Types of Market Structure
PERFECT COMPETITION AND
MONOPOLY
Perfect Competition
ASSUMPTIONS OF PERFECT
COMPETITION
• Many independent firms
• Each seller is small relative to the whole market
• Homogene...
Price Taking
The perfectly competitive firm is said to be a
price-taker, because it takes the market price
as given and ha...
If the firm tried to charge a higher price, it
would lose all its business. Customers could
go elsewhere to buy the same p...
The demand curve for the product of the
perfectly competitive firm shows how much
can be sold at specific prices. Let’s se...
The firm can sell 10 units for $5.
price
$5

10

quantity
The firm can sell 20 units for $5.
price
$5

20

quantity
The firm can sell 30 units for $5.
price
$5

30

quantity
The firm can sell 40 units for $5.
price
$5

40

quantity
The firm can sell 50 units for $5.
price

$5

50

quantity
So all these points are on the demand
curve for the firm’s product.
price
$5

quantity
Connecting these points, we have the
demand curve for the firm’s product.
price
$5

demand

quantity
The demand curve for the perfectly
competitive firm’s product is a
horizontal line at the market price.
price
market price...
Recall: Total Revenue
Total Revenue = Price x Quantity
TR = P Q
Recall: Marginal Revenue (MR)
Marginal Revenue is the additional revenue
earned from selling one additional unit of
output...
comment
For ease of writing, instead of writing the
“perfectly competitive” firm we will
frequently write the “p.c.” firm.
The MR Curve
for the p.c. Firm
For the p.c. firm, MR is equal to the market price.
So MR is a horizontal line at the level...
The demand curve (D) and the MR
curve for the perfectly competitive
firm’s product.
price
market price

D = MR

quantity
Optimal Output Level
Recall:
To maximize profit, the firm will produce at
the output level where MR = MC.
So the firm will...
Draw your axes; label them quantity and $.
$

Quantity
Draw your ATC, AVC, and MC curves. (Make sure
MC intersects ATC and AVC at the minimum.)
$
ATC

AVC

MC
Quantity
Draw the D = MR curve horizontal
at the market price.
$

D = MR
ATC

AVC

MC
Quantity
If the market price is P1 ,
the quantity produced will be Q1.
P1

$

D = MR
ATC

AVC

MC
Q1

Quantity
If the market price is P2 ,
the quantity produced will be Q2.
$

ATC

D = MR

P2
AVC
MC
Q2

Quantity
If the market price is P3 ,
the quantity produced will be Q3.
$
ATC
P3

AVC
D = MR

MC
Q3

Quantity
If the market price is P4 ,
the quantity produced will be Q4.
$
ATC
P4

AVC
D = MR

MC
Q4

Quantity
If the market price is P5 ,
the quantity produced will be Q5.
$
ATC

AVC
D = MR

P5
MC
Q5

Quantity
Price P5 was the minimum of the AVC curve
(the shutdown point). If the price fell any
lower than P5 the firm would produce...
The p.c. firm’s short run supply curve
The firm’s supply curve shows the quantity the firm
will produce at each price.
The...
The p.c. firm’s short run supply curve
Supply

$

ATC
AVC

MC
Quantity
The market short run supply curve
To determine the total amount that all the
firms will produce at each price, we simply
a...
Graphing Profit
A little trick for graphing a firm’s profit
Recall for a rectangle: Area = length . width
length

Area

width
We also know TR = P . Q.
So, if we can find a rectangle
whose length is P and whose
width is Q, then its area must
be tota...
To determine Total Cost, first remember
ATC = TC / Q
So, ATC . Q = TC
To determine Total Cost, first remember
ATC = TC / Q
So, ATC . Q = TC
ATC

Now, if we can find a rectangle
whose length is...
Then to determine profit,
we just subtract the TC area from the TR area.
Graphing Profit:
The six steps
Step 1 a. Draw your axes and label them Q and
$. ( Label the origin 0.)
$

0

Quantity
Step 1b. Draw the firm’s ATC curve. (If the price is below the
minimum of ATC, you will also need to draw the AVC curve.)
...
Step 1 c. Draw the MC curve and D=MR curve. (For a
positive profit, D must be at least partly above ATC.)

