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Market structure Market structure Presentation Transcript

  • Market Structure 1
  • MARKET STRUCTURE• Market structure consists of four main market characteristics:(2) the number of sellers,(3) the nature of the product,(4) the ability of individual firms to influence the market price,(5) the ease of entry into or exit from the market. 2
  • PERFECT COMPETITION• Definition - PC is a market structure inwhich there are many small firms sellinghomogeneous product.• Characteristics:1. many small firms2. homogeneous product3. Price taker4. Very easy entry and exit 3 View slide
  • The meaning of price taker• A price-taker firm has no power toinfluence the market price.• It faces a perfectly elastic demandcurve - It can sell all it wishes at themarket-determined price, but it will sellnothing above the given market price. 4 View slide
  • P Market Supply and Demand1312 S10 8 6 42 DQ 5 10 15 20 25 30 35 40 45 5
  • P1412 Individual firm’s demand10 D 8 6 4 2 5 10 15 20 25 30 35 40 45 Q 6
  • The individual firm’s Demand CurveA horizontal line at the market price – firm will offer all of its output at this price (price taker) 7
  • Profit maximising condition:(1) TR-TC approachThe total revenue-total cost methodis one way the firm determines thelevel of output that maximizesprofit.Profit reaches a maximum whenthe vertical difference between thetotal revenue and the total costcurves is at a maximum. 8
  • TR/TC/Π500 TR Maximize Profit400 TC300200100 1 2 3 4 5 Q 9
  • (2) MR=MC approach• The MR = MC rule states that the firmmaximizes profit or minimizes loss byproducing the output where marginalrevenue equals marginal cost.• If the price (average revenue) is belowthe minimum point on the averagevariable cost curve, the MR = MC ruledoes not apply, and the firm shuts downto minimize its losses. 10
  • P Equilibrium MC141210 8 MR=AR=D 6 4 2 0 1 2 3 4 5 6 Q 11
  • Short Run Equilibrium• Supernormal Profit : when TR>TC AR>AC• Subnormal Profit: when TR<TC AR<AC•Normal Profit: when TR=TC AR=AC 12
  • What is a Normal Profit? The minimum profit necessary to keep a firm in operation 13
  • P ATC MC70 P=MR=AR6050 Profit40302010 1 2 3 4 5 6 7 8 Q 14
  • P70 MC ATC605040 Loss P=MR=AR302010 1 2 3 4 5 6 7 8 9 Q 15
  • P NORMAL PROFIT MC7060 ATC504030 MR2010 1 2 3 4 5 6 7 8 9 Q 16
  • Firm will shut down Price (MR) is below minimum average variable costSHORT RUN SHUT DOWN DECISION 17
  • PC firm’s short run supply curve• The perfectly competitive firm’s short-runsupply curve is a curve showing the relationshipbetween the price of a product and the quantitysupplied in the short run.• The individual firm always produces along itsmarginal cost curve above its intersection with theaverage variable cost curve.• The perfectly competitive industry’s short-runsupply curve is the horizontal summation of theshort-run supply curves of all firms in theindustry. 18
  • P Industry Supply130 S =∑ MC120100 80 60 40 20 5 10 15 20 25 30 35 40 45 Q 19
  • Long run equilibrium• Long-run perfectly competitiveequilibrium occurs when the firmearns a normal profit by producingwhere price equals minimum long-run average cost equals minimumshort-run average total cost equalsshort-run marginal cost. 20
  • Long-Run Competitive EquilibriumP LRMC706050 LRAC4030 MR2010 1 2 3 4 5 6 7 8 9 Q 21
  • In the long-run, if existing firms make Supernormal Profits:New firms enter the industryMarket supply increasesA downward pressure is put on pricesUntil all firms only able to make normal profit 22
  • In the long-run, if existing firms make losses: Some firms leave the industry (those whose losses are larger than TVC)Market supply decreaseAn upward pressure is put on pricesUntil remaining firms make normal profit 23
  • Short-Run Shutdown (P=min AVC)P70 MC60 ATC50 AVC4030 P=MR=AR2010 1 2 3 4 5 6 7 8 9 Q 24
