firms in markets

Firms in MarketsFirms in Markets

• Tap water• Cable TV

Monopoly

• Novels• Movies

MonopolisticCompetition

• Tennis balls• Crude oil

Oligopoly

Number of Firms?

Perfect

• Wheat• Milk

Competition

Type of Products?

Identicalproducts

Differentiatedproducts

Onefirm

Fewfirms

Manyfirms

The Four Types of Market Structure The Four Types of Market Structure

• 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.

WHAT IS A COMPETITIVE WHAT IS A COMPETITIVE MARKETMARKET

• 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.

WHAT IS A COMPETITIVE WHAT IS A COMPETITIVE MARKETMARKET

• A competitive market has many buyers and sellers trading identical products so that each buyer and seller is a price taker.– Buyers and sellers must accept the

price determined by the market.

WHAT IS A COMPETITIVE WHAT IS A COMPETITIVE MARKETMARKET

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

TR = (P TR = (P Q) Q)• Total revenue is proportional to the amount of

output.• Average revenue tells us how much revenue a

firm receives for the typical unit sold.• Average revenue is total revenue divided by the

quantity sold.

The Revenue of a Competitive The Revenue of a Competitive FirmFirm

• In perfect competition, average revenue equals the price of the good.

The Revenue of a Competitive The Revenue of a Competitive FirmFirm

A v erag e R ev en u e = T o ta l rev e n u eQ u an tity

P rice Q u an tityQ u an tity

P rice

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

• For competitive firms, marginal revenue equals the price of the good.

The Revenue of a Competitive The Revenue of a Competitive FirmFirm

MR =MR =TR/ TR/ QQ

Table 14-1: Total, Average, and Table 14-1: Total, Average, and Marginal Revenue for a Competitive Marginal Revenue for a Competitive

FirmFirm

664868

664267

663666

663065

662464

661863

$ 661262

$ 6$ 6$ 61

(MR = ∆TR/∆Q)(AR = TR/ Q)(TR = P x Q)(P)(Q)

Marginal Revenue

Average Revenue

Total RevenuePrice

Quantity (in litres)

• The goal of a competitive firm is to maximize profit, which equals total revenue minus total cost.

• This means that the firm will want to produce the quantity that maximizes the difference between total revenue and total cost.

PROFIT MAXIMIZATION AND THE PROFIT MAXIMIZATION AND THE COMPETITIVE FIRM’S SUPPLY COMPETITIVE FIRM’S SUPPLY

CURVE CURVE

Table 14-2: Profit Maximization: A Table 14-2: Profit Maximization: A Numerical ExampleNumerical Example

(MR - MC)

Change in Profit

- 3- 2- 101

96147488

86438427

76630366

66723305

56717244

246612183

33648122

$ 4$ 2$ 61561

- $ 3$ 3$ 00

(MC = ∆TC/∆Q)(MR = ∆TR/∆Q)(TR - TC)(TC)(TR)(Q)

Marginal Cost

Marginal RevenueProfitTotal Cost

Total Revenue

Quantity (in litres)

Costs and

Revenue

Quantity0

MC1

Q1

The firm maximizes

profit by producing

the quantity at which

marginal cost equals

marginal revenue.

MC

AVC

Q MAX

MC2

Q 2

P = MR1 = MR2 P = MR ATC

Figure 14-1: Profit Maximization for a Figure 14-1: Profit Maximization for a Competitive Firm Competitive Firm

• While a competitive firm is a price taker, a monopoly firm is a price maker.

• A firm is considered a monopoly monopoly if . . .– it is the sole seller of its product.– its product does not have close

substitutes.

MONOPOLYMONOPOLY

• The fundamental cause of monopoly is barriers to entry.

• Barriers to entry have three sources:– Ownership of a key resource.– The government gives a single firm the

exclusive right to produce some good.– Costs of production make a single producer

more efficient than a large number of producers.

Why Monopolies AriseWhy Monopolies Arise

Cost

Quantity of Output0

Averagetotalcost

Figure 15-1: Economies of Scale as Figure 15-1: Economies of Scale as a Cause of Monopolya Cause of Monopoly

• Monopoly versus Competition– Monopoly

• Is the sole producer• Faces a downward-sloping demand curve• Is a price maker• Reduces price to increase sales

– Competitive Firm• Is one of many producers• Faces a horizontal demand curve• Is a price taker• Sells as much or as little at same price

Pricing and Production Pricing and Production DecisionsDecisions

(a) Competitive Firm (b) MonopolyPrice

0 0

Price

Demand

Demand

Quantity of OutputQuantity of Output

Figure 15-2: Demand Curves for Figure 15-2: Demand Curves for Competitive and Monopoly FirmsCompetitive and Monopoly Firms

• Total RevenueP Q = TR

• Average RevenueTR/Q = AR = P

• Marginal RevenueTR/Q = MR

A Monopoly’s RevenueA Monopoly’s Revenue

Table 15-1: A Monopoly’s Total, Table 15-1: A Monopoly’s Total, Average, and Marginal Revenue.Average, and Marginal Revenue.

- 4 32438

- 242847

053056

263065

472874

682483

891892

$ 10 $ 1010101

------$ 0$ 110

(MR = ∆TR/∆Q)(AR = P x Q)(TR = P x Q)(P)(Q)

Marginal Revenue

Average Revenue

Total RevenuePrice

Quantity of Water

• A Monopoly’s Marginal Revenue– A monopolist’s marginal revenue is

always less than the price of its good.• The demand curve is downward sloping.• When a monopoly drops the price to sell

one more unit, the revenue received from previously sold units also decreases.

