MARKET STRUCTURE

A Presentation by:

Saman Javed
Market Structure
 What do we understand by the term
“Market”?
• Economists have defined market as an area
where buyer and sellers come in contact with
each other by any means of communication in
order to determine the price of a product
through the forces of demand and supply.
Market area is not restricted. It can be a
village, a city, a country or it may extend
beyond national boundaries.

Abdul Haleem Khawja P.119

 Market Structure
• Market structure – identifies how a market
is made up in terms of:
– The number of firms in the industry
– The nature of the product produced
– The degree of monopoly power each firm has
– The degree to which the firm can influence price
– Profit levels
– Firms’ behaviour – pricing strategies, non-price
competition, output levels
– The extent of barriers to entry
– The impact on efficiency

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 Market Structure
Perfect Pure
Competition Monopoly

More competitive (fewer imperfections)

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 Market Structure
Perfect Pure
Competition Monopoly

Less competitive (greater degree

of imperfection)

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 Market Structure
Pure
Perfect
Monopoly
Competition

Monopolistic Competition Oligopoly Duopoly Monopoly

The further right on the scale, the greater the degree

of monopoly power exercised by the firm.

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 Perfect Competition
• One extreme of the market structure
spectrum
• Characteristics:
– Large number of firms
– Products are homogenous (identical)
– Freedom of entry and exit into and out
of the industry

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 Monopolistic or Imperfect Competition

• Where the conditions of perfect competition do

not hold, ‘imperfect competition’ will exist
• Varying degrees of imperfection give rise to
varying market structures
• Monopolistic competition is one of these – not to
be confused with monopoly!

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 Monopolistic or Imperfect Competition
• Characteristics:
– Large number of firms in the industry
– May have some element of control over price due to the
fact that they are able to differentiate their product in
some way from their rivals – products are therefore close,
but not perfect, substitutes
– Entry and exit from the industry is relatively easy – few
barriers to entry and exit
– Consumer and producer knowledge imperfect

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 Monopolistic or Imperfect Competition
• Some important points about monopolistic
competition:
– May reflect a wide range of markets
– Not just one point on a scale – reflects many
degrees of ‘imperfection’

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 Monopolistic or Imperfect Competition
• Restaurants
• Plumbers/electricians/local builders
• Solicitors
• Private schools
• Plant hire firms
• Insurance brokers
• Health clubs
• Hairdressers
• Funeral directors
• Estate agents
• Damp proofing control firms
 Monopolistic or Imperfect Competition
• In each case there are many firms
in the industry
• Each can try to differentiate its product
in some way
• Entry and exit to the industry is relatively free
• Consumers and producers do not have perfect knowledge of
the market – the market may indeed be relatively localised.

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 Oligopoly
• Competition between the few
– May be a large number of firms in the industry but the
industry is dominated
by a small number of very large producers

