Market structures ± Perfect

competition
Market Structures
÷ Market structure refers to the number and
size of buyers and sellers in the market for
a good or service.
÷ A market can be defined as a group of
firms willing and able to sell a similar
product or service to the same potential
buyers.
àlassification of market
structures
÷ 4 broad categories ±
1. Perfect competition
2. Monopoly
3. Monopolistic competition
4. Oligopoly
Major features that determine
market structure
÷ Number of sellers

÷ Product differentiation

÷ Entry and exit conditions

˜hat we analyze in all Market
Structures«
÷ AR, MR
÷ Aà, Mà
÷ he point where MR = Mà ( Profit
maximum )
÷ Q* ( Equilibrium Output )
÷ P* ( Equilibrium Price )
Profit
÷ Normal Profit : hat part of the cost that is
paid to the entrepreneur as a part of his
compensation.
÷ Super-normal Profit : he profit that the
entrepreneur may get over and above the
compensation he gets from the firm, for his
contribution.
Perfect competition
÷ Features ±
1. Large number of buyers and sellers
2. Products are perfect substitutes of each other;
homogeneous products
3. Free entry and exit from the market
4. Perfect knowledge of the market to both buyers
and sellers
5. No govt. intervention
6. ransport cost are negligible hence don¶t affect
pricing.
 he Meaning of àompetition
±As a result of its characteristics, the
perfectly competitive market has the
following outcomes:
± he actions of any single buyer or seller in
the market have a negligible impact on the
market price.
±Each buyer and seller §
 the market
price as given.
 he Meaning of àompetition

Buyers and sellers in competitive

markets are said to be price takers.

Buyers and sellers must accept the

price determined by the market.
Revenue of a àompetitive Firm

otal revenue for a firm is the Ú



 times the
 Ú
.

TR = (P - Q)
Revenue of a àompetitive Firm

Average revenue tells us how much

revenue a firm receives for the typical
unit sold.
Revenue of a àompetitive Firm

In perfect competition, average

revenue equals the price of the
good.





á







` 


 

Revenue of a àompetitive Firm

Marginal revenue is the change in total

revenue from an additional unit sold.


¢T 
¢
Revenue of a àompetitive Firm

For competitive firms, marginal

revenue equals the price of the good.
 otal, Average, and Marginal Revenue
for a àompetitive Firm

h
  
  
  
  

 
h  h h ¢
D ¢h

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
 Profit Maximization for the
àompetitive Firm
± he goal of a competitive firm is to
maximize profit.
± his means that the firm will want to
produce the quantity that maximizes
the      
  


Ú.
Short run price and output
determination
÷ In SR a firm has to decide about the output it
should produce at the market price so that profit
is maximum.
÷ Some inputs are fixed=> fixed costs
÷ A firm may stay in business to cover these costs
even if it incurs losses in SR
÷ àost functions of firms are different as factors of
production are not homogeneous
÷ Hence each firm has different profit levels.
àonditions for Profit Maximization
÷ MR = Mà ( Necessary condition )
÷ Màà should intersect MRà from below or
Màà should be rising
 |
 § §§ 
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§ §
§



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§ 

Î Firm has to take the price as given by the market
ÎAt the ruling price firm can sell any amount of
its product
Î emand is perfectly elastic
ÎAR is parallel to X axis
ÎEquilibrium is at pt. E where demand is equal to
supply
Î his determines the price P*
Î his price is taken by the individual firm
÷ Equilibrium for the firm is where MR =Mà
and Mà curve cuts MR curve from below.
I.e. at point A

÷ Profit in the short run is the P*ABà

÷ he firm may incur short run losses also. If

the Aà curve lies above the AR=MR curve
the firm in the short run will incur losses.
 Ú
  
  
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r  

 
 
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ã


r  
ã

Long run equilibrium of the firm and
industry
÷ All factors are variable in the long run
÷ Hence all costs are variable
÷ Firm can change the plant and adjust the
capacity according to the requirements of
production
÷ If profits are supernormal, more firms enter
the market and vice versa.
÷ Entry and exit of firms is possible
Long run equilibrium of the firm and
industry
÷ If the number of firms increase, ( because they
might be attracted towards the supernormal
profits ), or the same firms increase their
production, the supply curve moves to the right.
At the same demand, this results in a decrease in
price.
÷ If the number of firms decrease, ( because of
losses ), or the same firms decrease production,
the supply curve shifts to the left. At the same
demand, this results in an increase in price.
Long run equilibrium of the firm and
industry
÷ Hence, in the long run, supernormal profit is not
possible and all firms have to survive at a Normal
profit.
÷ his means that all the firms will stop production
at the point where Aà is lowest. his is also the
price they will sell the goods at.
÷ Hence in the long run, firms have no incentive to
expand or contract their production capacity or
leave the industry and new firms have no
incentive to enter the industry.
÷ MR = Mà in long run as well
÷ Under perfect competition, since MR =AR, in
equilibrium also Mà is equal to AR
÷ Price must also equal Aà.
÷ P > Aà => supernormal profits
÷ New firms enter the market
÷ If there are losses, firms will leave the market.
÷ hus in the long run equality of P and Aà
becomes a necessary condition.
÷ hus,
P(AR) =MR =Aà = Mà in the long run
Long run
÷ 