  • Monopoly• Monopoly is a single seller facing the entire industry demand curve because the firm is the industry.• Characteristics:(3)Single seller(4)Unique product(5)Price maker(6)Impossible entry into the market 25
  • BARRIERS TO ENTRYBarriers to entry that prevent newfirms from entering an industry are:(1) ownership of an essentialresource,(2) legal barriers, and(3) economies of scale. 26
  • NATURAL MONOPOLYA natural monopoly arises because of economiesof scale in which the LRAC curve falls asproduction increases.Without government restrictions, EOS allow asingle firm to produce at a lower cost than anyfirm producing a smaller output.Thus, smaller firms leave the industry, new firmsfear competing with the monopolist, and theresult is that a monopoly emerges naturally. 27
  • P Minimizing Costs in a40 Natural Monopoly3530 5 firms25201510 5 2 firms 1 firm Q 20 40 60 80 100 28
  • MONOPOLY AS APRICE MAKER•A price-maker firm faces adownward-sloping demand curve. Ittherefore searches its demand curveto find the price-output combinationthat maximizes its profit orminimizes its loss. 29
  • MR, AR and TR• The MR and AR (demand) curves aredownward-sloping for a monopolist.• The MR curve for a monopolist isalways below the AR (demand) curve.• The TR curve reaches its maximumwhere MR equals zero. 30
  • P AR=D MR Q 31
  • Price elasticity of demand andMR curve.• When MR is positive, demand iselastic, Ed > 1 (P↓ TR↑)• When MR is equal to zero, demand isunit elastic, Ed = 1 (TR max)• When MR is negative, demand isinelastic, Ed < 1 (P ↑ TR ↓)• Q: where would a monopolist normallychoose to produce? 32
  • P Ed > 1 Ed =1 Ed < 1 Q AR=D MR 33
  • EQUILIBRIUM MONOPOLY• The profit-maximizing monopolist, like theperfectly competitive firm, locates the profit-maximizing output level where the MR and theMC curves intersect and charges the pricecorresponds to that MR (refer diagram on nextslide) : MR=MC determines eqm output level P = AR, and is always higher than MR Remember P>MR!!! 34
  • P MR=MC35 MC3025201510 5 MR D 1 2 3 4 5 6 7 8 9 Q 35
  • SHORT RUN EQUILIBRIUM• SR-profit-maximizing Q=MR=MC andprice is the AR above that point ofintersection between MR and MC.• 3 types of profits: Supernormal profit: TR>TC, AR>AC Normal profit: TR=TC, AR=AC Subnormal profit: TR<TC, AR<AC 36
  • P200175 MC150125100 ATC 75 Profit 50 25 MR D 1 2 3 4 5 6 7 8 9 Q 37
  • P4035 MC302520 ATC1510 5 MR D 1 2 3 4 5 6 7 8 9 Q 38
  • P200 MC ATC175150125 Loss100 75 50 25 MR D 1 2 3 4 5 6 7 8 9 Q 39
  • LONG RUN EQUILIBRIUM• The long-run-profit-maximizingmonopolist earns a positive profitbecause of perfect barriers to entry.• If demand and cost conditions preventthe monopolist from earning a profit, itwill leave the industry. 40
  • Price discrimination• Price discrimination is the practice ofa seller charging different prices for thesame good not justifies by costdifferences.• Price discrimination allows themonopolist to increase profits bycharging buyers different prices, ratherthan a single price. 41
  • Conditions necessary for PriceDiscriminationThree conditions:(2)the demand curve must be downward- sloping (firm must be a monopoly)(3)buyers in different markets must have different price elasticities of demand (high elasticity low price, vice versa), and(4)buyers must be prevented from reselling the product at a higher price than the purchase price. 42
  • P Price Discrimination Market for inelastic demand MR=MCT1 MC MR D Q1 Q 43
  • P Monopolist Price Discrimination Market for elastic demand MR=MCT2 MC MR D Q2 Q 44
  • Disadvantages of monopoly(1)A monopolist charges a higher price and produces less output than a perfectly competitive firm,(2)Resource allocation is inefficient because the monopolist produces less than if competition existed (P>min AC, P>MC),(3)monopoly produces higher long-run profits than if competition existed, and(4)monopoly transfers income from consumers to producers to a greater degree than under perfect competition. 45