$

MC

ATC

P

...
Step 2: Determine the profit-maximizing
output (Q*) by finding where MR = MC.
MC

$
P

0

ATC
D = MR

Q*

Quantity
Step 3: Find your TR = PQ rectangle.
MC

$
P

0

ATC
D = MR

Q*

Quantity
Step 4: Determine ATC at the profit-maximizing
output level.
MC

$
P

ATC
D = MR

ATC

0

Q*

Quantity
Step 5: Find your TC = ATC . Q rectangle.
MC

$
P

ATC
D = MR

Q*

Quantity
Step 6: Find profit π = TR - TC.
MC

$
P

ATC
D = MR

profit

Q*

Quantity
You follow the same steps to
draw a firm that is making a loss
or breaking even (zero profits).
Let’s do a firm with a los...
Step 1: Draw & label the curves & axes. For a loss, put D
above the minimum of AVC & below the minimum of ATC.

$

MC

ATC...
Step 2: Determine the profit-maximizing
output (Q*) by finding where MR = MC.
MC

$

ATC
AVC

P

D = MR

0

Q*

Quantity
Step 3: Find your TR = PQ rectangle.
$

MC

ATC
AVC

P

D = MR

0

Q*

Quantity
Step 4: Determine ATC at the profit-maximizing
(or loss-minimizing) output level.
$

MC

ATC

ATC
AVC

P

D = MR

0

Q*

Q...
Step 5: Find your TC = ATC . Q rectangle.
$

MC

ATC

ATC
AVC

P

D = MR

0

Q*

Quantity
Step 6: Find profit (or loss) π = TR - TC.
MC

$

AVC

loss

P

ATC

D = MR

0

Q*

Quantity
A firm that is breaking even
(zero profits)
Step 1: Draw & label the curves & axes. To break even,
make D tangent to the minimum of ATC.

$

P

0

MC

ATC
D = MR

Qua...
Step 2: Determine the profit-maximizing
output (Q*) by finding where MR = MC.
MC

$

D = MR

P

0

ATC

Q*

Quantity
Step 3: Find your TR = PQ rectangle.
MC

$

D = MR

P

0

ATC

Q*

Quantity
Step 4: Determine ATC at the profit-maximizing
output level.
MC

$

D = MR

ATC = P

0

ATC

Q*

Quantity
Step 5: Find your TC = ATC . Q rectangle.
MC

$

D = MR

ATC = P

0

ATC

Q*

Quantity
Step 6: Find profit π = TR - TC.
MC

$

D = MR

ATC = P

0

ATC

Q*

Quantity
Adapting to Changes
in Demand
Constant Cost Industry
an industry in which costs of production remain
constant as output in the industry expands
Let’s start with the industry in long run equilibrium.
What is each firm’s economic profit (+, – , or 0)?
Zero.
That means...
If firms were just breaking even (zero economic profit) at
the old price, what will profit be at the new higher price?
It ...
What will happen to the supply of the product as new firms
enter the industry?
It will increase.
What happens to the price...
So what has happened as a result of the increase
in demand in this constant cost industry?
We now have the same price we h...
That means that the long run supply curve in a
constant cost industry is horizontal.
Market
P

long run
supply curve

P1= ...
Increasing Cost Industry
an industry in which costs of production increase
as output in the industry expands
Let’s start again with the industry
in long run equilibrium.
What is each firm’s economic profit (+, – , or 0)?
Zero.
So t...
If firms were just breaking even (zero economic profit) at the
old price, what will happen to profit at the new higher pri...
What will happen to the supply of the product as
new firms enter the industry?
It will increase.
Before when we had a cons...
So the industry supply curve is shifting to the right,
and the ATC and other cost curves are creeping up.
As the supply in...
So what has happened as a result of the increase
in demand in this increasing cost industry?
Supply expanded in response t...
That means that the long run supply curve in
an increasing cost industry is upward sloping.
Market
P

long run
supply curv...
Decreasing Cost Industry
an industry in which costs of production fall
as output in the industry expands
Let’s start again with the industry
in long run equilibrium.
What is each firm’s economic profit (+, – , or 0)?
Zero.
So t...
If firms were just breaking even at the old price, what
will happen to profit at the new higher price?
It will be positive...
What will happen to the supply of the product as
new firms enter the industry?
It will increase.
Now we have a decreasing ...
So the industry supply curve is shifting to the right,
and the ATC and other cost curves are sliding down.
As the supply i...
So what has happened as a result of the increase
in demand in this decreasing cost industry?
Supply expanded in response t...
That means that the long run supply curve in an
decreasing cost industry is downward sloping.
Market
P

P1
P2

long run
su...
Good Things about Perfect Competition
• Costs are minimized.

