Reading 12: Firms and Market Structures

Book 1: Economics

Short-Run

the time period over which some factors of production are fixed

Long Run

all factors if production are variable in the long run

Variable costs

costs that directly pertain to the production of goods

In the Long-Run, when should a firm shut down?

P < ATC

In the Short-Run, when should a firm shut down?

P < AVC

In the Short Run, when should a firm stay open?

P > ATC

• A firm does not have to shut down in the short run if price exceeds average total cost because although a firm is losing money on producing goods, the firm can cover some of its fixed costs. A firm loses more money if it shuts down as opposed to staying open and paying its FC

Price-Taker Firms

Firms that face a horizontal demand curve

Price-Searcher Firms

Firms that face downward sloping demand curves

Price is influenced by the top player who benefits fro the best competitive advantage

For Price-Taker Firms, what does Marginal Cost = ?

MC = P

• This is under perfect competition. The additional cost to produce one more unit is the exact value of the market cost for consumers to switch to an exact substitute—it is not worth it to produce another good—and because firms do not have pricing power, they must make the price = MC

Breakeven Point under Perfect Competition

Price = ATC = AR

Breakeven Point under Imperfect Competition

TR = TC

Minimum Efficient Scale

where the ATC is at a minimum

Economies of Scale

ATC decreases as more units that are produced allow fixed costs to spread thinner—lowering the total costs

Diseconomies of Scale

ATC increases as more units are produced—the firm has grown so large that there is increased complexity and cost with managing resources, people, and processes; size creates inefficiencies

Constant Returns to Scale

constant costs across a range of outputs

• (Dis)economies of scale are not in effect

Which market structure has the steepest demand curve?

Monopolies

What are the 5 factors to analyze different market structures?

1.) Number of firms and relative size

2.) Degree of product differentiation

3.) Bargaining power of firms on price (elasticity)

4.) Barriers to entry

5.) Degree to which firms compete on other factors other than price

Perfect Competition

market where firms produce identical products, barriers to entry are low, and firms compete for sales only on the basis of price

Monopolistic Competition

products are not identical in the mind of the consumer

Oligopoly

only a few firms in the industry

Monopoly

single seller of a product with no good substitutes

Key characteristic of an oligopoly?

firms are interdependent

In monopolistic competition, where are profits maximized?

MC = MR

In Short-Run, is price above or below the ATC?

Above.

Firms have pricing power due to differentiated products. This allows firms to set the price above the ATC, however, this only holds when there is no competition, when competition occurs in the long-run, it erodes competitive advantage and price is driven down to the ATC

Kinked Demand Curve Model

a firm unlikely to match a price increase by a competitor, but very likely to match a price decrease by a competitor

Cournot Duopoly Model

two firms with identical MC curves each choose their price based on the price of the other firm in the previous period

Stackelberg Model

pricing decisions are made sequentially

• There is a market leader who essentially sets the price first and receives a greater proportion of market profits

Nash Equilibirum

Game theory, study the table in notes

Dominant Firm Model

a single firm has a large market share because of greater scale and lower cost structure

• The price is set by DF

  • CF take the price

TRUE or FALSE (DFM): If a CF lowers its price, the DF will not touch its price as the CF will eventually be crowded out as MC begins to exceed MR

FALSE.

The DF will match the CF’s price and the CF will eventually be driven out of the industry

Where does price settle at in an oligopoly?

Between the Collusion and Perfect Competition

Collusion

when competitors make a join agreement to charge a specific level of output

Is collusion illegal?

in most countries

How do analysts prefer to identify market structures?

measuring the elasticity of demand

N-Firm Concentration Ratio

sum of the % market share of the largest N firms

Herfindahl-Hirschman Index (HHI)(

sum of squares of the largest market shares in the market

• Helps navigate around M&A activity