2
                    Marginal
                1   Revenue

                0     1        2   3   4    5   6    7 Output
Chapter 10                             33
         Monopolist’s Output Decision
• Profits are maximized at MR=MC.
  Thus, a monopolist choose the Quantity at MR=MC.
      – Price is set at the highest price the firm can charge for the
        profit-maximizing quantity.
      – The price is determined from the demand curve for the firm’s
        product.

• At output levels below MR = MC the additional revenue per
  unit output is greater than the increase in cost per unit
  output (MR > MC), so it better to increase Q to increase
  profit.

• At output levels above MR = MC the increase in cost is
  greater than the decrease in revenue (MR < MC), so it is
  better to decrease Q to increase profit.
Chapter 10                          34
         Monopolist’s Output Decision
       $ per
      unit of
      output                    MC



                P*




                                     D = AR


                           MR

                     Q*              Quantity
Chapter 10            35
   The Firm’s Decisions in Monopoly
              (Profit/Loss)
• Profits and Losses in the Short Run
   – Maximum profit is not always a positive economic profit.
   – To determine whether a firm is making an economic profit
     or incurring an economic loss, we compare the firm’s
     average total cost at the profit-maximizing output with the
     market price.
   – Figure 11.4 on the next slide shows the three possible
     profit outcomes.
   P>ATC =Economic Profit
   P<ATC = Economic Loss
   P=ATC = 0 economic profit /normal profit
The Firm’s Decisions in Monopoly (Shut
    Down or Continue Production)
– The shutdown point is the output and price at which the
  firm just covers its total variable cost.
– This point is where average variable cost is at its minimum.
– It is also the point at which the marginal cost curve crosses
  the average variable cost curve.
– At the shutdown point, the firm is indifferent between
  producing and shutting down temporarily.
– It incurs a loss equal to total fixed cost from either action.
  In other words, total variable cost is greater than total
  revenue at all output levels.
The Firm’s Decisions in Monopoly
    (Shut Down or Continue
           Production)
– If the price exceeds minimum average variable
  cost, the firm produces the quantity at which
  marginal cost equals price.
– Price exceeds average variable cost, and the firm
  covers all its variable cost and at least part of its
  fixed cost.
P>AVC=continue production
P<AVC=shut down production
P=AVC= indifferent toshut down / to continue
         Price Discrimination
– A monopolist can do price discrimination.
– Price discrimination is the practice of selling
  different units of a good or service for different
  prices.
To be able to price discriminate, a monopoly must:
1. Identify and separate different buyer types.
2. Sell a product that cannot be resold.
          Price Discrimination
• Price Discrimination and Consumer Surplus
  – Price discrimination converts consumer surplus
    into economic profit.
  – A monopoly can discriminate
   Among units of a good. Quantity discounts are an
      example. (But quantity discounts that reflect
    lower costs at higher volumes are not price
    discrimination.)
   Among groups of buyers. (Advance purchase and
    other restrictions on airline tickets are an
    example.)
 Price Discrimination

Profiting by Price
Discriminating
 Figures 12.8 and 12.9 show
 the same market with a
 single price and price
 discrimination.
As a single-price monopoly,
this firm maximizes profit by
producing 8 trips a year and
selling them for $1,200
each.
Price Discrimination

By price discriminating, the
firm can increase its profit.
In doing so, it converts
consumer surplus into
economic profit.
Monopolistic
  Characteristics of Monopolistic
          Competition
1. Many firms compete- Each firm has only a small
   market share and therefore has small market
   power to influence the price of its product.
2. Each firm produces a differentiated product-
   same products but there are small differences in
   term quality, packaging and etc.
3. Firms compete on product quality, price, and
   marketing/advertising.
4. Firms are free to enter and exit the industry-
   relatively lower cost to start up the business.
             Monopolistic Competition
• Examples of this very common market
  structure include:
      – Toothpaste
      – Soap
      – Cold remedies




Chapter 12              45
Examples of firms in monopolistic
          competition




 The 4 largest     firms.
 Next 4 largest    firms.
 Next 12 largest   firms.
 Price and Output in Monopolistic
           Competition
• The Firm’s Short-Run Output and Price Decision
  – A firm that has decided the quality of its product and
    its marketing program produces the profit-maximizing
    quantity at which its marginal revenue equals its
    marginal cost (MR = MC).

  – Price is set at the highest price the firm can charge for
    the profit-maximizing quantity.
  – The price is determined from the demand curve for
    the firm’s product.
      A Monopolistically Competitive
                  Firm
$/Q
                              MC
                                   •Choose profit
                                   maximizing
PSR                                Quantity at
                                   MR=MC
                        DSR
                                   •Price on the
                                   demand curve
                 MRSR              where MR=MC
         QSR      Quantity
The importance of Product Development ,
Innovation, and Marketing/Advertising in
        Monopolistic Competiton
 – We’ve looked at a firm’s profit-maximizing output
   decision in the short run and the long run of a
   given product and with given marketing effort.
 – To keep making an economic profit, a firm in
   monopolistic competition must be in a state of
   continuous product development and advertising.
 – New product development allows a firm to gain a
   competitive edge, if only temporarily, before
   competitors imitate the innovation and shift to
   competitors’ prosucts.
 The Firm’s Decisions in Monopolistic
             (Profit/Loss)
• Profits and Losses in the Short Run
   – Maximum profit is not always a positive economic profit.
   – To determine whether a firm is making an economic profit
     or incurring an economic loss, we compare the firm’s
     average total cost at the profit-maximizing output with the
     market price.
   – Figure 11.4 on the next slide shows the three possible
     profit outcomes.
   P>ATC =Economic Profit
   P<ATC = Economic Loss
   P=ATC = 0 economic profit /normal profit
The Firm’s Decisions in Monopolistic(Shut
     Down or Continue Production)
 – The shutdown point is the output and price at
   which the firm just covers its total variable cost.
 – This point is where average variable cost is at its
   minimum.
 – It is also the point at which the marginal cost
   curve crosses the average variable cost curve.
 – At the shutdown point, the firm is indifferent
   between producing and shutting down
   temporarily.
 – It incurs a loss equal to total fixed cost from either
   action.
   The Firm’s Decisions in
  Monopolistic (Shut Down or
    Continue Production)
– If the price exceeds minimum average variable
  cost, the firm produces the quantity at which
  marginal cost equals price.
– Price exceeds average variable cost, and the firm
  covers all its variable cost and at least part of its
  fixed cost.
P>AVC=continue production
P<AVC=shut down production
P=AVC= indifferent toshut down / to continue
The End

				
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