÷ he fundamental economic problem is a
scarcity of resources.
÷ efinition of Efficiency
÷ Efficiency is concerned with the optimal
production and distribution or these scarce
resources.
 ypes of Efficiencies
÷ here are different types of efficiency
÷
| §




÷ his occurs when the maximum number of goods and
services are produced with a given amount of inputs. his
will occur on the production possibility frontier.
÷ ON the curve it is impossible to produce more goods
without producing less services.
÷ Productive efficiency will also occur at the lowest point
on the firms average costs curve
÷
 ypes of Efficiencies
÷ ! 
 §




÷ his occurs when goods and services are
distributed according to consumer preferences.
An economy could be productively efficient but
produce goods people don¶t need this would be
allocative inefficient.
÷ Allocative efficiency occurs when the price of the
good = the Mà of production
÷
 ypes of Efficiencies
÷ O 




÷ his occurs when firms do not have
incentives to cut costs, for example a
monopoly which makes supernormal
profits may have little incentive to get rid
of surplus labor. herefore a firms average
cost may be higher than necessary
÷
 ypes of Efficiencies
÷ — 




 
÷ his occurs when the firms produces on the
lowest point of its Long run average cost
and therefore benefits fully from
economies of scale
÷
 ypes of Efficiencies
÷ V  



 his refers to

efficiency over time for example a Ford
factory in 1920 would be very efficient for
the time period but would now be
inefficient by comparison therefore it is
necessary for firms to constantly introduce
new technology and reduce costs over time
 ypes of Efficiencies
÷  




÷ his occurs when externalities are taken
into consideration and the social cost of
production (SMà) = the social benefit
(SMB)
÷
 ypes of Efficiencies
÷   
 



÷ Optimum combination of factor inputs to
produce a good: related to productive
efficiency.
Efficiency of Perfect àompetition
÷ 1. Allocative Efficient. his is because P = Mà
÷ 2. Productive Efficient. his is because firms
produce at the lowest point on the Aà
÷ 3. X Efficient. àompetition between firms will
act as a spur to increase efficiency
÷ 4. Resources will not be wasted through
advertising because products are homogenous
÷ 5. Normal profit means consumers are getting the
lowest price.
his also leads to greater equality in society
 isadvantages of Perfect àompetition

÷ 1. No scope for economies of Scale, this is because there are many

small firms producing relatively small amounts. Industries with high
fixed costs would be particularly unsuitable to perfect competition.
· his is one reason why p.c. is unlikely in the real world
÷ 2. Undifferentiated products is boring giving little choice to
consumers. ifferentiated products are very important in industries
such as clothing and cars
÷ 3. Lack of supernormal profit may make investment in R& unlikely
this would be important in an industry such as pharmaceuticals which
require significant investment
÷ 4. ˜ith perfect knowledge there is no incentive to develop new
technology because it would be shared with other companied
÷ 5. If there are externalities in production or consumption there is
likely to be market failure without govt intervention
àompetitive Markets
÷ In the real world perfect competition is very rare and the model is
more theoretical than practical.
÷ However in general economists often talk about competitive markets
which do not require the strict criteria of perfect competition.
÷ A competitive market is one where no one firm has a dominant
position but the consumer has plenty of choice when buying goods or
services. herefore in competitive markets we would expect
÷ 1. Firms to have a small share of the market
2. Few barriers to entry
3. Low prices for consumers
4. Allocative efficiency
5. Incentives for firms to cut costs and develop new products
6. Profits will be lower than in markets with Monopoly power
÷ · his is linked closely to the idea of àontestable markets which is
concerned with low barriers to entry and freedom of entry.
Monopoly
÷ A monopoly has only one seller, who is
able to influence the total supply and price
of the goods and services. Further, there are
no close substitutes for the goods produced
by the monopolist and there are barriers to
entry.
 Main factors that lead to monopoly
are:
÷ Ownership of strategic raw materials and exclusive
technical know-how
÷ Possession of product/process patent rights
÷ Acquisition of government license to procure certain
goods
÷ High entry costs
÷ he size of the market may not allow more than one firm
to exist. Hence, the market creates a 


.
hus, the government usually supplies and produces the
commodity to avoid consumer exploitation