2. Market structure – identifies how a market
is made up in terms of:
 The number of firms in the industry
 The nature of the product produced
 The degree of monopoly power each firm has
 The degree to which the firm can influence price
 Profit levels
 Firms’ behaviour – pricing strategies, non-price
competition, output levels
 The extent of barriers to entry
 The impact on efficiency
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3. Economists group industries into four distinct
market structures based on their
characteristics. The four market models are:




Pure competition
Monopolistic competition
Oligopoly
Pure monopoly
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4. Pure competition is one of four market
structures in which thousands of firms each
produce a tiny fraction of market supply in their
respective industries.

Examples: farm commodities (wheat, soybean,
strawberries, milo), the stock market, and the
foreign exchange market
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5. 



Ver y large numbers – a large number of
independently acting sellers who offer their
products in large markets.
Standardized product – firms produce a
product that is identical or homogenous.
Price taker – the firm cannot change the
market price, but can only accept it as
“given” and adjust to it.
Free entr y and exit – no barriers to entry
exist.
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6. Advantages:
 optimal allocation of resources
 competition encourages efficiency
 consumers charged a lower price
 responsive to consumer wishes: Change in demand, leads extra
supply
Disadvantages:
 insufficient profits for investment
 lack of product variety
 lack of competition over product design and specification
 unequal distribution of goods & income
 externalities e.g. Pollution
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7. The demand schedule and demand curve faced
by the individual firm in a purely competitive
industry is perfectly elastic at the market price.


Recall that the firm is a price taker and cannot
influence the market price.
However, the industry as a whole, which determines
the market demand curve, can affect price by
changing industry output.
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8. INDUSTRY (OR
MARKET) DEMAND
AND SUPPLY
Price
S
INDIVIDUAL
FIRM DEMAND
Price
D
P
D
Q
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Quantity
Quantity
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9. If market supply increases, the market price falls. Since each firm is
a price taker, it has no choice but to charge the lower price for its product.
MARKET DEMAND AND SUPPLY
Price
S1
Price
FIRM DEMAND
S2
P1
P2
D1
D2
D
Q1 Q 2
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Quantity
Quantity
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10. 
Average revenue (AR) is total revenue from
the sale of a product divided by the quantity of
the product sold.


AR = TR ÷ Q
Total revenue (TR) is the total number of
dollars received by a firm from the sale of a
product.

TR = P x Q
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11. 
Marginal revenue (MR) is the change in
total revenue that results from selling 1 more
unit of output.
MR = (change in TR) ÷ (change in Q)
 MR is constant at the market determined price—
each additional unit of output produced adds the
same amount to total revenue.

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12. 

Graphically, total revenue is a straight line that
slopes upward to the right.
The demand, marginal revenue, and average
revenue curves are horizontal at the market
price P. All three curves coincide.
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13. Price
$12
TR
$8
D = AR = MR
$4
1
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2
3
4
Quantity
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14. 

Because the purely competitive firm is a price
taker, it can maximize its economic profit (or
minimize its economic loss) only by adjusting
its output.
In the short run, the firm can adjust its variable
resources (but not its fixed resources) to
achieve the output level that maximizes profit.
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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

15. 
In deciding how much to produce, the firm will
compare the marginal revenue and marginal
cost of each successive unit of output.
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16. 

As long as producing is preferable to shutting
down, the firm should produce any unit of
output whose marginal revenue exceeds its
marginal cost.
If the marginal cost of a unit of output exceeds
its marginal revenue, the firm should not
produce that unit.
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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

17. 
A method of determining the total output at
which economic profit is at a maximum (or
losses at a minimum) is known as the MR
= MC rule.



This rule only applies if producing is preferable to
shutting down.
In pure competition only, we can restate this rule
as P = MC.
A firm will adjust output until marginal revenue is
equal to marginal cost.
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18. Profit Maximization
If price exceeds ATC at the MR = MC output
(q*), the firm will realize an economic profit
equal to q*(P – ATC).
Loss Minimization
If price exceeds the minimum AVC but is less
than ATC, the MR = MC output will permit the
firm to minimize losses equal to q*(P – ATC).
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19. Using the MR = MC rule, output is q*. Since price is greater
than ATC at q*, the firm is earning an economic profit.
P
MC
ECONOMIC
PROFIT
ATC
AVC
MR
P*
ATC
q*
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Q
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20. The price is less than ATC at q* so the firm is making a loss.
Since price is greater than the minimum AVC at q*, the firm
continues
LOSS
P
to operate
MC
at a loss.
ATC
AVC
ATC
P*
AVC
MR
q*
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Q
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21. Shutdown
 If price falls below the minimum AVC, the
competitive firm will minimize its losses in the
short run by shutting down.
 A firm shuts down if the total revenue that it
would get from producing is less than the
variable costs of production.
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22. Price
Break-even
(normal profit)
point
MC
ATC
P5
MR5
AVC
P4
P3
MR4
MR3
P2
MR2
P1
MR1
Shutdown point
(if P is below)
Q2 Q3Q4 Q5
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quantity
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23. Generalized Depiction
Price P1 is below the firm’s minimum AVC; the firm
will not operation and quantity supplied will be zero.
 Price P is just equal to the minimum AVC. The firm
2
will produce at a loss equal to its fixed cost.
 Between price P and P , the firm will minimize its
2
4
losses by producing and supplying the MR = MC
quantity.

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24. Generalized Depiction
At price P4, the firm will just break even and earns a
normal profit.
 At price P5, the firm will realize an economic profit
by producing to the point where
MR (=P) =
MC.

McGraw-Hill/Irwin
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

25. 
The competitive firm’s shor t-run supply
cur ve tells us the amount of output the firm
will supply at each price in a series of prices.


It is the portion of the MC curve above the
shutdown point.
It slopes upward because of the law of diminishing
returns.
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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

26. 
Equilibrium price is determined by the
intersection of total, or market, supply and total
demand.


The individual supply curve of each of the identical
firms in an industry are summed horizontally to get
the total supply curve.
The market supply together with market demand
will determine the equilibrium price in a competitive
industry.
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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

27. 
The long-run assumptions in a competitive
industry are:



The only adjustment is the entry or exit of firms.
All firms in the industry have identical cost curves.
The industry is a constant cost industry.
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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.