econ 308 week 5 chapter 6: market structure market structure: objectives students should be able to...
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ECON 308
Week 5
Chapter 6: Market Structure
Market structure: Objectives
• Students should be able to
• Differentiate among the four archetypal market structures
• Distinguish between price takers and price searchers
Market structure
• What is a market?• All firms and individuals willing and able to
buy or sell a particular product
• What is market structure?• Defined by attributes of the market
environment
Demand Facing the Firm
$P $P $P $P
Q Q Q Q
D1
D2
D3 D4
Increasing degrees of Competition Increasing degrees of Market Power
Market structurethe archetypes
• Monopoly
• Oligopoly
• Monopolistic competition
• Perfect competition
Alternative Market Structures
The Most Competitive Case:
The Price Taker Firm
Perfect competition = Price TakerCharacteristics
• Many buyers and sellers
• Product homogeneity
• Low cost and accurate information
• Free entry and exit
• Best regarded as a benchmark
Market and Firm Demand$P
Q/T
Pe
Qe
$P
Q/T
Pe
Market Firm
D
D
DS
S
Firm supply
• Short run– Marginal cost curve above average
variable cost– P* = SRMC
• Long run– Long-run marginal cost curve
above long-run average cost
Price Taker Firm
$ P
Q/T
Pe D = MR
MCMC
Qe
Profit Maximizing Rate of output
Price = Marginal Price = Marginal RevenueRevenue
Total Revenue = Pe x Qe
$ P
Q/T
Pe D
MCMC
Qe
Total RevenueTotal Revenue
$ P
Q/T
Pe D
MC
Qe
AC
Total Cost = AC x Q
AC at Qe
Total CostTotal Cost
Profit = TR - TC$ P
Q/T
Pe D
MC
Q
AC
$ P
Q/T
Pe D = MR
MC
Qe
AC
Profits occur if (P=MC) > AC
Market Response to Profits$P
Qx/T
Pe
Qe
D
DSo
SoS’
P’
Q’
Price Taker Firm: Zero Profits
$ P
Q/T
Pe’ D’ = MR
MCMC
Qe
ATC
D
Price Taker Firm: Loss
$ P
Q/T
Pe D = MR
MCMC
Qe
ATC
Loss
Market Response to Losses$P
Qx/T
P’
Q’
D
DS’
S’So
Po
Qo
Price Taker Firm: Zero Profits
$ P
Q/T
Pe’ D’ = MR
MCMC
Qe
ATC
DPo
Implications of Price-Taker Industry
• Demand for the firm is horizontal at the market price
• Efficiency: Price equals marginal cost of production
• Competition drives price to equal Average cost
• Economic profits only exist in the short-run.
Long-Run Industry EquilibriumLong-Run Industry Equilibrium$P
Q/T
Pe
Qe
$P
Q/T
Pe
Market Firm
D
D
DS
SMC
ATC
Qe
Sources of Market Power:Barriers to entry
Incumbent reactions
• Specific assets• Economies of scale• Excess capacity• Reputation effects
Incumbent advantages• Precommitment
contracts• Licenses and patents• Learning-curve effects• Pioneering brand
advantages
Monopoly
• Strong barriers to entry single supplier
• Profit maximization– faces market demand and sets MR=MC
• Unexploited gains from trade
Oligopoly
• A few firms produce most market output
• Products may or may not be differentiated
• Effective entry barriers protect firm profitability
• Firm interdependence requires strategic thinking
Monopolistic competition
• Multiple firms produce similar but differentiated products
• Firms face downsloping demand curves
• Profit maximization occurs where MC=MR
• In the limit, firms compete away economic profits
• Tend to see lots of advertising