Types of Market Structure in the Construction Industry Chapter 8 Types of Market Structure in the Construction Industry

Markets and the Competitive Environment Economists identify four market types: 1. Perfect competition 2. Monopolistic competition 3. Oligopoly 4. Monopoly

Markets and the Competitive Environment 1. Perfect competition Arises when there are many firms each selling an identical product, many buyers, and no restrictions on the entry of new firms into the industry.

Markets and the Competitive Environment 2. Monopolistic competition A market structure in which a large number of firms compete by making similar buy slightly different products. Product differentiation gives a monopolistically competitive firm an element of monopoly power.

Markets and the Competitive Environment 3. Oligopoly A market structure in which a small number of firms compete.

Markets and the Competitive Environment 4. Monopoly An industry that produces a good or service for which no close substitutes exists and in which there is one supplier that is protected from competition by a barrier preventing the entry of new firms.

Perfect Competition Characteristics of Perfect Competition Many firms, each selling an identical product. Many buyers. No restrictions on entry into the industry. 5

Perfect Competition Characteristics of Perfect Competition Firms in the industry have no advantage over potential new entrants. Firms and buyers are well informed about prices of the products of each firm in the industry. 6

Perfect Competition As a result of these characteristics, perfect competitors are price takers. Price takers Firms that cannot influence the price of a good or service. 7

Economic Profit and Revenue The firm’s goal is to maximize economic profit. Total cost is the opportunity cost -- including normal profit. 9

Economic Profit and Revenue Total revenue is the value of a firm’s sales. Total revenue = P  Q Marginal revenue (MR) Change in total revenue resulting from a one-unit increase in quantity sold. Average revenue (AR) Total revenue divided by the quantity sold—revenue per unit sold. In perfect competition, Price = MR = AR 10

The Firm’s Decisions in Perfect Competition A firm’s task is to make the maximum economic profit possible, given the constraints it faces. In order to do so, the firm must make two decisions in the short-run, and two in the long-run. 21

The Firm’s Decisions in Perfect Competition Short-run A time frame in which each firm has a given plant and the number of firms in the industry is fixed Long-run A time frame in which each firm can change the size of its plant and decide to enter the industry. 22

The Firm’s Decisions in Perfect Competition In the short-run, the firm must decide: Whether to produce or to shut down. If the decision is to produce, what quantity to produce. 23

The Firm’s Decisions in Perfect Competition In the long-run, the firm must decide: Whether to increase of decrease its plant size. Whether to stay in the industry or leave it. We will first address the short-run. 24

Total Revenue, Total Cost, and Economic Profit TC TR Economic loss 300 Total revenue & total cost (dollars per day) 225 Economic profit = TR - TC 183 Instructor Notes: 1) Economic profit, in the graph is the height of the blue area between the total cost and total revenue curves. 2) Swanky make maximum economic profit, $42 a day ($225 - $183), when it produces 9 sweaters--the output at which the vertical distance between the total revenue and total cost curves is at its largest. 3) At outputs of 4 sweaters a day and 12 sweaters a day, Swanky makes zero economic profit--these are break-even points. 4) At outputs less than 4 and greater than 12 sweaters a day, Swanky incurs an economic loss. 100 Economic loss 0 4 9 12 Quantity (sweaters per day) 31

Total Revenue, Total Cost, and Economic Profit Economic profit/loss 42 Profit/loss (dollars per day) Economic profit Economic loss 20 Instructor Notes: 1) The graph shows Swanky’s profit curve. 2) The profit curve is at its highest when economic profit is at a maximum and cuts the horizontal axis at the break-even points. Quantity (sweaters per day) 4 9 12 Profit maximizing quantity -20 Profit/ loss -40 34

Marginal Analysis Using marginal analysis, a comparison is made between a units marginal revenue and marginal cost. 35

Marginal Analysis If MR > MC, the extra revenue from selling one more unit exceeds the extra cost. The firm should increase output to increase profit. If MR < MC, the extra revenue from selling one more unit is less than the extra cost. The firm should decrease output to increase profit. If MR = MC economic profit is maximized. 36

Profit-Maximizing Output maximization point MC Loss from 10th sweater 30 MR 25 Marginal revenue & marginal cost (dollars per day) Profit from 9th sweater 20 Instructor Notes: 1) The graph shows that marginal cost and marginal revenue are equal when Swanky produces 9 sweaters a day. 2) If marginal revenue exceeds marginal cost, and increase in output increase economic profit. 3) If marginal revenue is less than marginal cost, and increase in output decreases economic profit. 4) If marginal revenue equal marginal cost, economic profit is maximized. 10 8 9 10 Quantity (sweaters per day) 45

The Firm’s Short-Run Supply Curve Fixed costs must be paid in the short- run. Variable-costs can be avoided by laying off workers and shutting down. Firms shut down if price falls below the minimum of average variable cost. 46

A Firm’s Supply Curve MC = S 31 MR2 MR1 25 AVC s MR0 17 7 9 10 Marginal revenue & marginal cost (dollars per day) MR1 25 AVC Shutdown point s Instructor Notes: 1) The graph shows Swanky’s supply curve--the number of sweaters Swanky will produce at each price. 2) It is made up of its marginal cost curve at all points above its average variable cost curve and the vertical axis at all prices below minimum average variable cost. MR0 17 7 9 10 Quantity (sweaters per day) 53

A Firm’s Supply Curve S 31 25 s 17 7 9 10 Quantity (sweaters per day) Marginal revenue & marginal cost (dollars per day) 25 s Instructor Notes: 1) The graph shows Swanky’s supply curve--the number of sweaters Swanky will produce at each price. 2) It is made up of its marginal cost curve at all points above its average variable cost curve and the vertical axis at all prices below minimum average variable cost. 17 7 9 10 Quantity (sweaters per day) 54

Short-Run Industry Supply Curve Shows the quantity supplied by the industry at each price when the plant size of each firm and the number of firms remain constant. It is constructed by summing the quantities supplied by the individual firms. 55

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