Market Structure- Micro Economics

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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

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Market Structure- Micro Economics

  1. 1. Market Structure
  2. 2. 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
  3. 3. Introduction • Perfect competition, with an infinite number of firms, and monopoly, with a single firm, are polar opposites. • Monopolistic competition and oligopoly lie between these two extremes.
  4. 4. 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.
  5. 5. The Meaning of Competition As a result of its characteristics, the perfectly competitive market has the following outcomes: The actions of any single buyer or seller in the market have a negligible impact on the market price. Each buyer and seller takes the market price as given. Thus, each buyer and seller is a price taker.
  6. 6. Perfect Competition
  7. 7. Profit-Maximizing Level of Output • The goal of the firm is to maximize profits. • Profit is the difference between total revenue and total cost.
  8. 8. Revenue of a Competitive Firm Total revenue for a firm is the selling price times the quantity sold. TR = (P X Q)
  9. 9. Revenue of a Competitive Firm Marginal revenue is the change in total revenue from an additional unit sold. MR =∆TR/ ∆Q
  10. 10. Revenue of a Competitive Firm For competitive firms, marginal revenue equals the price of the good.
  11. 11. Total, Average, and Marginal Revenue for a Competitive Firm Quant it y (Q) Price (P) Tot al Revenue (TR= PxQ) Average Revenue (AR= TR/ Q) Marginal Revenue (MR= ) 1 $6.00 $6.00 $6.00 2 $6.00 $12.00 $6.00 $6.00 3 $6.00 $18.00 $6.00 $6.00 4 $6.00 $24.00 $6.00 $6.00 5 $6.00 $30.00 $6.00 $6.00 6 $6.00 $36.00 $6.00 $6.00 7 $6.00 $42.00 $6.00 $6.00 8 $6.00 $48.00 $6.00 $6.00 QTR ∆∆ /
  12. 12. TC TR 0 Totalcost,revenue $385 350 315 280 245 210 175 140 105 70 35 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 McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
  13. 13. 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.
  14. 14. Profit-Maximizing Level of Output • 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.
  15. 15. How to Maximize Profit • If marginal revenue does not equal marginal cost, a firm can increase profit by changing output. • The supplier will continue to produce as long as marginal cost is less than marginal revenue.
  16. 16. How to Maximize Profit • The supplier will cut back on production if marginal cost is greater than marginal revenue. • Thus, the profit-maximizing condition of a competitive firm is MC = MR = P.
  17. 17. Again! MR=MC • Profit is maximized when MR=MC. – If the cost of producing one more unit is less than the revenue it generates, then a profit is available for the firm that increases production by one unit. – If the cost of producing one more unit is more than the revenue it generates, then increasing production reduces profit.
  18. 18. Profit Maximization: Using MR and MC curves
  19. 19. Profit Maximization: The Numbers Q P TR TC TR-TC MR MC ATC 0 $1 $0 $1.00 -$1.00 $1 1 $1 $1 $2.00 -$1.00 $1 $1.00 $2.00 2 $1 $2 $2.80 -$0.80 $1 $0.80 $1.40 3 $1 $3 $3.50 -$0.50 $1 $0.70 $1.17 4 $1 $4 $4.00 $0.00 $1 $0.50 $1.00 5 $1 $5 $4.50 $0.50 $1 $0.50 $0.90 6 $1 $6 $5.20 $0.80 $1 $0.70 $0.87 7 $1 $7 $6.00 $1.00 $1 $0.80 $0.86 8 $1 $8 $6.86 $1.14 $1 $0.86 $0.86 9 $1 $9 $7.86 $1.14 $1 $1.00 $0.87 10 $1 $10 $9.36 $0.64 $1 $1.50 $0.94 11 $1 $11 $12.00 -$1.00 $1 $2.64 $1.09 MR=MCMR=MC
  20. 20. 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.
  21. 21. The Interaction of Firms and Markets FirmFirm MarketMarketPricePrice AndAnd CostsCosts PricePrice qqFF QQMM aa bb cc dd AA BB qq11qq22qq33qq44 QQ11 QQ22 MCMC P=MRP=MR00 ATCATC P=MRP=MR11 AVCAVC SS11 SS22 DD00 $10$10 ATCATC =$7=$7 10 units10 units
  22. 22. The Marginal-Cost Curve and the Firm’s Supply Decision... Quantity0 Costs and Revenue MC ATC AVC Q1 P1 P2 Q2 This section of the firm’s MC curve is also the firm’s supply curve (long- run).
  23. 23. 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.
  24. 24. Determining Profit and Loss • The firm makes a profit when the ATC curve is below the MR curve. • The firm incurs a loss when the ATC curve is above the MR curve.
  25. 25. Determining Profit and Loss From a Graph • Zero profit or loss where MC=MR. – Firms can earn zero profit or even a loss where MC = MR. – Even though economic profit is zero, all resources, including entrepreneurs, are being paid their opportunity costs.
  26. 26. (a) Profit case (b) Zero profit case (c) Loss case Determining Profits Graphically Quantity Quantity Quantity Price 65 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 0 1 2 3 4 5 6 7 8 910 12 1 2 3 4 5 6 7 8 910 12 D MC A P = MR B ATC AVC E 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 = MR P = MR Price Price © The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill
  27. 27. Loss Minimization Average cost of a unit of outputAverage cost of a unit of output RevenueRevenue generated by agenerated by a unit of outputunit of output MarketMarket priceprice fallsfalls
  28. 28. The Firm’s Short-Run Decision to Shut Down The firm shuts down if the revenue it gets from producing is less than the variable cost of production. Shut down if TR < VC Shut down if TR/Q < VC/Q Shut down if P < AVC
  29. 29. The Shutdown Point • If total revenue is more than total variable cost, the firm’s best strategy is to temporarily produce at a loss. • It is taking less of a loss than it would by shutting down.
  30. 30. 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
  31. 31. 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 < TC Exit if TR/Q < TC/Q Exit if P < ATC
  32. 32. The Firm’s Long-Run Decision to Exit or Enter a Market A firm will enter the industry if such an action would be profitable. Enter if TR > TC Enter if TR/Q > TC/Q Enter if P > ATC

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