1. www.lrjj.cn Market Structure

2. www.lrjj.cn The Degree of Competition The four market structures –perfect competition –monopoly –monopolistic competition –oligopoly Classifying markets –number of firms –freedom of entry to industry –nature of product –nature of demand curve

3. www.lrjj.cn Market Structures

4. www.lrjj.cn Perfect Competition Assumptions –firms are price takers –freedom of entry –identical products –perfect knowledge

5. www.lrjj.cn The Revenue of Competitive Firm Total revenue (TR) –How much does the firm receive for the sale of the total output? TR = P × Q Average revenue (AR) –How much does the firm receive for the sale of one typical unit of output? AR = TR/Q Marginal revenue (MR) –How much does the firm receive for the sale of one additional unit of output? MR = ΔTR/ΔQ

6. www.lrjj.cn Cost of Production Includes all the opportunity costs of making its output of goods and services. –Explicit costs: input costs that require a direct outlay of money by the firm (e.g. opportunity cost of $100 electricity fee) –Implicit costs: input costs that do not require an outlay of money by the firm (e.g. opportunity cost of renting out building)

7. www.lrjj.cn Profit

8. www.lrjj.cn Profit Maximization The firm will want to produce the quantity that maximizes the difference between total revenue and total cost. Occurs at the quantity where marginal revenue equals marginal cost (MR=MC). Why don’t the firm just produce the maximum quantity?

9. www.lrjj.cn Marginal Analysis QP=ARTCTRProfitMRMC  Profit 063-3 1651624 2684633 3612186642 4617247651 5623307660 66 36667 763842468-2

10. www.lrjj.cn Marginal Analysis QP=ARTCTRProfitMRMC  Profit 0630-3 16561624 268124633 36 186642 4617247651 5623307660 66 36667 763842468-2

11. www.lrjj.cn O £ (b) Firm Q (thousands) O (a) Industry P Q (millions) S D PePe MC AR D = AR = MR QeQe AC Short-run equilibrium of industry and firm under perfect competition Firm is a price taker. Price is given by the market.

12. www.lrjj.cn Profit Maximization When MR > MC, increase Q When MR < MC, decrease Q When MR = MC, profit is maximized

13. www.lrjj.cn Profits return to normal OO (a) Industry P£ Q (millions) S1S1 D (b) Firm LRAC PLPL P1P1 QLQL SeSe AR 1 D1D1 AR L DLDL Q (thousands) New firms enter Supernormal profits Long-run equilibrium

14. www.lrjj.cn £ Q O (SR)AC (SR)MC LRAC AR = MR DLDL LRAC = (SR)AC = (SR)MC = MR = AR Long-run equilibrium

15. www.lrjj.cn Produce or shut down – the short-run Shut down (short-run decision) Exit (long-run decision) Which costs are relevant? –If the firm shuts down, it only incurs fixed cost, which is sunk and cannot be recovered. –Relevant cost in the short run is variable cost.

16. www.lrjj.cn Produce or shut down - the short-run The firm shuts down if the revenue it gets from producing is less than the variable cost of production. –Shut down if TR < VC –Shut down if TR/Q < VC/Q –Shut down if P < AVC As long as P ≥ AVC (or TR ≥ TVC), the firm should operate even if it is losing money (loss-minimizing)

17. www.lrjj.cn Enter or exit – the long run In the long run, the firm exits if the revenue it would get from producing is less than its total cost. –Exit if TR < TC –Exit if TR/Q < TC/Q –Exit if P < ATC A firm will enter the industry if such an action would be profitable.

18. www.lrjj.cn Monopoly A firm that is the sole seller of a product for which no close substitutes exist. The firm is protected from competitors by barriers that prevent entry from other firms

19. www.lrjj.cn Barriers to entry Monopoly resources Government-created monopolies Natural monopolies (economies of scale) Product differentiation and brand loyalty Aggressive tactics Lower costs for an established firm

20. www.lrjj.cn £ Q O MC AC QmQm MR AR AC Profit maximising under monopoly AR Total profit Profit maximised at output of Q m (where MC = MR)

21. www.lrjj.cn Profit Maximization under Monopoly MR = MC (true for all firms!) In a competitive firm, P = MR –Profit maximization leads to P = MC → P = MC = MR For a monopoly, P > MR –Profit maximization leads to P > MC Why?

22. www.lrjj.cn £ Q O MC ( = supply under perfect competition) Q1Q1 MR P1P1 P2P2 Q2Q2 AR = D Comparison with Perfect competition Equilibrium under PC & Monopoly – the same MC curve

23. www.lrjj.cn Monopolistic Competition A situation where there are a lot of firms competing with their own market segment Each firm has some discretion as to what price to charge for its products

24. www.lrjj.cn Monopolistic Competition Assumptions –Independence –Freedom of entry –Product differentiation

25. www.lrjj.cn £ Q O QsQs AR  D MC AC MR PsPs AC s Monopolistic Competition – Short run equilibrium

26. www.lrjj.cn AR L  D L MR L £ Q O QLQL PLPL LRAC LRMC New firms entering the industry reduce demand for each individual firm. Price falls to P L Monopolistic Competition – Long run equilibrium

27. www.lrjj.cn Oligopoly A few firms share a large proportion of the market Key features of oligopoly –barriers to entry –interdependence of firms Competition versus collusion Collusive oligopoly: cartels

28. www.lrjj.cn £ Q O Industry D  AR Industry MC Industry MR Q1Q1 P1P1 Industry profit maximised at Q 1 and P 1. Members must agree to restrict total output to Q 1. Profit-maximising cartel

29. www.lrjj.cn Factors favoring collusion Few firms Open with each other Similar production methods and average costs Similar products Dominant firm Significant entry barriers Stable market No government measures to curb collusion