Hall & Leiberman; Economics: Principles And Applications, Market Structure Sellers want to sell at the highest possible price Buyers want to buy at the lowest possible price All trade is voluntary Yet we see that different goods and services are sold in vastly different ways One culprit is the market structure –Characteristics of a market that influence behavior of buyers and sellers when they come together to trade

Hall & Leiberman; Economics: Principles And Applications, Market Structure To determine structure of any particular market, we begin by asking –How many buyers and sellers are there in the market? –Is the good homogeneous or differentiated? –Are there any barriers to entry or exit? Answers to these questions help us to classify a market into one of four basic types –Perfect competition –Monopoly –Monopolistic –Oligopoly

Hall & Leiberman; Economics: Principles And Applications, The Three Requirements of Perfect Competition Large numbers of buyers and sellers Sellers offer a standardized product Free entry and exit

Hall & Leiberman; Economics: Principles And Applications, A Large Number of Buyers and Sellers In perfect competition, there must be many buyers and sellers –How many? Number must be so large that no individual decision maker can significantly affect price of the product by changing quantity it buys or sells

Hall & Leiberman; Economics: Principles And Applications, A Standardized Product Buyers do not perceive significant differences between products of one seller and another –For instance, buyers of wheat do not prefer one farmer’s wheat over another

Hall & Leiberman; Economics: Principles And Applications, Free Entry and Exit A perfectly competitive market has no significant barriers to discourage new entrants What are the common barriers to entry? What are some of the industries that have barriers to entry?

Hall & Leiberman; Economics: Principles And Applications, Free Entry and Exit Perfect competition is also characterized by easy exit –A firm suffering a long-run loss must be able to sell off its plant and equipment and leave the industry for good, without obstacles Why is this important? What are the industries where there are barriers to exit?

Hall & Leiberman; Economics: Principles And Applications, Is Perfect Competition Realistic? NO! The assumptions that a market must satisfy to be perfectly competitive are rather restrictive But … remember what we said about models in the first lecture? Economists use a model of perfectly competitive markets all the time. Why?

Hall & Leiberman; Economics: Principles And Applications, The Perfectly Competitive Firm When we examine a competitive market from a distance, we get one view of what is occurring –When we closely examine the individual competitive firm, we get an entirely different picture In learning about competitive firm, must also discuss competitive market in which it operates

Hall & Leiberman; Economics: Principles And Applications, Figure 1: The Competitive Industry and Firm Ounces of Gold per Day Price per Ounce D $400 S Market Demand Curve Facing the Firm $400 Firm 1.The intersection of the market supply and the market demand curve… 3.The typical firm can sell all it wants at the market price… Ounces of Gold per Day Price per Ounce 2.determine the equilibrium market price 4.so it faces a horizontal demand curve

Hall & Leiberman; Economics: Principles And Applications, Goals and Constraints of the Competitive Firm Perfectly competitive firm faces a cost constraint like any other firm Cost of producing any given level of output depends on –Firm’s production technology –Prices it must pay for its inputs

Hall & Leiberman; Economics: Principles And Applications, The Demand Curve Facing a Perfectly Competitive Firm Notice the demand curve for the firm in Fig(1) is different from the demand curve for the industry. It’s not downward sloping It’s horizontal, or infinitely price elastic Why???

Hall & Leiberman; Economics: Principles And Applications, The Demand Curve Facing a Perfectly Competitive Firm Means Small Time has no control over the price of its output –Simply accepts market price as given Since a competitive firm takes the market price as given –Its only decision is how much output to produce and sell

Hall & Leiberman; Economics: Principles And Applications, Cost and Revenue Data for a Competitive Firm For a competitive firm, marginal revenue at each quantity is the same as the market price For this reason, marginal revenue curve and demand curve facing firm are the same –A horizontal line at the market price

Hall & Leiberman; Economics: Principles And Applications, Figure 2a: Profit Maximization in Perfect Competition TR 550 $2,800 2,100 TC Slope = 400 Ounces of Gold per Day Dollars Maximum Profit per Day = $700

Hall & Leiberman; Economics: Principles And Applications, Figure 2b: Profit Maximization in Perfect Competition MC $400 D = MR Ounces of Gold per Day Dollars

Hall & Leiberman; Economics: Principles And Applications, The Total Revenue and Total Cost Approach Most direct way of viewing firm’s search for the profit-maximizing output level At each output level, subtract total cost from total revenue to get total profit at that output level –Total Profit = TR - TC

Hall & Leiberman; Economics: Principles And Applications, The Marginal Revenue and Marginal Cost Approach Firm should continue to increase output as long as marginal revenue __ marginal cost Profit-maximizing output is found where MC curve crosses MR curve from below