Competition forces efficient operation. Inefficient firms
wi...
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  1. 1. Types of Market Structure PERFECT COMPETITION AND MONOPOLY
  2. 2. Perfect Competition
  3. 3. ASSUMPTIONS OF PERFECT COMPETITION • Many independent firms • Each seller is small relative to the whole market • Homogeneous (identical) product • Easy entry and exit (no barriers to entry)
  4. 4. Price Taking The perfectly competitive firm is said to be a price-taker, because it takes the market price as given and has no control over the price. Why?...
  5. 5. If the firm tried to charge a higher price, it would lose all its business. Customers could go elsewhere to buy the same product for less. Since the firm is very small, it can sell as much as it wants at the market price. So there’s no reason to charge a lower price.
  6. 6. The demand curve for the product of the perfectly competitive firm shows how much can be sold at specific prices. Let’s see what it would look like... The firm can sell as little or as much as it wants at the market price. Suppose, for example, the market price is $5.
  7. 7. The firm can sell 10 units for $5. price $5 10 quantity
  8. 8. The firm can sell 20 units for $5. price $5 20 quantity
  9. 9. The firm can sell 30 units for $5. price $5 30 quantity
  10. 10. The firm can sell 40 units for $5. price $5 40 quantity
  11. 11. The firm can sell 50 units for $5. price $5 50 quantity
  12. 12. So all these points are on the demand curve for the firm’s product. price $5 quantity
  13. 13. Connecting these points, we have the demand curve for the firm’s product. price $5 demand quantity
  14. 14. The demand curve for the perfectly competitive firm’s product is a horizontal line at the market price. price market price demand quantity
  15. 15. Recall: Total Revenue Total Revenue = Price x Quantity TR = P Q
  16. 16. Recall: Marginal Revenue (MR) Marginal Revenue is the additional revenue earned from selling one additional unit of output. MR = ∆TR / ∆Q
  17. 17. comment For ease of writing, instead of writing the “perfectly competitive” firm we will frequently write the “p.c.” firm.
  18. 18. The MR Curve for the p.c. Firm For the p.c. firm, MR is equal to the market price. So MR is a horizontal line at the level of that price. The demand curve for the p.c. firm is also a horizontal line at the level of the market price. So, for the p.c. firm, the demand curve and the MR curve are the same horizontal line.
  19. 19. The demand curve (D) and the MR curve for the perfectly competitive firm’s product. price market price D = MR quantity
  20. 20. Optimal Output Level Recall: To maximize profit, the firm will produce at the output level where MR = MC. So the firm will produce where the MR and MC curves intersect.
  21. 21. Draw your axes; label them quantity and $. $ Quantity
  22. 22. Draw your ATC, AVC, and MC curves. (Make sure MC intersects ATC and AVC at the minimum.) $ ATC AVC MC Quantity
  23. 23. Draw the D = MR curve horizontal at the market price. $ D = MR ATC AVC MC Quantity
  24. 24. If the market price is P1 , the quantity produced will be Q1. P1 $ D = MR ATC AVC MC Q1 Quantity
  25. 25. If the market price is P2 , the quantity produced will be Q2. $ ATC D = MR P2 AVC MC Q2 Quantity
  26. 26. If the market price is P3 , the quantity produced will be Q3. $ ATC P3 AVC D = MR MC Q3 Quantity
  27. 27. If the market price is P4 , the quantity produced will be Q4. $ ATC P4 AVC D = MR MC Q4 Quantity
  28. 28. If the market price is P5 , the quantity produced will be Q5. $ ATC AVC D = MR P5 MC Q5 Quantity
  29. 29. Price P5 was the minimum of the AVC curve (the shutdown point). If the price fell any lower than P5 the firm would produce no output.
  30. 30. The p.c. firm’s short run supply curve The firm’s supply curve shows the quantity the firm will produce at each price. The P, Q values we have shown, therefore, are points on the firm’s supply curve. But those points are all on the firm’s MC curve. So, the firm’s supply curve is the part of the MC curve that is above the minimum of the AVC curve.
  31. 31. The p.c. firm’s short run supply curve Supply $ ATC AVC MC Quantity
  32. 32. The market short run supply curve To determine the total amount that all the firms will produce at each price, we simply add up the amounts that each of the firms will produce at that price.
  33. 33. Graphing Profit
  34. 34. A little trick for graphing a firm’s profit Recall for a rectangle: Area = length . width length Area width
  35. 35. We also know TR = P . Q. So, if we can find a rectangle whose length is P and whose width is Q, then its area must be total revenue. P TR Q
  36. 36. To determine Total Cost, first remember ATC = TC / Q So, ATC . Q = TC
  37. 37. To determine Total Cost, first remember ATC = TC / Q So, ATC . Q = TC ATC Now, if we can find a rectangle whose length is ATC and whose width is Q, then its area is TC. TC Q
