Market Structure

Market Structure
The selling environment in which a firm
produces and sells its product is called a
market structure.
Defined by three characteristics:
The number of firms in the market
The ease of entry and exit of firms
The degree of product differentiation

Introduction
Perfect competition, with an infinite
number of firms, and monopoly, with a
single firm, are polar opposites.
Monopolistic competition and oligopoly lie
between these two extremes.

Perfect Competition
A perfectly competitive market has the

following characteristics:
There

are many buyers and sellers in the

market.
The goods offered by the various sellers
are largely the same.
Firms can freely enter or exit the market.

The Meaning of Competition

As a result of its characteristics, the

perfectly competitive market has the

following outcomes:
The

actions of any single buyer or seller in

the market have a negligible impact on the
market price.
Each buyer and seller takes the market
price as given.

Thus, each buyer and seller is a price taker.

Perfect Competition

Profit-Maximizing Level of
Output
The goal of the firm is to maximize
profits.
Profit is the difference between total
revenue and total cost.

Revenue of a Competitive Firm

Total revenue for a firm is the selling
price times the quantity sold.

TR = (P X Q)

Revenue of a Competitive Firm

Marginal revenue is the change in
total revenue from an additional unit
sold.

MR =TR/ Q

Revenue of a Competitive Firm

For competitive firms, marginal

revenue equals the price of the
good.


T
R
/Q

Total, Average, and Marginal

Revenue for a Competitive Firm
Quantity
(Q)
1
2
3
4
5
6
7
8

Price
(P)
$6.00
$6.00
$6.00
$6.00
$6.00
$6.00
$6.00
$6.00

Total Revenue Average Revenue Marginal Revenue

(TR=PxQ)
(AR=TR/ Q)
(MR=
)
$6.00
$6.00
$12.00
$6.00
$6.00
$18.00
$6.00
$6.00
$24.00
$6.00
$6.00
$30.00
$6.00
$6.00
$36.00
$6.00
$6.00
$42.00
$6.00
$6.00
$48.00
$6.00
$6.00

Profit Determination Using Total

Cost and Revenue Curves
Total cost, revenue

TC

Loss
$385
350
315 Maximum profit =$81
280
245
210
$130
175
140
105
Profit =$45
70
Loss
35
0

1 2 3 4 5 6 7 8 9

McGraw-Hill/Irwin

TR

Profit

Quantity

2004 The McGraw-Hill Companies, Inc., All

Rights Reserved.

Profit Maximization Using

Total Revenue and Total Cost

Profit is maximized where the vertical

distance between total revenue and
total cost is greatest.
At that output, MR (the slope of the
total revenue curve) and MC (the slope
of the total cost curve) are equal.

Profit-Maximizing Level of
Output

Marginal revenue (MR) the change

in total revenue associated with a
change in quantity.
Marginal cost (MC) the change in
total cost associated with a change in
quantity.
A firm maximizes profit when MC = MR.

How to Maximize Profit

If marginal revenue does not equal
marginal cost, a firm can increase profit
by changing output.
The supplier will continue to produce as
long as marginal cost is less than
marginal revenue.

How to Maximize Profit

The supplier will cut back on production
if marginal cost is greater than marginal
revenue.
Thus, the profit-maximizing condition of a
competitive firm is MC = MR = P.

Again! MR=MC
Profit is maximized when MR=MC.
If the cost of producing one more unit is
less than the revenue it generates, then a
profit is available for the firm that
increases production by one unit.
If the cost of producing one more unit is
more than the revenue it generates, then
increasing production reduces profit.

Profit Maximization: Using MR

and MC curves

Profit Maximization: The

Numbers

MR=MC

TR

TC

TR-TC

MR

MC

ATC

$1

$0

$1.00

-$1.00

$1

$1

$1

$2.00

-$1.00

$1

$1.00

$2.00

$1

$2

$2.80

-$0.80

$1

$0.80

$1.40

$1

$3

$3.50

-$0.50

$1

$0.70

$1.17

$1

$4

$4.00

$0.00

$1

$0.50

$1.00

$1

$5

$4.50

$0.50

$1

$0.50

$0.90

$1

$6

$5.20

$0.80

$1

$0.70

$0.87

$1

$7

$6.00

$1.00

$1

$0.80

$0.86

$1

$8

$6.86

$1.14

$1

$0.86

$0.86

$1

$9

$7.86

$1.14

$1

$1.00

$0.87

10

$1

$10

$9.36

$0.64

$1

$1.50

$0.94

11

$1

$11

$12.00

-$1.00

$1

$2.64

$1.09

The Marginal Cost Curve

Is the Supply Curve

The marginal cost curve is the firm's

supply curve above the point where
price exceeds average variable cost.
The MC curve tells the competitive firm
how much it should produce at a given
price.

The Interaction of Firms and Markets

Price
And
Costs

Firm

Price

Market

S1

MC
A

S2

$10

P=MR0

ATC
=$7

ATC

b
c

AVC

P=MR1

D0
q4

q3

q2
q1
10 units

qF

Q1

Q2

QM

The Marginal-Cost Curve and the

Firms Supply Decision...
Costs
and
Revenue

This section of the

firms MC curve is
also the firms
supply curve
(long-run).

MC

P2
ATC

P1

AVC

Q1

Q2

Quantity

Determining Profit and Loss

Find output where MC = MR.
The intersection of MC = MR (P)
determines the quantity the firm will
produce if it wishes to maximize profits.

Find profit per unit where MC = MR.

Drop a line down from where MC equals MR,
and then to the ATC curve.
This is the profit per unit.
Extend a line back to the vertical axis to
identify total profit.

Determining Profit and Loss

The firm makes a profit when the ATC
curve is below the MR curve.
The firm incurs a loss when the ATC curve
is above the MR curve.

Determining Profit and Loss

From a Graph
Zero profit or loss where MC=MR.

Firms can earn zero profit or even a loss

where MC = MR.
Even though economic profit is zero, all
resources, including entrepreneurs, are being
paid their opportunity costs.

Determining Profits Graphically

MC
MC
MC
Price
Price
Price
65
65
65
60
60
60
55
55
55
ATC
50
50
50
ATC
45
45
45
40
40 D
A
P = MR 40
Loss
P = MR
35
35
35
P
=
MR
Profit
30
30
30
B ATC
AVC
25
25 C
25
AVC
AVC
E
20
20
20
15
15
15
10
10
10
5
5
5
0
0
0
1 2 3 4 5 6 7 8 910 12
1 2 3 4 5 6 7 8 9 10 12
1 2 3 4 5 6 7 8 9 10 12
Quantity
Quantity
Quantity
(b) Zero profit case
(a) Profit case
(c) Loss case
Irwin/McGraw-Hill

The McGraw-Hill Companies, Inc., 2000

Loss Minimization
Average cost of a unit of output

Market
price
falls
Revenue
generated by a
unit of output

The Firms Short-Run

Decision to Shut Down

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

The Shutdown Point

If total revenue is more than total
variable cost, the firms best strategy is
to temporarily produce at a loss.
It is taking less of a loss than it would by
shutting down.

The Shutdown Decision

MC

Price
60

ATC

50
40

Loss
P = MR

30

AVC

20
$17.80

10
0

Quantity

The Firms Long-Run Decision

to Exit or Enter a Market
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

The Firms Long-Run Decision

to Exit or Enter a Market
A firm will enter the industry if such an
action would be profitable.

Enter if TR > TC
Enter if TR/Q > TC/Q
Enter if P > ATC