1

Q TC TFC TVC ATC AFC AVC MC

1 120 100 20 120 100 20 --

2 138 100 38 69 50 19 18

3 151 100 51 50.3 33.3 17 13

4 162 100 62 40.5 25 15.5 11

5 175 100 75 35 20 15 13

6 190 100 90 31.7 16.7 15 15

7 210 100 110 30 14.3 15.7 20

8 234 100 134 29.3 12.5 16.8 24

9 263 100 163 29.2 11.1 18.1 29

10 300 100 200 30 10 20 37

2

$ per time period

Q3Q2Q1

Output per time period (units)(b) Unit costs

MC

ATCAVC

AFC

Why these shapes? Relationships between costs?

3

Chapter 6Market Structure I:Perfect Competition

• Market Structure

• Perfect Competition Vs Monopoly

• What determines the level of competition?

• Perfect Competition in Detail

4

Market Structure

• Competitive environment for a good or service• Market – all firms and individuals willing and

able to buy or sell a particular product

5

Factors that determine the level of competition

• Product Differentiation

• Barriers to Entry

• Number of Buyers and Sellers

• Information availability

6

Types of Markets

• Perfect Competition

• Monopoly

• Monopolistic Competition

• Oligopoly

7

Perfect Competition

• Large number of buyers and sellers – each firm produces small amount of industry supply and each customer buys a small part of the total.

• Product Homogeneity – Output of each firm is essentially the same.

• Free Entry – firms are not restricted from entering the market.• Perfect Information – costs, prices and quality is know by all

buyers and sellers• Buyers and Sellers are “price takers” as they can’t influence

the price, must take as given (market price). • An Extreme?• Practical Examples?

8

GE Stock

• Individual has 1000 shares of GE common stock• 9.93 Billion shares outstanding• Value of stock is obtained from broker (or

internet)• Market determines price, can sell or buy as many

as you want at this price.• Can’t sell any above the price or buy any below

the price.• Buyers and Sellers are Price Takers!

9

Milk Market

• No single buyer can influence price• Seller has little price control as products are

exactly the same as their competition• Can sell all you want at market price – little

incentive to charge less – charge more buyers substitute

• Buyers and sellers take market price as given• Entry and Exit?

10

The Market Price in Perfect Competition

• Industry Supply and Industry Demand

• Individuals and firms have no control

• Sum supply and demand for all firms and all consumers to get industry

11

Market Price in Perfect Competition

10

8

6

4

2

0

Industry Supply

50 100 150 200 250 300 350 400

Quantity per time period (millions)

Price per unit ($)

P = – $0.254 + $0.000025Q

P = $40 – $0.0001Q

Industry Demand

12

Mathematics

• Demand = P = 40 – 0.0001Q

• Supply = P = -.254 + 0.000025Q

• 40 – 0.0001Q = -.254 + 0.000025Q

• Q = 322, 032

• P = 40 – 0.0001*322,032

• $7.80

• Check Graph

13

Why can’t a firm influence prices in this market

structure?

Why can’t a firm influence prices in this market

structure?

Look at impact of them pulling all of their goods off of the market!

14

Firm pulls all output off market.Firm pulls all output off market.

D

S$

Q

S’

• Supply shift very small.

• Equilibrium price increases.

• However, price increase is so small (e.g., 1/10 penny) that it is not noticed in the market.

Pe

Pe’

15

P = 6 = “Price Takers”Profit Max: P = AR =MR = MC

Q TR TC Profit MR AR MC

0 0 3 -3 -- -- --

1 6 5 1 6 6 2

2 12 8 4 6 6 3

3 18 12 6 6 6 4

4 24 17 7 6 6 5

5 30 23 7 6 6 6

6 36 30 6 6 6 7

7 42 38 4 6 6 8

8 48 47 1 6 6 9

16

Price Taking FirmPrice Taking Firm

Firm Market

D

S

df=MR=AR=Pe

$

q

$

Q Q1

17

The Price Output Decision for a Firm under Perfect Competition

• Profit Max requires that MR = MC• Under PC price is constant (market price)• MR = P• AR = MR if price is constant (AR = TR/Q =

P*Q/Q = P)• Profit Max: P = MR = AR = MC• Firms have horizontal demand curve• Think about GE stock example!