A Monopoly’s RevenueA Monopoly’s Revenue

• A Monopoly’s Marginal Revenue– When a monopoly increases the amount

it sells, it has two effects on total revenue (P Q).• The output effect—more output is sold, so

Q is higher.• The price effect—price falls, so P is lower.

A Monopoly’s RevenueA Monopoly’s Revenue

Price

Quantity of Water

1 2 3 4 5 6 7 8

11

109876543210–1–2–3–4

Marginal revenue

Demand (average revenue)

Figure 15-3: The Demand and Figure 15-3: The Demand and Marginal Revenue Curves for a Marginal Revenue Curves for a

Monopoly Monopoly

• A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost.

• It then uses the demand curve to find the price that will induce consumers to buy that quantity.

Profit MaximizationProfit Maximization

Costs and Revenue

Quantity0

Marginal costMarginal revenue

Demand

Average total cost

Q1 Q2

2. … and then the demand curve shows the price consistent with this quantity.

Monopoly price

B

A

1. The intersection of the MR curve and the MC curve determines the profit maximizing quantity…

QMAX

Figure 15-4: Profit Maximization for a Figure 15-4: Profit Maximization for a Monopoly Monopoly

• Comparing Monopoly and Competition – For a competitive firm, price equals marginal

cost.P = MR = MC– For a monopoly firm, price exceeds marginal

cost.P > MR = MC

Profit MaximizationProfit Maximization

• Profit equals total revenue minus total costs.– Profit = TR - TC– Profit = (TR/Q - TC/Q) Q– Profit = (P - ATC) Q

• The monopolist will receive economic profits as long as price is greater than average total cost.

A Monopoly’s ProfitA Monopoly’s Profit

Costs and Revenue

Quantity0

Monopoly price

QMAX

Monopolyprofit

Marginal cost

Marginal revenue

Demand

Average total cost

D

BE

CAverage

total cost

Figure 15-5: The Monopoly’s Profit Figure 15-5: The Monopoly’s Profit

• Imperfect competition refers to those market structures that fall between perfect competition and pure monopoly.

MONOPOLISTIC MONOPOLISTIC COMPETITIONCOMPETITION

• Types of Imperfectly Competitive Markets– Monopolistic Competition

• Many firms selling products that are similar but not identical.

• Markets that have some features of competition and some features of monopoly.

– Oligopoly• Only a few sellers, each offering a similar or

identical product to the others.

MONOPOLISTIC MONOPOLISTIC COMPETITIONCOMPETITION

• Attributes of Monopolistic Competition– Many sellers– Product differentiation– Free entry and exit

MONOPOLISTIC MONOPOLISTIC COMPETITIONCOMPETITION

• Many Sellers– There are many firms competing for the same group

of customers.• Product examples include books, CDs, movies, computer

games, restaurants, piano lessons, cookies, furniture, etc.

• Product Differentiation– Each firm produces a product that is at least slightly

different from those of other firms.– Rather than being a price taker, each firm faces a

downward-sloping demand curve.

MONOPOLISTIC MONOPOLISTIC COMPETITIONCOMPETITION

• Free Entry or Exit– Firms can enter or exit the market without

restriction.– The number of firms in the market adjusts

until economic profits are zero.

MONOPOLISTIC MONOPOLISTIC COMPETITIONCOMPETITION

• The Monopolistically Competitive Firm in the Short Run – Short-run economic profits encourage new

firms to enter the market. This:• Increases the number of products offered.• Reduces demand faced by firms already in the

market.• Incumbent firms’ demand curves shift to the left.• Demand for the incumbent firms’ products fall, and

their profits decline.

The Monopolistically The Monopolistically Competitive Firm in the Short Competitive Firm in the Short

RunRun

• The Monopolistically Competitive Firm in the Short Run – Short-run economic losses encourage firms to

exit the market. This: • Decreases the number of products offered.• Increases demand faced by the remaining firms.• Shifts the remaining firms’ demand curves to the

right.• Increases the remaining firms’ profits.

The Monopolistically The Monopolistically Competitive Firm in the Short Competitive Firm in the Short

RunRun

(a) Firm Makes ProfitPrice

Quantity 0

Price

(b) Firm Makes Losses

Quantity 0

Average total cost

Price

Profit

MC

MR

Demand

ATC

Profit-maximizing

quantity

Losses

MC

MR

Demand

ATC

Loss-minimizing

quantity

Price

Average total cost

Figure 17-1: Monopolistic Figure 17-1: Monopolistic Competitors in the Short Run Competitors in the Short Run

• There are two noteworthy differences between monopolistic and perfect competition—excess capacity and markup.

Monopolistic Competition Monopolistic Competition Versus Perfect CompetitionVersus Perfect Competition

(a) Monopolistically Competitive FirmPrice

Quantity 0

Price

(b) Perfectly Competitive Firm

Quantity 0

MC

MR

Demand

ATC

Quantity produced

Marginal cost

Price

Efficient scale

Markup

MC

ATC

P = MC P = MR

Quantity produced = efficient scale

Figure 17-3: Monopolistic versus Figure 17-3: Monopolistic versus Perfect Competition Perfect Competition