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 Oligopoly
• Features of an oligopolistic market structure:
– Price may be relatively stable across the industry –
kinked demand curve?
– Potential for collusion
– Behaviour of firms affected by what they believe their rivals
might do – interdependence of firms
– Goods could be homogenous or highly differentiated
– Branding and brand loyalty may be a potent source of
competitive advantage
– Non-price competition may be prevalent
– Game theory can be used to explain some behaviour
– AC curve may be saucer shaped – minimum efficient scale
could occur over large range of output
– High barriers to entry
 Duopoly
• Market structure where the industry is dominated
by two large producers
– Collusion may be a possible feature
– Price leadership by the larger of the two firms may exist – the
smaller firm follows the price lead
of the larger one
– Highly interdependent
– High barriers to entry
– Cournot Model – French economist – analysed duopoly –
suggested long run equilibrium would see equal market share and
normal profit made
– In reality, local duopolies may exist
 Monopoly
• Pure monopoly – where only
one producer exists in the industry
• In reality, rarely exists – always
some form of substitute available!
• Monopoly exists, therefore,
where one firm dominates the market
• Firms may be investigated for examples of
monopoly power when market share exceeds 25%
• Use term ‘monopoly power’ with care!
 Monopoly
• Monopoly power – refers to cases where firms influence
the market in some way through their behaviour –
determined by the degree
of concentration in the industry
– Influencing prices
– Influencing output
– Erecting barriers to entry
– Pricing strategies to prevent or stifle competition
– May not pursue profit maximisation – encourages unwanted
entrants to the market
– Sometimes seen as a case of market failure
 Monopoly
• Origins of monopoly:
– Through growth of the firm
– Through amalgamation, merger
or takeover
– Through acquiring patent or license
– Through legal means – Royal charter,
nationalisation, wholly owned plc
 Monopoly
• Summary of characteristics of firms exercising
monopoly power:
– Price – could be deemed too high, may be set to destroy
competition (destroyer or predatory pricing), price
discrimination possible.
– Efficiency – could be inefficient due to lack of competition
(X- inefficiency) or…
• could be higher due to availability of high profits
 Monopoly
• Innovation - could be high because
of the promise of high profits, Possibly encourages
high investment in research and development (R&D)
• Collusion – possible to maintain monopoly power of
key firms in industry
• High levels of branding, advertising
and non-price competition
 Monopoly
• Problems with models – a reminder:
– Often difficult to distinguish between a monopoly
and an oligopoly – both may exhibit behaviour
that reflects monopoly power
– Monopolies and oligopolies do not necessarily aim
for traditional assumption of profit maximisation
– Degree of contestability of the market may influence behaviour
– Monopolies not always ‘bad’ – may be desirable
in some cases but may need strong regulation
– Monopolies do not have to be big – could exist locally
• Distinguishing features of the Four Market Structures

Pure Monopolistic
Characteristics Competition Competition Oligopoly Monopoly
Number of Many Few to many Few No direct
competitors competitors
Ease of entry into Easy Somewhat Difficult Regulated by
industry by new Difficult government
firms
Similarity of goods Similar Different Can be either No directly
or services offered similar or competing goods or
by competing firms different service
Control over prices None Some Some Considerable
by individual firms
Demand curves Totally Can be either Kinked; Can be either elastic
facing individual elastic elastic or inelastic or inelastic
firms inelastic below kink;
more elastic
above
Examples 2000-acre Banana BP Commonwealth
ranch Republic Edison
THE BEHAVIOUR OF VARIABLES.
 PERFECT COMPETITION, DEMAND
• The demand curve for the output produced by a perfectly
competitive firm is perfectly elastic at the going market
price.

• The firm can sell all of the output that it wants at this price
because it is a relatively small part of the market. As a price
taker, the firm has no ability to charge a higher price and no
reason to charge a lower one.

• The market price facing a perfectly competitive firm is also

average revenue and, most important, marginal revenue.
 PERFECT COMPETITION, DEMAND(EXAMPLE)

Phil the Zucchini Grower

• Take, for example, the production of zucchinis by Phil the
gardener. While Phil the zucchini grower is not actually a
perfectly competitive firm, because the real world does not
contain any perfectly competitive firms that perfectly satisfy
all of the characteristics of perfect competition, Phil does
come close.

• He is one of gazillions of zucchini growers. His zucchinis are

identical to all other growers. He and others can easily enter
and leave the zucchini growing business. And he has the
same price and production technique information as other
growers.
 PERFECT COMPETITION, DEMAND(EXAMPLE)

Phil the Zucchini Grower

• In this case, the price that Phil charges and receives
for his zucchinis is the going market price. There is
nothing special about Phil's zucchinis that would let
him charge a higher price, and there is no reason for
him to charge less.