  • P200 P>min AC, P>MC175 MC150125100 ATC 75 Profit 50 25 MR D 1 2 3 4 5 6 7 8 9 Q 46
  • P P=min AC, P=MC MC70 ATC60504030 MR2010 1 2 3 4 5 6 7 8 9 Q 47
  • IMPERFECT COMPETITION• Imperfect competition is themarket structure between theextremes of perfect competition andmonopoly.• Monopolistic Competition andOligopoly belong to the imperfectcompetition category. 48
  • MONOPOLISTIC COMPETITION Monopolistic competition is a market structure characterized by(2)many small sellers(3)differentiated product(4)Some ability to influence market price (firm’s demand curve is downward sloping)(5)easy market entry and exit. 49
  • PRODUCT DIFFERENTIATION• Product differentiation is a keycharacteristic of monopolisticcompetition. It is the process ofcreating real or apparent differencesbetween products.• Each firm’s output is a closesubstitute of another’s 50
  • NONPRICE COMPETITION• Under imperfect competition,firms may compete using non-pricecompetition, rather than pricecompetition.• Non-price competition includesadvertising, packaging, free gift,rebate, product development, betterquality, and better service. 51
  • SHORT RUN and LONG RUNEQUILIBRIUM• Short-run equilibrium for amonopolistic competitor can yieldsupernormal profit (TR>TC),subnormal profit (TR<TC), or normalprofit (TR=TC).• In the long run, monopolisticcompetitors make normal profits onlydue to easy market entry and exit. 52
  • Short Run Eqm: Supernormal Profit P5040 MC3025 ATC2015 Profit10 5 MR AR=D 1 2 3 4 5 6 7 8 9 Q 53
  • P200 Short Run Eqm: Subnormal Profit ATC175 MC150125 Loss100 75 50 25 MR AR=D 1 2 3 4 5 6 7 8 9 Q 54
  • P40 NORMAL PROFIT35 MC302520 ATC1510 5 AR=D MR 1 2 3 4 5 6 7 8 9 Q 55
  • Comparison:Monopolistic Comp & Perfect Comp • Differences: Monopolistic competitive firm charges a higher price, restricts output, and does not achieve productive efficiency (P>min AC) and allocative efficiency (P>MC). • Similarities: Both earn normal profits in the long run. Why? 56
  • P40 Normal Profits35 Minimum MC LRAC302520 ATC1510 5 MR D 1 2 3 4 5 6 7 8 9 Q 57
  • P Perfect Competition$40 Minimum MC$35 LRAC LRAC$30$25 MR$20$15$10 $5 1 2 3 4 5 6 7 8 9 Q 58
  • OLIGOPOLYOligopoly is a market structure characterized by(2)few sellers,(3)a homogeneous or differentiated product,(4)considerable power to influence market price but prefer to engage in non-price competition(5)difficult market entry.**Oligopolies are mutually interdependent because an action by one firm may cause a reaction on the part of other firms. 59
  • NONPRICE COMPETITION• The nonprice competition model is atheory that might explain oligopolisticbehavior.• Under this theory, firms use advertisingand product differentiation, rather thanprice reductions, to compete. 60
  • MODELS TO EXPLAIN PRICESTABILITY IN OLIGOPOLY• Paul Sweezy’s Kinked Demand Curve• Price Leadership• Cartel 61
  • Paul Sweezy’ Model of KinkedDemand Curve• The model explains why prices may berigid (stable) in an oligopoly market.• The kink is established because anoligopolist assumes that rivals will match aprice decrease, but ignore a price increase. 62
  • 400 P Oligopolist’s Kinked Demand Curve350 MC300250200150100 50 AR=D 5 10 15 20 25 30 35 40 45 Q MR 63
  • PRICE LEADERSHIP• Price leadership is another theory ofpricing behavior under oligopoly.• When a dominant firm in an industryraises or lowers price, other firmsfollow suit.• Reason: To avoid “price war” 64
  • CARTEL• A cartel is a formal agreementamong firms to set prices and outputquotas.• The goal is to maximize profits,but firms have an incentive to cheat,which is a constant threat to a cartel. 65
  • Comparison between OligopolyPerfect Competition• Oligopolist charges a higher price,restricts output so that price may exceedaverage cost and allocates resourcesinefficiently.• Oligopolist are able to maintainsupernormal profit in the long run due toeffective market entry barriers. 66