MARKET STRUCTURE

• Goals of the firm

  • Profit maximization
  • Growth
  • Satisficing
  • Sales and revenue maximization
  • Market dominance
• Profit


  Total revenue - Total cost
• Normal profit


  Revenue = Cost
• Economic (abnormal) profit


  Revenue > Cost
• Average revenue


  Total revenue / Quantity sold
• Marginal revenue


  Change in total revenue / Change in quantity sold
• Total revenue


  Price x Quantity sold
• Market structure


  The competitive environment in which a firm operates
• Sales and revenue maximization


  • Firm attempts to sell at a price which achieves the greatest sales revenue
  • Firm reduces price to generate the highest possible sales
• Market dominance


  • Companies force out competitors by using predatory pricing
• In perfect competition, the industry sets the price through the forces of demand and supply
• In the short run, there are three possible cost structures for a firm: low cost, high cost, and marginal
• The level of profit which the firm earns in the short run depends on the cost structure of the firm
• If the market price is lower than the average cost, losses would occur in the short run
• Firms' behaviour in the long run

  1. Firms will enter if there is profit

  2. Firms will leave if there is loss

  3. All firms break even, they make no economic profit
• In long run equilibrium, a perfectly competitive firm is extremely efficient
• Firms incur losses in the short run

  Firms will cease production and leave the industry
• Firms leaving the industry

  Leads to a decline in overall output of the industry
• Firms leaving the industry

  Causes a leftward shift of the supply curve
• Price increases


  Quantity decreases
• Price increases


  Quantity increases
• In the long run equilibrium of perfect competition, firms make zero economic profit (normal profit)
• Disadvantages of perfect competition

  • Firms cannot afford research and development to earn economies of scale
  • Firms lack variety
  • Firms are too small to have any dominance over the market
• Imperfect competition


  Markets where firms set their own prices
• Demand curve for price-setting firms

  Downward sloping, unlike perfect competition where it is horizontal
• Marginal revenue curve


  Declines more rapidly than the average revenue curve, generally twice as fast
• Monopoly


  • Most efficient firm with the largest resource base can charge a lower price and out-compete rivals
  • Established firm can build goodwill and obtain preferential access to credit
• Marginal cost


  The quantity of output the firm is willing to sell at each price level, represents the supply curve
• If the firm cannot cover its variable costs in the short run, it makes sense to shut down
• A monopolist restricts output level compared to a perfectly competitive market
• A monopolist sets a larger price compared to a perfectly competitive market
• Natural monopoly


  • One firm producing all the industry output at the lowest average cost
• Unregulated natural monopoly


  Charges high price and makes super-normal profits
• Regulator imposes price cap on natural monopoly


  Achieves allocative efficiency but firm makes losses
• Approaches to pricing for natural monopoly

  • Do nothing (set price at MR=MC)
  • Marginal cost pricing (P=MC)
  • Average cost pricing (P=AC)
• Marginal Cost pricing


  A price rule for a natural monopoly that sets price equal to marginal cost. This rule leads to an efficient use of resources, but the monopoly incurs an economic loss because AC is greater than price is less than AC.
• Average Cost Pricing Rule

  A price rule for a natural monopoly that sets the price equal to average cost and enables the firm to cover its costs and earn a normal profit. Although this rule does not produce an efficient amount of output, it allows the firm to earn a normal profit and the quantity produce at this level is closer to the efficient quantity than the profit maximizing level or MR =MC.
• Price Discrimination


  • Where the same commodity is sold to different consumers in different markets for different prices for reasons that have nothing to do with cost
  • Monopoly/market power
  • Markets must be separate into different subgroups
  • There may be differing price elasticities of demand between two markets
  • Separation of the market also requires that the firm must be able to avoid arbitrage between separate markets
• Monopolistic competition


  • Higher Prices
  • Wasteful Expenditure and Excess Capacity
  • Allocative Inefficiency
  • Advertising Impact
• Oligopoly


  • Products could be highly differentiated or homogenous
  • Price stability within the market - Kinked demand curve - Prices are very inflexible
  • Potential for collusion
  • High degree of interdependence between firms