ECON Chapter 8

Market Structure

  • Market structure affects firm behavior and performance:

    • Number and size of sellers

    • Knowledge of actions

    • Freedom of entry/exit

    • Product differentiation

Four Major Market Structures

  1. Perfect Competition

  2. Monopolistic Competition

  3. Oligopoly

  4. Monopoly

Characteristics of Perfectly Competitive Market

  • Many buyers/sellers

  • Homogeneous products

  • Easy entry/exit

  • Firms are price takers

Assumptions of Perfect Competition

  • Homogeneous product

  • Consumer knowledge about prices

  • Small output level relative to industry

  • Freedom of entry/exit

  • Firms act as price takers

Price Taking Behaviour

  • Firms face perfectly elastic demand

  • Cannot influence market price

  • Take price given by market conditions

  • At higher prices, customers will buy from competitors

Revenue Concepts

  1. Total Revenue (TR): TR=pimesQTR = p imes Q

  2. Average Revenue (AR): AR=racpimesQQ=pAR = rac{p imes Q}{Q} = p

  3. Marginal Revenue (MR): MR=racDTRDQ=pMR = rac{D TR}{D Q} = p

    • For competitive firms: P=MR=ARP = MR = AR

Profit Maximizing Methods

  • Marginal Approach: Profit maximization at MR=MCMR = MC.

  • Total Cost-Total Revenue Approach: Profit is maximized when revenue exceeds total cost.

Short Run Decisions

  • Firm aims to maximize profits: Profits=TR−TCProfits = TR - TC

  • Consideration of variable and fixed costs for production decisions.

Shut Down Price

  • Firms should not produce if total revenue < total variable cost.

  • Shut down point occurs where price < average variable cost.

Short Run Equilibrium

  • Occurs when quantity demanded = quantity supplied

  • Firms may experience profits, losses, or break-even.

Long Run Equilibrium

  • Long-run equilibrium occurs when firms earn zero economic profits.

  • Adjustments in supply and price based on profits/losses lead to equilibrium.

Long Run Supply Curve

  1. Constant Cost Industry: Price of inputs does not change; horizontal LRS curve.

  2. Increasing Cost Industry: Input prices rise with output increase; upward sloping LRS.

  3. Decreasing Cost Industry: Input prices fall with output increase; downward sloping LRS.

Efficiency in Perfect Competition

  • Productive Efficiency: Firms operate at minimum ATC.

  • Allocative Efficiency: P=MCP = MC, reflecting consumer preferences.

  • Competitive markets ensure supply equals demand, ensuring efficiency.