In this segment we want toexamine the theoretical

implications of market structure for market

performance

Theory predicts that “competitive”markets lead to socially

efficient resource allocation.By contrast, imperfectly competitive

market structures resultin resource misallocation. We wantto lay out this argument in a formal

way.

Definitions

•P is market price measured in dollars, yen, lira, . . .

•Q is market quantity measured in units, tons, bushels, . . .

•TR is total revenue from the sale of goods or services

•AR is average revenue

•MR is marginal revenue--the increment to total revenue attributable to the last unit sold.

Note that:

QPTR

Q

TR

Q

QPAR

and

Q

TRMR

(1)

(2)

(3)

Definitions, part 2

•TC is total cost--the total cost of producing a given quantity of output measured in dollars, yen , lira, . . .

•ATC is average total cost or cost per unit of output produced.

•MC is marginal cost--the increment to total cost attributable to the last unit produced.

Note that:

Q

TCATC

and

Q

TCMC

(4)

(5)

Definitions, part 3

•Pc is the competitive price--the price that would prevail in equilibrium in a competitively structured market.

•Qc is the competitive output-the output that would prevail in equilibrium in a competitively structured market.

•PM is the monopoly price--that price that would prevail in equilibrium in a monopolistically structured market.

•QM is the monopoly output-- the output that would prevail in equilibrium in a monopolistically structured market.

Definitions, part 4•CS is consumer surplus--the difference between what consumers are willing to pay to get a given quantity of a good or service and what they actually pay for that quantity

•PS is producer surplus--the difference between the total revenue received by sellers and the minimum revenue that would be sufficient to induce sellers to offer that quantity for sale on the market.

•TS is the total surplus--the sum of CS and PS, that is:

PS CS TS

Resource allocation is sociallyefficient, or Pareto optimal, if a reallocation of existing resourcescould not make any one person

better off without making at leastone other person worse off.

The necessary condition for allocative (Pareto) efficiency is:in all markets

P = MC

Demand curve as schedule of marginal benefits (MB)P

rice

/bus

hel (

$)

Quantity/bushels0

Market price is an index of the benefits derived from the production/consumption of the marginal unit.

13

9

51 117

•The 51st bushel adds $13 to society’s benefits.

•The 117th bushels adds $9 to society’s benefits from apples.

Price

Quantity0

F

K

Q1 Q2 QC

CD = AR = MB

S = MC

EPC

A

PS = CPCECS = PCAE

TS = PS + CS = CAE

Vertical distance FK is the excess of benefits over costs for the marginal unit when Q = Q1

Price, Cost

MR

Competitive supply curve

0 QMQC Quantity

D = AR

ATC = MC

K

A

B

EPC

PM

Competition Monopoly

Price PC PM

Quantity QC QM

CS PCKE PMKA

Econ. zero PcPMAB

DWL Zero AEB