• As an extremely miniscule part of the zucchini

market, Phil can sell every zucchini he produces at
the going market price. He faces a perfectly elastic
demand curve.
PERFECT COMPETITION, DEMAND
Demand Curve, Perfect
Competition
 PERFECT COMPETITION, SHORT-RUN
SUPPLY CURVE:
• A perfectly competitive firm's supply curve is that
portion of its marginal cost curve that lies above the
minimum of the average variable cost curve.
• A perfectly competitive firm maximizes profit by
producing the quantity of output that equates price
and marginal cost.
• As such, the firm moves along its positively-sloped
marginal cost curve in response to changing prices.
PERFECT COMPETITION, SHORT-RUN
SUPPLY CURVE:
 Only Perfect Competition

• This short-run supply curve explanation relies on Phil being a perfectly

competitive price taker. The marginal cost curve is a supply curve only
because a perfectly competitive firm equates price with marginal cost.
This happens only because price is equal to marginal revenue for a
perfectly competitive firm. Should price and marginal revenue NOT be
equal, then a profit-maximizing firm does NOT equate price to marginal
cost. As such, the marginal cost curve is NOT the firm's supply curve.

• Because perfect competition does not exist in the real world, most real
world firms do not have equality between price and marginal revenue,
and thus do not equate price to marginal cost. In fact, real world firms
with varying degrees of market power do not have supply curves
comparable to that of an idealistic perfectly competitive firm. This
recognition is a major stumbling block in the explanation of the law of
supply and the role that the law of supply is plays in market analysis.
 LONG-RUN PRODUCTION ANALYSIS:

An analysis of the production decision made

The central characteristic of long-run production analysis
is that all inputs under the control of the firm are variable.
The central principle guiding production in the long run is
returns to scale, which indicates how production responds
to proportional changes in all inputs. A contrasting
analysis is short-run production analysis.

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 LONG-RUN PRODUCTION ANALYSIS:
• Long-run production analysis extends and augments short-run
production analysis commonly used to explain the law of
supply.
• The critical difference between the long run and the short run
is the law of diminishing marginal returns. This law applies to
the short run, which has at least one fixed input, but not the
long run, which has all inputs variable.

• The guiding principle for the long run is returns to scale,

which indicates how production changes due to proportional
changes in all inputs. Returns to scale can be either
increasing, decreasing, or constant.
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 All Inputs: Variable
long run
• In the long run, all inputs under the control of the producer are
variable. A variable input is an input used in production and
under the control of the producer that can be changed during
the time period of analysis. While the short-run is characterized
by at least one fixed input, usually capital (factory, production
facility, building, and/or equipment), in the long run all inputs,
including the quantity of capital is variable.

• From a practical standpoint, this means that a firm not only has
the ability to adjust the number of workers, but also the size of
the factory. If the existing production plant is being used
beyond capacity, then a bigger one can be constructed in the
long run. If the existing office building has unused space, then a
firm can move to a smaller one in the long run.

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 All Inputs: Variable
long run
• Note that the phrase "under the control of the producer" is
included in the specifications of short run, long run, and
variable input. The reason is that long-run production analysis
is most concerned with how producers adjust the inputs
under their control in response to changing prices.

• Any production activity invariably includes inputs that are

beyond the control of the producer, including government
laws and regulations, social customs and institutions,
weather, and the forces of nature. These other variables are
certainly worthy of consideration, but are not fundamental to
explaining and understanding the basic principles of market
supply

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 Three Returns to Scale: Increasing,
Decreasing, and Constant
• If a firm or producer changes all inputs proportional, the
resulting change in production is guided by returns to scale,
which come in three varieties.

• First, production might actually increase proportionally to the

increase in inputs. Second, production might increase more
than the increase in the inputs.

• Third, production might increase less than the increase in

inputs. These three alternatives are technically termed
constant returns to scale, decreasing returns to scale, and
increasing returns to scale.
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 Three Returns to Scale: Increasing,
Decreasing, and Constant
• Constant Returns to Scale: This occurs if a proportional increase in all
inputs under the control of a firm results in an equal proportional increase
in production. In other words, a 10 percent increase in labor, capital, and
other inputs, also results in an equal 10 percent increase in production.

