Market Structures

MONOPOLY

OLIGOPOLY

MONOPOLISTIC COMPETITION

Competitive Markets

What is a market structure?

• The way consumers and producers are organized in a market– Amount of firms?– Variety of goods?– Control over prices?– Barriers to entry?

How many firms are in the market?

Variety of goods

• How different are the goods in the market?

Control over prices

• How much control does a firm have over their prices?

Competitive Markets & the Profit Maximizing Firm

Chapter 14

What does this have to do with competition?

Do you think economists would consider this a competitive market?

What are competitive markets?• Two main conditions that must be met:–Many buyers and sellers–Goods offered are identical or largely the

same

• Also:–Firms can freely enter and exit the market

Economists sometimes call competitive markets perfect

competition. So, whether you hear a firm is in a competitive market or in a perfectly competitive market, it is the

same thing!

There are very few markets that compete perfectly

The market for wheat is a competitive market. This is because there are many buyers and sellers of wheat AND all

wheat is largely identical.

Most markets are not perfectly competitive, but very close.

The burger market is close to perfectly competitive because there are many buyers and sellers, but the product they sell is NOT identical. So, these firms are monopolistically competitive.

Monopolistic Competition

• Firms that produce differentiated products.– Products that are slightly different than one

another

We’ll talk more about monopolistic competition in chapter 17!

So which market do you think buyers have more control over price?

The perfectly competitive firm

If Joe the farmer sells wheat for $5 a bushel, then I’ll just

go buy wheat from Bob instead who sells it for $4 a bushel. What do I care? All wheat is the same so I just want the cheapest price!

Price Takers• Firms that are competing in a perfectly

competitive market are the “price takers.”• The firms have no control over price, so the

only thing they can control is how much they produce.

Nike has SOME control over the price of

sweaters because they can offer a slightly

different version than their competitors.

Joe the farmer has NO control over prices because

his wheat is exactly the same as his competitors. So if he

raises the price of his wheat, the customers will buy from

his competitors instead. Therefore, Joe the farmer is a

price taker.

Political Cartoon Contest• Think of a market that is monopolistically

competitive.• Draw a political cartoon of what that market

would look like if it was perfectly competitive.– Make it unique and eye catching– Creativity and humor definitely helps– Using popular figures also helps dramatically

• The top three will be chosen by the Social Studies Department

• Then, the residents of Econville will vote for the best cartoon in the class

Profit Maximization for competitive firms

Review: Key Concepts for Competitive Markets

• Market price = MR and AR• Profit maximization occurs where MR = MC• If MR > MC, the firm should increase output• If MR < MC, the firm should decrease output• The MC curve is also the firms supply curve– This is because the MC curve shows the quantity

supplied by the firm at any given price

The firms short run decision to shut down

What does shut down mean?• Shutting down is a short-run decision not to

produce anything for a specific period of time• When firms decide to close down forever and

leave the market, that is called an exit.

Most golf courses shut down in the winter.

In 2011, Borders exited the book market.

THE SUPPLY CURVE IN A COMPETITIVE MARKET

• Short-Run Supply Curve– The portion of its marginal cost curve that lies

above average variable cost.

• Long-Run Supply Curve– The marginal cost curve above the minimum point

of its average total cost curve.

MC

ATC

AVC

Costs

and

Revenue

Quantity

Short run supply curve starts here

Long run supply curve starts here

So when does a firm decide to shut down?

• Even if a firm does not make profit, there are instances where it is a rationale decision to stay open. Why?

• Because there are still fixed costs to pay!

Lets analyze a firm’s cost and revenue graph to understand the shut down

decision

Q3

P3

Optimal

Optimal

At what market price(s) will this firm have guaranteed profit?

P1 and P2

Q4

P4

Q3

P3

Optimal

Optimal

At what market price(s) will this firm have guaranteed losses?

P3 and P4

Q4

P4

Q3

P3

Optimal

Optimal

If market price was at P4, should the firm shut down?

NO!

Q4

P4

Q3

P3

Optimal

Optimal

At P4, the MR is greater than AVC. That means the quantity produced at P4 will cover all of the firm’s

variable costs plus some of its fixed costs.

So, this is better than shutting down and having to pay all of the firm’s fixed costs

Q4

P4

Q3

P3

Optimal

Optimal

If market price was P3, should the firm shut down?

Yes!

Q4

P4

Q3

P3

Optimal

Optimal

At P3, the MR is less than AVC. That means the quantity produced at P3 will not cover all of the

firm’s variable costs.

So, the firm won’t be able to cover its variable costs and even its fixed costs. Shut down!

Q4

P4

Review: Shut Down Key Concepts

• The short run supply curve is the portion of the MC curve that lies above AVC.

• The shut down decision only happens on the short run supply curve (short run decision)

• If MR > AVC, the firm does not shut down• If MR < AVC, the firm does shut down

sh

Q3

P3

Optimal

Optimal

Q4

P4

Questions?

The firms long run decision to exit the market

MC

ATC

Costs

Quantity

Long run supply curve starts here

Remember, the long run supply curve starts at the MC curve above the minimum point of ATC curve

So this is what a long run cost decision looks like (notice there is no AVC curve)

The rules of long run decisions

• When MR < ATC, the firm exits the market• When MR > ATC, new firms enter the market

MC

ATC

Costs

Quantity

P1

P2

P3

Q3Q2Q1

If market price was P1, the firm should exit the market because the revenue does not cover the total costs.

MC

ATC

Costs

Quantity

P1

P2

P3

Q3Q2Q1

If market price was P3, more firms will enter the market because the revenue not only covers the costs, but earns

profit for the firm.

MC

ATC

Costs

Quantity

P1

P2

P3

Q3Q2Q1

What would happen if market price was P2?

MC

ATC

Costs

Quantity

P1

P2

P3

Q3Q2Q1

If market price was P2, no firms would exit or enter the market. This is because profits in this market have been driven to zero.

Competitive Markets in the Long Run

How did the energy shot market go from this… TO THIS?

The Long Run: Market Supply with Entry and Exit

• Firms will enter or exit the market until profit is driven to zero.

• In the long run, price equals the minimum of average total cost.

• The long-run market supply curve is horizontal at this price.

So lets look at the long run energy shot market

The beginning days the energy shot

Firm(a) Initial Condition

Quantity (firm)0

Price

Market

Quantity (market)

Price

0

DDemand, 1

SShort-run supply, 1

P 1

ATC

Long-runsupplyP1

1Q

A

MC

The energy shot market began in long run equilibrium.

And the firms earned zero profit.

Teens start to get hooked on energy shots

Market Firm(b) Short-Run Response

Quantity (firm)0

Price

P 1

Quantity (market)

Long-runsupply

Price

0

D1

D2

P1

S 1

P 2

Q1

A

Q2

P2B

ATCMC

An increase in market demand…

…raises price and output.The higher P encourages firms to produce more…

…and generates short-run profit.

New firms enter the energy shot market

P 1

Firm(c) Long-Run Response

Quantity (firm)0

Price

MC ATC

Market

Quantity (market)

Price

0

P1

P2

Q1 Q2

Long-runsupply

B

D1

D2

S1

AS 2

Q3

C

Profits induce entry and market supply increases.

The increase in supply lowers market price. In the long run market price is restored, but market supply is greater.

We now have…