18

Firm Demand Curve under PC

10

8

6

4

2

0

Price per unit ($)

50 100 150

Demand

Quantity per time period (000)

Under PC demand curve is basically flat, price is not a function of output. Firms are price takers. Higher price, no demand

19

Profit Maximizing in Perfect Competition

• MR = MC: • MR>MC – produce more, • MR<MC -produce less• Market Price is constant – price taker

(horizontal line)• If price is constant then AR=MR=P• So we can say profit is maximized where

MR = MC = P = AR • MC curve is the firms supply curve!

20

Profit Maximization for FirmProfit Maximization for Firm

Firm Market

D

S

df=MR=AR=Pe

MC=sf

$

q

$

Qq1 Q1

21

The Graph

• Firm sells Q* where MR=MC• Average cost of C dollars• Market Price is P• Economic Profits = P (AR) – C (from ATC) dollars

per unit• Total economic profit = (P-C)*Q = shaded area on

the graph• Above normal rate of return – see that AR>ATC so

economic profit• In SR positive economic profits

22

SR Perfect Competition

ATC

Cost and revenueper unit ($)

Output per time periodQ*

N

M

MC

P = AR = MRP

C

Economic Profit

23

In the Long Run …

• Positive Economic Profits (above normal rate of return – shaded area on pervious graph) attract competitors (free firm entry)

• Expanding supply pushes prices down• Expanding supply pushes costs of inputs up• Long-Run equilibrium: all economic profits and

losses have been eliminated for each firm in the industry

• Only receiving “normal rate of return” that is included in economic costs (opportunity cost)

24

The Long Run Graph

• P = MR = AR = ATC – no economic profits or losses

• Prices fall from SR and ATC increases from SR• No firms enter or exit• Prices are stable• Each firm is operating at minimum ATC• Shareholders get adequate rate of return based on

risk (and that is all).

25

Long Run PC

ATC

Cost and revenueper unit ($)

Output per time period

Q*

MC

P = AR = MRP

26

Questions for Class?

• Under Perfect Competition:

• 1. When would a firm shut down production?

• 2. When would a firm exit the market?

Answer to question

• Under Perfect Competition:

• 1. When would a firm shut down production?

• When AVC is not being covered.

• The shut down point is where AR=AVC

• 2. When would a firm exit the market?

• If AVC is not covered it will shut down.

27

28

Application: Tax Incidence In Perfect Competition

Q

P

Market Demand

Market Supply

PC = PP

No tax: PC = PP

29

Application: Tax Incidence In Perfect Competition

In the Long Run,

• Consumers pay all of the tax (100%)

• Producers pay none of tax (0%)

• There are no firms making losses

30

Monopoly

• Single Seller• Unique Product• Blocked entry (exit)• May not be perfect information about prices,

quality, etc.• Industry demand curve equal to firm demand

curve• Downward Sloping demand (industry is firm)

31

Monopoly Demand Curve

Demand

Quantity per time period200150100500

2

4

8

10

12

Price per unit ($)

6

Monopolist picks point on Demand curve – Which point?

32

Monopoly Price and Output

• MR = MC for profit maximization

• Since demand curve is not horizontal, MR is not equal to price (except first output)

• MR < Price = AR = Demand Curve

• MR = MC simultaneously determines output and price

33

Monopoly Price and Quantity

• TR = P*Q• Output Effect: increase output increase revenue • Same as Perfect Competition• Price Effect: Monopolist sells one more unit, he

must lower price. This will lower revenue.• For a monopolist output is a function of price,

not true for perfect competition (no price effect under PC)

34

Price = Demand Curve =ARP>MR (except first point)

Q Price TR AR MR

0 11 0 -- --

1 10 10 10 10

2 9 18 9 8

3 8 24 8 6

4 7 28 7 4

5 6 30 6 2

6 5 30 5 0

7 4 28 4 -2

8 3 24 3 -4

35

Profit Max for Monopoly

C'

Price and costper unit ($)

P 'P

C

MR

Demand = Price

MCATC

Quantity per time periodQ

MR = MCP>ATC economic profits are earned

36

Long Run Monopoly Market

• Less Output

• Higher Prices

• Incentive to under produce and drive up price

• Social Costs?

37

Comparison

• Perfect Competition• 75,000 haircuts• Price = $20• Economic Profits = 0

• Monopoly• 37,500 haircuts• Price = $50• Economic Profits =

$1,125,000

38

Monopoly Always Bad?

• Natural Monopoly

• Microsoft?

• Antitrust Laws

• Government Regulation

Monopolistic Competition

39

40

Profit Max for Monopolistic Competition

Price and costper unit ($)

P

C

Demand = Price

MC

ATC

Quantity per time periodQ

MR = MCP>ATC economic profits are earned

MR

The profit

Oligopoly

41