• Increasing Returns to Scale: This occurs if a proportional increase in all

inputs under the control of a firm results in a greater than proportional
increase in production. In other words, a 10 percent increase in labor,
capital, and other inputs, results in a production increase that is greater
than 10 percent.

• Decreasing Returns to Scale: This occurs if a proportional increase in all

inputs under the control of a firm results in a less than proportional
increase in production. In other words, a 10 percent increase in labor,
capital, and other inputs, results in a production increase that is less than
10 percent.

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 SHORT-RUN PRODUCTION ANALYSIS:
• An analysis of the production decision made by a firm in the
short run, with the ultimate goal of explaining the law of
supply and the upward-sloping supply curve.

• The central feature of this short-run production analysis is

the law of diminishing marginal returns, which results in the
short run when larger amounts of a variable input, like labor,
are added to a fixed input, like capital.

• A contrasting analysis is long-run production analysis.

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 Two Inputs: Fixed and Variable
short run
• The analysis of short-run production assumes that at least
one input in the production process is fixed and at least one is
variable. As already noted, the fixed and variable inputs are
intertwined with the notion of short run and long run.

• Fixed Input: A fixed input is an input used in production and

under the control of the producer that does not change
during the time period of analysis (the short run).
• Variable Input: A variable input is an input used in production
and under the control of the producer that does change
during the time period of analysis (the short run).

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 Two Inputs: Fixed and Variable
short run
• The variable input used by most producers is
more often than not labor. The fixed input for
most production operations is usually capital.
The presumption is that the size of a firm's
workforce can be adjusted more quickly that
the size of the factory or building, the amount
of equipment, and other capital.

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Three Returns: Increasing, Decreasing,
and Negative short run
• The addition of a variable input (like labor) to a fixed input (like capital)
can have one of three basic results. First, production might increase at a
increasing rate. Second, production might increase at a decreasing rate.
Third, production might actually decrease. These three alternatives are
technically termed increasing marginal returns, decreasing marginal
returns, and negative marginal returns.

• Increasing Marginal Returns: This occurs if each additional unit of a

variable input added to a fixed input causes incremental production to
increase. For example, the one worker contributes 10 units of output to
production, the next worker contributes another 12 units, and the
subsequent worker contributes 14 units. With increasing marginal
returns, each worker contributes more to production that the previous
worker.

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Three Returns: Increasing, Decreasing,
and Negative short run
• Decreasing Marginal Returns: This occurs if each additional unit of a
variable input added to a fixed input causes incremental production to
decrease. For example, the one worker contributes 10 units of output to
production, the next worker contributes another 8 units, and the
subsequent worker contributes only 6 units. With decreasing marginal
returns, each worker contributes less to production that the previous
worker.

• Negative Marginal Returns: This results if the addition of a variable

input added to a fixed input actually causes the total production to
decline. For example, if 10 workers produce a total of 100 units of
output, and 11 workers produce a total of 99 units, then the eleventh
worker is said to have negative marginal returns.

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Three Product Curves
short run

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 Three Production Stages

• Short-run production exhibits three distinct stages reflected by the shapes

and slopes of the three product curves--total product, marginal product,
and average product.

• Stage I: The first stage is increasing marginal returns and is

characterized by the increasingly steeper positive slope of the
total product curve, the positive slope of the marginal
product curve, and the positive slope of the average product
curve. Moreover, the marginal product curve reaches a peak
at the end of Stage I.

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 Three Production Stages

• Stage II: The second stage is decreasing marginal returns and is reflected
in the positive but flattening slope of the total product curve and the
negative slope of the marginal product curve. Moreover, the average
product reaches a peak and is equal to marginal product in this stage.
The marginal product curve intersects the horizontal quantity axis at the
end of Stage II.

• Stage III: The third and last stage is negative marginal returns illustrated
by the negative value of marginal product and the negative slope of the
total product curve. Average product is positive, but the average
product curve has a negative slope.

