PAS 2201 - Chapter 6

• market structure

  the number and relative size of firms in an industry
• factors of 5 types of market structure

  1. monopoly
  2. duopoly
  3. oligopoly
  4. monopolistic competition
  5. perfect competition
• monopoly

  • one that produced the entire market supply of a particular good or service
  • price setter
  • no direct competitions
  • has complete market power
  • has the ability to alter the market price of a good or service
• duopoly

  only two firms supply a product
• oligopoly

  a few large firms supply all or most of a particular product
• monopolistic competition


  many firms supply essentially the same product but each enjoys significant brand loyalty
• four conditions for perfect competition

  1. homogeneous product
  2. many small firms
  3. free entry and exit
  4. all firms face same costs
• homogeneous product

  the product of any one seller be the same as the product of other seller
• many small firms

  each participant in the market, whether buyer or seller, to be small, in relation to the entire market, that one cannot affect the product's price
• free entry and exit

  • each resource must be able to enter or leave the market and switch from one use to another, very readily
  • low barrier to entry
• all firms face same costs

  • consumers must be aware of all prices
  • firms must know the prices of all inputs
• a perfectly competitive firm:

  • one without market power

  - market power: the ability to alter the market price of a good or service

  - no market power: output of a firm is so small relative to market supply that it has no significant effect on the total quantity or price in the market

  • not able to alter the market price of the good it produces
  • it is a price taker
  • competes with many other firms selling homogenous products
• competitive market

  • no buyer or seller has market power
  • no single producer or consumer has any control over the price or quantity of the product
• market demand curve for perfect competition

  
• market demand curve for a perfectly competitive firm

  
• production decision

  • the selection of the short-run rate of output (with existing plant and equipment)
  • involves determining how much to produce
• output, revenues, and profits

  • maximizing output or revenue is not the way to maximize profits (profit = revenue - cost)
  • total profits depend on how both revenue and cost increases as output expands
  • a business is profitable only within a certain range of output
• profit-maximizing rate of output

  • a competitive firm wants to expand the rate of production whenever price exceeds marginal cost
  • never produce anything that costs more than it brings in (need to compare price and marginal cost)
  • price > MC - increase output rate
  • price = MC - maintain output rate
  • price < MC - decrease output rate
• profit-maximizing rate of output

  
• total profit

  total profit = total revenue - total cost

  
• supply behavior

  • how firms make production decisions helps explain how the market establishes prices and quantities
  • competitive firms adjust the quantity until MC = price

  
• competitive market supply

  
• market supply

  • total quantity of a good that sellers are willing and able to sell at alternative prices in a given time period
  • market supply curve is the sum of the marginal cost curve of all the firms.

  
• marginal costs determine the supply decisions of a firm

  • anything that alters marginal cost will change supply behavior

  
• • the number of firms in a competitive industry is not fixed
  • industry entry and exit is a driving force affecting market equilibrium

  
• industry entry

  economic profits attract firms

  • additional firms will enter the industry when profits are plentiful
  • most firms enter the industry
  • the market supply curve shifts to the right
  • the price decreases
  • industry output increases and price falls when firms enter an industry
• industry entry

  
• industry entry

  • new firms continue to enter a competitive industry as long as profits exit
  • once price falls to the level of minimum average cost, all economic profits disappear
  • entry is the force driving down market prices
  • price falls until there are no economic profits
• industry exit

  • firms exit the industry when profit opportunities look better elsewhere
  • firms leave the industry if price falls below average cost
  • as firm exit the industry, the market supply curve shifts to the left
  • price rises until there are no economic losses
• equilibrium

  • the existence of profits in a competitive industry induces entry
  • the existence of losses in a competitive industry induces exits
  • as long as it is easy for existing producers to expand production or for new firms to enter an industry, economic profits will not last long.