ECON 308 Week 5 Chapter 6: Market Structure Market structure: Objectives Students should be able to Differentiate among the four archetypal market structures.

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