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 At what market price(s) will this firm have guaranteed profit? P1 and P2 Q4 P4

Q3 P3 Optimal At what market price(s) will this firm have guaranteed losses? P3 and P4 Q4 P4

Q3 P3 Optimal If market price was at P4, should the firm shut down? NO! Q4 P4

Q3 P3 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 If market price was P3, should the firm shut down? Yes! Q4 P4

Q3 P3 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 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-run supply P 1 1 Q 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-run supply Price 0 D 1 D 2 P1P1 S 1 P 2 Q 1 A Q 2 P 2 B ATC MC 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 P 1 P2P2 Q1Q1 Q2Q2 Long-run supply B D1 D 2 S1S1 A S 2 Q 3 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…