  38. 38. Then to determine profit, we just subtract the TC area from the TR area.
  39. 39. Graphing Profit: The six steps
  40. 40. Step 1 a. Draw your axes and label them Q and $. ( Label the origin 0.) $ 0 Quantity
  41. 41. Step 1b. Draw the firm’s ATC curve. (If the price is below the minimum of ATC, you will also need to draw the AVC curve.) $ MC ATC P 0 Quantity
  42. 42. Step 1 c. Draw the MC curve and D=MR curve. (For a positive profit, D must be at least partly above ATC.) $ MC ATC P D = MR 0 Quantity
  43. 43. Step 2: Determine the profit-maximizing output (Q*) by finding where MR = MC. MC $ P 0 ATC D = MR Q* Quantity
  44. 44. Step 3: Find your TR = PQ rectangle. MC $ P 0 ATC D = MR Q* Quantity
  45. 45. Step 4: Determine ATC at the profit-maximizing output level. MC $ P ATC D = MR ATC 0 Q* Quantity
  46. 46. Step 5: Find your TC = ATC . Q rectangle. MC $ P ATC D = MR Q* Quantity
  47. 47. Step 6: Find profit π = TR - TC. MC $ P ATC D = MR profit Q* Quantity
  48. 48. You follow the same steps to draw a firm that is making a loss or breaking even (zero profits). Let’s do a firm with a loss.
  49. 49. Step 1: Draw & label the curves & axes. For a loss, put D above the minimum of AVC & below the minimum of ATC. $ MC ATC AVC P D = MR 0 Quantity
  50. 50. Step 2: Determine the profit-maximizing output (Q*) by finding where MR = MC. MC $ ATC AVC P D = MR 0 Q* Quantity
  51. 51. Step 3: Find your TR = PQ rectangle. $ MC ATC AVC P D = MR 0 Q* Quantity
  52. 52. Step 4: Determine ATC at the profit-maximizing (or loss-minimizing) output level. $ MC ATC ATC AVC P D = MR 0 Q* Quantity
  53. 53. Step 5: Find your TC = ATC . Q rectangle. $ MC ATC ATC AVC P D = MR 0 Q* Quantity
  54. 54. Step 6: Find profit (or loss) π = TR - TC. MC $ AVC loss P ATC D = MR 0 Q* Quantity
  55. 55. A firm that is breaking even (zero profits)
  56. 56. Step 1: Draw & label the curves & axes. To break even, make D tangent to the minimum of ATC. $ P 0 MC ATC D = MR Quantity
  57. 57. Step 2: Determine the profit-maximizing output (Q*) by finding where MR = MC. MC $ D = MR P 0 ATC Q* Quantity
  58. 58. Step 3: Find your TR = PQ rectangle. MC $ D = MR P 0 ATC Q* Quantity
  59. 59. Step 4: Determine ATC at the profit-maximizing output level. MC $ D = MR ATC = P 0 ATC Q* Quantity
  60. 60. Step 5: Find your TC = ATC . Q rectangle. MC $ D = MR ATC = P 0 ATC Q* Quantity
  61. 61. Step 6: Find profit π = TR - TC. MC $ D = MR ATC = P 0 ATC Q* Quantity
  62. 62. Adapting to Changes in Demand
  63. 63. Constant Cost Industry an industry in which costs of production remain constant as output in the industry expands
  64. 64. Let’s start with the industry in long run equilibrium. What is each firm’s economic profit (+, – , or 0)? Zero. That means that the price is at the minimum of the ATC curve and is just sufficient to cover the cost per unit of producing the good. Next suppose that demand increases. What happens to the price? It increases.
  65. 65. If firms were just breaking even (zero economic profit) at the old price, what will profit be at the new higher price? It will be positive. Does positive economic profit mean that the firms are doing better, worse, or about the same as firms in other industries are doing? Better. What is the nature of barriers to entry in perfect competition? There are no barriers to entry. So we’ve got positive economic profit and no barriers to entry. What will happen? Firms will enter the industry.
  66. 66. What will happen to the supply of the product as new firms enter the industry? It will increase. What happens to the price of the product? It falls. So the price goes back to where it was before the demand change, but there is more output being produced by more firms. Note that if the price didn’t drop enough, there would still be positive economic profits and firms would continue to enter the industry, supply would keep increasing, and the price would drop some more. If the price dropped too much, it would not cover costs per unit, and there would be losses. Firms would leave the industry, supply would fall and the price would come back up to just covering costs per unit.
  67. 67. So what has happened as a result of the increase in demand in this constant cost industry? We now have the same price we had before, but we now have more output because we have more firms in the industry. So in a constant cost industry, firms will produce as much or as little as the economy demands at a price which is just enough to cover the cost per unit.
  68. 68. That means that the long run supply curve in a constant cost industry is horizontal. Market P long run supply curve P1= P2 Q1 Q2
  69. 69. Increasing Cost Industry an industry in which costs of production increase as output in the industry expands
