Market Structure

1
Rose-Hulman Institute of Technology Department of
Humanities Social Sciences / K. Christ SL 151,
Principles of Economics

• Market Structure
• Perfect competition
• Pure monopoly v. market power
• Imperfectly competitive markets
• Perfect Competition
• Production decisions in competitive markets
• Market supply in competitive markets
• Efficiency characteristics of competitive markets
  
• Monopoly Market Power

Slides 6
2
Summary of Market Structures
Imperfectly Competitive Markets
Perfect Competition
Monopolistic Competition
Monopoly
Oligopoly
Number of firms
Many
Many
Few
One
Homogenous or Differentiated
Characteristics of products
Homogenous (Standardized)
Unique
Differentiated
Free Entry or Exit
Free Entry or Exit
Market Entry
Difficult Entry
Barriers to Entry
3
P
The behavior of marginal revenue for a price
taker
Firms Total Revenue
TR
Q 0 1 2 3 4 5
P 2 2 2 2 2 2
TR 0 2 4 6 8 10
MR 2 2 2 2 2
Q
P
Firms Marginal Revenue
MR
2
As sales increase, Marginal Revenue is equal to
price and constant
Q
4
Putting marginal revenue and marginal cost
together
P
P
The Firm
The Market
MC
S
ATC
MR d
2
P 2
D
Q
q
Q
q
5
The competitive process
F
The allocative role of economic profits
The existence (or absence) of economic profit is
a signal to resource owners about where resources
should be deployed.
P
P
The Market
The Firm
MC
S
S
ATC
MR d
2 ATC
P 2 P lt 2
MR d
D
Q
q
Q
q
6
Competitive equilibrium
Short run Long run The transition between
short run and long run
q q q
In a short-run competitive equilibrium,
competitive firms can earn an economic profit or
suffer an economic loss. In a long-run
competitive equilibrium, all firms earn
zero economic profit (the normal profit
condition) and production occurs at minimum
average total cost. Short run profits or
losses provoke entry and exit of resources until
all incentives to enter or leave are eliminated.
7
What are the three characteristics that help
define market structure? What are the
distinguishing characteristics of a perfectly
competitive market? Why are firms in a
perfectly competitive market assumed to be price
takers? Do perfectly competitive firms have any
incentive to raise price? Do perfectly
competitive firms have any incentive to lower
price?
8
Short-run production decisions for a competitive
firm -- The competitive firms short-sun
supply curve
P
MC
ATC
Operate at a profit
AVC
MR AR d
Break even
Continue operations at a loss
Shut down
q
q
9
Long-run production decisions for a competitive
firm -- The competitive firms long-sun
supply curve
P
MC
ATC
Continue to operate
AVC
MR AR d
Break even
Exit the marketplace
q
q
10
Short-Run Industry supply
Firm 1
Firm 2
Firm 3
Industry
P
P
P
P
S



Q
11
Long-run industry supply
Constant Cost Industry Horizontal long-run
industry supply
P
The Market
S
S
Long-run industry supply
D
D
Q
Q
Q
12
Long-run industry supply
Constant Cost Industry Horizontal long-run
industry supply Increasing Cost Industry
Long-run industry supply slopes upward
P
P
The Market
The Firm
MC
ATC
MC
S
S
Long-run industry supply
ATC
P
D
D
Q
q
Q
Q
q
13
Long-run industry supply
Constant Cost Industry Horizontal long-run
industry supply Increasing Cost Industry
Long-run industry supply slopes
upward Decreasing Cost Industry Long-run
industry supply slopes downward
P
P
The Market
The Firm
MC
S
S
ATC
MC
ATC
P
Long-run industry supply
D
D
Q
q
Q
Q
q
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What conditions could lead to an upward sloping
long-run industry supply curve? What term do we
use to describe such an industry? What
conditions could lead to a downward sloping
long-run industry supply curve? What term do we
use to describe such an industry? Why is
long-run industry supply typically more elastic
than short-run industry supply?
15
Two elements of economic efficiency
Productive efficiency Allocative efficiency
q q
Resources are allocated such that the economy
cannot increase the production of one good
without decreasing the production of
another. Maximum output at minimum cost.
Are the goods services being produced at
lowest possible cost? Resources are allocated
such that all opportunities for Pareto
improvement have been exhausted. What
individuals give up to obtain a good is equal to
what society gives up to produce it.
Are the right goods and services being
produced?
F
F
16
Efficiency outcomes of competitive markets
Perfectly competitive markets are
productively efficient. Perfectly competitive
markets are allocatively efficient.
q q
F
Output tends to occur where average production
costs are at a minimum. Price equals marginal
cost.
F
17
TR
The behavior of marginal revenue for a price
maker
Firms Total Revenue
TR(Q)
Q 0 1 2 3 4 5
P 6 5 4 3 2 1
TR 0 5 8 9 8 5
MR 5 3 1 -1 -3
Q
MR
Firms Marginal Revenue
As sales increase, Marginal Revenue decreases
more rapidly than price
Q
MR(Q)
18
Production decisions for a monopolist
The Firm (and the Market)
P
MC
ATC
ATC
d D
MR
q Q
19
Comparing Pure Monopoly and Pure Competition
Societys View
For each of these purchases (which do not occur
with monopolization), Private benefit gt Private
cost
P
S (Private Cost)
P
m
P
D (Private Benefit)
MR
Q
Q
Q
m
20
Sources of barriers to entry / monopoly power
Control of a key resource Legal creation of
monopoly rights Economies of scale (natural
monopolies)
q q q
P, ATC
LRATC
Q
21
The standard case against monopoly
Monopolies restrict output and thus cause
prices to rise above competitive
levels. Monopolies generate social welfare
losses Monopolies are likely to engage in
anti-competitive practices to sustain their
advantage.
q q q
F
Because P gt MC, output in monopolized markets is
said to be allocatively inefficient. Lack of
competitive pressure implies that production may
not occur at minimum ATC. Thus, production may
be productively inefficient.
F
22
Monopoly behavior and monopoly power
A firm that is the sole seller of a
product without close substitutes. The ability
to raise and sustain price above marginal cost.
(Also called market power. Any costly
activity undertaken by a firm to preserve
monopoly (or market) power. (A manifestation of
inefficiency.) Tacit or explicit agreements by
firms to behave like a monopoly or to
exercise monopoly power.
Monopoly Monopoly power Rent
seeking Collusion
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Possible responses to monopoly power
Anti-trust laws Regulation Nationalization
(public provision) Status quo
q q q q
24
What are the three characteristics that help
define market structure? What are the
distinguishing characteristics of a pure
monopoly? What is monopoly power? What
are some sources of monopoly power?
25
True or False
Generally, monopolists are more concerned with
maximizing profits than are perfect
competitors. Monopolists can charge any price
they want. Monopolists can never be productively
efficient. Monopolies are not allocatively
efficient. When a natural monopoly exists,
consumers may be better off being served by the
monopolist rather than by competitive
firms. Microsoft is a pure monopolist. Microsoft
has considerable monopoly power.
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Discuss
1. Why do economists consider competitive markets
to be so good? What are the classic economic
arguments in favor of competitive
markets? 2. How many firms does it take for a
market to be competitive and/or to generate
efficient competitive outcomes? 3. Do you think
that competitive markets are an appropriate /
desirable allocation mechanism for all goods and
services? 4. Can competition ever be
destructive in the sense that society might be
better off with less competition in a given
market?