Lesson 10
MARKET STRUCTURE
LEARNING OBJECTIVES
By the end of this lesson, students will be able to:
o recognize and distinguish perfect competition and monopoly
o explain how a perfectly competitive firm makes output decisions
o determine the output and price that a monopolist can maximize profit and
revenue
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I PERFECT
COMPETITION
1. Perfect competition
2. A perfectly competitive firm’s supply decision
1. Perfect competition
- Perfect competition is a market in which both
buyers and sellers believe that their own actions
have no effect on the market price.
- Both suppliers and consumers are price takers.
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Characteristics
Many sellers Almost
and buyers perfect
Free
Homogenous information
enter and
products exit of firms
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Example of perfect competition
- does not really exist in real world
- have close approximations. E.g. agricultural markets: corns
✗ ≈ 300,000 corn farms in the US
✗ all farms producing the same good
✗ the price being determined at the CBOT
✗ not high barriers to entry/exit
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Other examples?
Foreign exchange Stock markets
markets
Online shopping
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Demand curve of the individual firm
Each perfectly competitive firm
o faces a horizontal demand curve DD
o can sell at the market price P0
→ is a price taker
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I PERFECT
COMPETITION
1. Perfect competition
2. A perfectly competitive firm’s supply decision
2. A perfectly competitive firm’s
supply decision
For a perfectly competitive firm:
✗ MR = P (set by the market)
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2a. A firm’s short-run supply curve
✗ Below P1 (point A): fails to cover SAVC
→ shuts down production
P1 is the SHUTDOWN PRICE.
✗ Between P1 and P3 (A and C): makes
short-run losses, but still remains in the
market
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2a. A firm’s short-run supply curve
✗ firm’s
The At P2 (point B): makes
short-run output
supply curveatis
which
the part P =SMC
of its MC curve above its
shutdown
✗ Above price (the minimum
P3: makes of the
short-run profits
SAVC curve).
above the opportunity cost of
• showing how much the firm would
capital
produce at each price level
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2b. A firm’s long-run supply curve
✗ Above P3 (such as P4): makes profits
because price is above long-run
average cost LAC
✗ Below P3 (such as P2): makes losses
because price is below LAC → exits
the industry
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2b. A firm’s long-run supply curve
✗ At
The P3: breaks
firm’s evensupply
long-run after paying
curve all
is
the economic
part of its costs
LMC curve above its exit
price makes
→ (the zero economic
minimum profits
of the LAC curve)
(NORMAL PROFITS)
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2c. Entry and exit
P3 is the entry or exit price.
o Below P3, the firm exits the market in the
long run.
o Above P3, the firm makes SUPERNORMAL
PROFITS, encouraging new firms to entry
the market.
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II
MONOPOLY
1. Pure monopoly
2. How a profit-maximizing monopolist chooses
output and price
1. Pure monopoly
no close
substitute No Competition
Sole supplier Monopolist
has 100%
market share
Monopolist controls Strong barriers to
price entry
Price
setter
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How can there be a
monopolist in the
market?
Barriers to entry
Large Legal barriers
economies of Ownership or control from
scale of key resources for governments
production
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The monopoly’s demand and marginal revenue curves
o A monopolist is a sole seller → its demand
curve is the market demand curve.
▪ The DD curve for a monopolist is
downward-sloping.
o The marginal revenue curve lies below the
demand curve.
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II
MONOPOLY
1. Pure monopoly
2. How a profit-maximizing monopolist chooses
output and price
3a. Total cost and total revenue for
a monopolist
In the figure:
▪ Total cost ↑ and TC curve slopes
upward (as output ↑)
▪ TR curve has a shape of a hill (as
output ↑ makes revenue ↑, but price ↓
makes revenue ↓)
Profits will be highest at the quantity of
output where TR is the farthest above TC.
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3b. Marginal revenue and Marginal
cost for a monopolist
In the figure:
• MR ↓ as the firm sells more units.
• MC curve slopes upward.
Monopolies maximize profits by setting
output so that MR = MC.
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3b. Marginal revenue and Marginal
cost for a monopolist
If the monopolist produces a lower
quantity, MR > MC.
produce extra units to make
→ should …………………………………
higher profits
If the monopolist produces a greater
quantity, MC > MR.
reduce output to make higher
→ should ……………………….
profits.
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3c. Monopoly profits
▪ To maximize profits, a firm chooses the output where
MR = MC
▪ A monopolist must check if P > SAVC and LAC. If not, it should:
- shut down (in the short run)
- exit the industry (in the long run)
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3c. Monopoly profits
Criteria that a monopolist decides how much to produce:
Average condition
Marginal condition
Short run Long run
MR <
MR > MC =
MR …… MC ≥ SAVC
P… P < SAVC P ≥ LAC P < LAC
MC
Output Shut down ………………
Stay Exit
Raise Optimal Lower Produce …………… ……………
decision
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I. Perfect competiton
q Definition, charactertistics and examples
q Demand curve of the individual firm
q Supply decision of a perfectly competitive firm
II. Monopoly
v Pure monopoly
q Definition, characteristics and examples
WRAP-UP
q Barriers to entry
q Demand and marginal revenue curves
q How a profit-maximizing monopolist chooses output
and price
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Thank you!
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