  70. 70. Let’s start again with the industry in long run equilibrium. What is each firm’s economic profit (+, – , or 0)? Zero. So the price is at the minimum of the ATC curve and is just sufficient to cover the cost per unit of producing the good. Next suppose that demand increases. What happens to the price? It increases.
  71. 71. If firms were just breaking even (zero economic profit) at the old price, what will happen to profit at the new higher price? It will be positive. Are the firms are doing better, worse, or about the same as firms in other industries are doing? Better. What is the nature of the barriers to entry in perfect competition? There are no barriers to entry. So we’ve got positive economic profit and no barriers to entry. What will happen? Firms will enter the industry.
  72. 72. What will happen to the supply of the product as new firms enter the industry? It will increase. Before when we had a constant cost industry, the costs remained the same as the industry expanded. However, now we have an increasing cost industry. That means that as the industry expands, it puts upward pressure on the price of the inputs used in the industry and the cost of production increases. So visualize all the cost curves, including the ATC, creeping up.
  73. 73. So the industry supply curve is shifting to the right, and the ATC and other cost curves are creeping up. As the supply increases, what happens to the price of the product? It falls. But the price does not fall back to where it was before the demand change, which was at the minimum of the old ATC curve. It only drops until we are back to zero economic profits under the new conditions, which is at the bottom of the new, higher, ATC curve.
  74. 74. So what has happened as a result of the increase in demand in this increasing cost industry? Supply expanded in response to the increased profits resulting from the increase in demand. However, costs increased so that we ended up with a higher price that is just enough to cover the new higher cost per unit.
  75. 75. That means that the long run supply curve in an increasing cost industry is upward sloping. Market P long run supply curve P2 P1 Q1 Q2 Q
  76. 76. Decreasing Cost Industry an industry in which costs of production fall as output in the industry expands
  77. 77. Let’s start again with the industry in long run equilibrium. What is each firm’s economic profit (+, – , or 0)? Zero. So the price is at the minimum of the ATC curve and is just sufficient to cover the cost per unit of producing the good. Next suppose that demand increases. What happens to the price? It increases.
  78. 78. If firms were just breaking even at the old price, what will happen to profit at the new higher price? It will be positive. Are the firms are doing better, worse, or about the same as firms in other industries are doing? Better. What is the nature of the barriers to entry in perfect competition? There are no barriers to entry. So we’ve got positive economic profit and no barriers to entry. What will happen? Firms will enter the industry.
  79. 79. What will happen to the supply of the product as new firms enter the industry? It will increase. Now we have a decreasing cost industry. That means that as the industry expands and infrastructure improves, the cost of production decreases. So visualize all the cost curves, including the ATC, sliding down.
  80. 80. So the industry supply curve is shifting to the right, and the ATC and other cost curves are sliding down. As the supply increases, what happens to the price of the product? It falls. But the price does not fall back to where it was before the demand change, which was at the minimum of the old ATC curve. It keeps dropping until we are back to zero economic profits under the new conditions, which is at the bottom of the new, lower, ATC curve.
  81. 81. So what has happened as a result of the increase in demand in this decreasing cost industry? Supply expanded in response to the increased profits resulting from the increase in demand. However, costs decreased so that we ended up with a lower price that is just enough to cover the new lower cost per unit.
  82. 82. That means that the long run supply curve in an decreasing cost industry is downward sloping. Market P P1 P2 long run supply curve Q1 Q2 Q
  83. 83. Good Things about Perfect Competition • Costs are minimized. Competition forces efficient operation. Inefficient firms will have losses and be forced out of business. • P = MC The price (which comes from the demand curve) is the amount that consumers value a good. MC is the cost of producing an additional unit of a good. So firms produce up to the point where the amount that consumers value a good is equal to the amount it costs to produce an additional unit of the good.
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