1. Winston Churchill High School
David Mayer
Winston Churchill High School
San Antonio, Texas
AP Microeconomics
Market Structures

2. Monopolistic Competition
Market Structures
Perfect Competition
Monopolistic Competition
Oligopoly
Monopoly

3. Monopolistic Competition
Market Structures
Perfect Competition
Monopolistic Competition
Oligopoly
Monopoly
Most Competitive
Least Competitive

4. Conditions for Perfect Competition
Many small independent producers and consumers
Firms produce identical product
No barriers to entry or exit
Firms are ‘price takers’

5. Total Revenue = Total Cost = 0 Economic Profit
Market
Individual Firm P P S MC
ATC
AVC P
P=MR=D
Total Revenue = Total Cost = 0 Economic Profit D Q Q q q
market
firm
Competitive Firm in Long Run Equilibrium, firms maximize profits by producing where MR=MC
Total Revenue = p*q = Total Cost = ATC*q = 0 Economic Profit
Market price = Marginal Revenue for firm = Demand for firm

6. Total Revenue = Total Cost = 0 Economic Profit
Market
Individual Firm P P S MC
ATC P
P=MR=D
Economic Profit
AVC
ATC P
P=MR=D
Total Revenue = Total Cost = 0 Economic Profit
Total Cost D D Q Q Q q q q
market
market
firm
firm
Competitive Firm Experiencing Short Run Economic Profits
Total Revenue – Total Cost = Economic Profit
(P*q) – (ATC*q) = Π

7. Total Revenue = Total Cost = 0 Economic Profit
Market
Individual Firm P P S MC S
ATC P
P=MR=D
Economic Profit
AVC
ATC P
P=MR=D
Total Revenue = Total Cost = 0 Economic Profit
Total Cost D Q Q Q q q q
market
market
firm
firm
Long Run Adjustment to Economic Profits in Perfect Competition – New firms enter the market in response to economic profits until economic profits = 0.

8. Adjustment to short-run losses & the decision to shut down.

9. Total Revenue = Total Cost = 0 Economic Profit
Market
Individual Firm P P S MC
ATC
ATC
AVC
ATC P
Economic
Loss
P=MR=D
Total Revenue = Total Cost = 0 Economic Profit P
P=MR=D
Total
Revenue D D Q Q Q q q q
market
market
firm
firm
Firms will operate at a loss (TC > TR) in the short run as long as P equals or exceeds AVC
If P < AVC, then firm shuts down and q = 0
As firms exit industry, industry supply will decrease and the market price will increase

10. Monopoly

11. Conditions for Monopoly
One Producer
Unique product with no close substitutes
Significant barriers to entry
Market Power… ‘price maker’

12. Marginal Revenue is different from demand.
Market
Individual Firm P P S MC
ATC
AVC P
P=MR=D D Q Q q q
market
firm
The market and the firm are one. But like in perfect competition MR=MC maximizes profit
Marginal Revenue is different from demand.
Monopolists operate in the elastic portion of the market demand curve

13. Monopoly P MC
ATC P Π
AVC
ATC
Total Cost D MR Q Q
The market and the firm are one. But like in perfect competition MR=MC maximizes profit
Marginal Revenue is different from demand.
Monopolists operate in the elastic portion of the market demand curve

14. P > MR=MC , therefore monopoly is allocatively inefficient
ATC P Π
Pcomp.
AVC
ATC
DWL
Total Cost D MR Q
Qcomp. Q
Monopolist produces Q at a point where ATC > minimum ATC (productively inefficient)
P > MR=MC , therefore monopoly is allocatively inefficient
Q mon. < Q comp., P mon. > P comp., Monopoly creates deadweight loss

15. Monopolistic Competition

16. Conditions for Monopolistic Competition
Relatively large number of producers
Product differentiation
Few barriers to entry
Advertising used to maintain profit

17. Monopolistic CompetitionMC
ATC P Π
AVC
ATC
Total Cost D MR Q Q
Like in perfect competition MR=MC maximizes profit, which in short run > 0
Marginal Revenue is different from demand.
Monopolistic Competitors face more elastic demand curve because of close substitutes

18. Monopolistic CompetitionMC
ATC P Π
Pcomp.
DWL
AVC
ATC
Total Cost D MR Q
Qcomp. Q
Monopolist comp. produces Q at a point where ATC > minimum ATC (productively inefficient)
P > MR=MC , therefore monopolistic comp. is allocatively inefficient
Q mc< Q comp., P mc > P comp., Monopolistic Comp. creates deadweight loss

19. Monopolistic CompetitionMC
ATC P Π
AVC
ATC
Total Cost D MR Q Q
In the long run competition reduces demand for monopolistic competitors product
Reduced demand leads to 0 economic profits
Monopolistic Competition creates inefficient excess capacity

20. Reduced demand leads to 0 economic profits
Monopolistic Competition P MC
ATC P Π
AVC
P =
ATC
Total Cost = Total Revenue = 0 Economic Profit
Total Cost D MR Q Q Q
In the long run competition reduces demand for monopolistic competitors product
Reduced demand leads to 0 economic profits
Monopolistic Competition creates inefficient excess capacity Qmc < Q min ATC

21. Oligopoly

22. Conditions for Oligopoly
A few large producers
Product differentiation or standardization across industry
Barriers to entry
Economic Interdependence

23. Strategic Behavior
Unlike other market structures, oligopoly is characterized by interdependent strategic behavior.
Because of the small number of firms in oligopolistic markets, individual firms production decisions reflect their strategic response to their competitors decisions.
Whether or not firms can collude is important in understanding the outcomes of oligopolists decisions.
Instead of supply and demand analysis, game theory provides a better insight into oligopoly.

24. Application of Game Theory to Oligopoly
Assume that two firms, A & B, are the only gas stations in a small town.
Use the payoff matrix below to determine their profit maximizing pricing strategy and their dominant, non-collusive pricing strategy.
A – Hi: $1000
B – Hi: $1000
A – Lo: $1200
B – Hi: $ 500
A – Hi: $ 500
B – Lo: $1200
A – Lo: $ 750
B – Lo: $ 750

25. Application of Game Theory to Oligopoly
Given the opportunity to collude and coordinate pricing, then both firms would rationally choose to set a high price and maximize profits at $1000 per firm.
However, because firms must act independently of other firms, then their dominant strategy is to set a low price. From each firm’s perspective, they can rationally expect to make at most $1200 and at least $750 by setting a low price, which is a better set of outcomes than is found by setting prices high.
A – Hi: $1000
B – Hi: $1000
A – Lo: $1200
B – Hi: $ 500
A – Hi: $ 500
B – Lo: $1200
A – Lo: $ 750
B – Lo: $ 750