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Three Production Stages

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 PERFECT COMPETITION, REVENUE
DIVISION:
• The marginal approach to analyzing a perfectly competitive
firm's short-run profit maximizing production decision can be
used to identify the division of total revenue among variable
cost, fixed cost, and economic profit.

• The U-shaped cost curves used in this analysis provide all of

the information needed on the cost side of the firm's
decision. The demand curve facing the firm (which is also the
firm's average revenue and marginal revenue curves)
provides all of the information needed on the revenue side.

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PERFECT COMPETITION, REVENUE
DIVISION:

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 PERFECT COMPETITION, REVENUE
DIVISION:
• Total Revenue: Because Phil is a perfectly competitive firm,
the MR curve is also average revenue and the product price,
$4 per pound. Total revenue is then simply the price ($4)
times the quantity of output (7), which is $28.
• Total revenue can be graphically highlighted as the rectangle
bounded by the vertical and horizontal axes on the left and
bottom, the MR curve on the top, and the vertical line at the
quantity of 7 pounds connecting the MR-MC intersection
point with the quantity axis on the right. Click the [Total
Revenue] button to highlight this area.

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PERFECT COMPETITION, REVENUE
DIVISION:
Revenue Division

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 IDEOLOGY OF PERFECT
COMPETITION IN THE LIGHT
OF ASSUMPTIONS
 PERFECT COMPETITION
• The concept of competition is used in two
ways of economics
• Competition as a process is rivalry among
firms.
• Competition as the perfectly competitive
market structure .

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• Perfect Competition describes the perfect
being a market in which there are many small
firms, all producing homogeneous goods.
• For example : TOYOTA ,NISSAN AND HONDA
•
• AUTOMOBILE INDUSTRY

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Perfect-Competition-notes
 CHARACTERISTICS OF PERFECT
COMPTITION
• Numerous sellers are present in the market all
selling similar products
• All buyers and sellers are informed about
markets and prices
• There is free entry into and exit from the market.
• No individual seller or buyer can influence market
price ; instead price is determined by market
supply and demand.
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• Firms in perfect competition have no control
over price .
• They are price takers ; accept and take the
established market price
• Market price is determined by market
demand and market suppy

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 Why are individual firms price takers?

• Each is small relative to size of market

• Buyers are well informed about existing
market price charged.
• Each firm is so small relative to the market
that each has no impact on the price market
• For example each farmer is a price taker

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 SOCIAL IMPACT OF PERFECT
COMPETITION
• ECONOMIC EFFICIENCY : Occurs when firms
produce at the minimum point on their long-run
average cost curves i.e. at least the possible cost
• ALLOCATIVE EFFICIENCY: Occurs when
consumers pay a price equal to marginal cost
• Producing the amount of output that consumers
value the most

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 THE EFFICIENCY OF PERFECT
COMPETITION
• Efficient Allocation of Resources among firms:

• Perfectly competitive firms have incentives to use

the best available technology.
• With a full knowledge of existing technologies
,firms will choose the technology that produces
the output they want at the least cost.

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 PRODUCING WHAT PEOPLE WANT
THE EFFICIENT MIX OF OUTPUT:
• Society will produce the efficient mix of
output if all firms equate price and marginal
cost .
SHORT RUN PROFIT MAXIMIZATION IN
PERFECT COMPETITION
• How does a perfectly competitive firm maximize
its total economic profit earned ?

• The perfectly competitive firm has no control

over price, however, what the firm does is
control the amount of output produced the
question is the perfect competitive firm is:
• How much should it produce to earn the greatest
amount of profit .
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 TWO APPROACHES TO PROFIT
MAXIMIZATION.
• TR-TC APPROACH
• Producing the quantity of output at which TR
exceeds by the greatest amount

• MARGINAL ANALYSIS APPROACH

• Produce the quantity of output where
• MR=MC …

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• MARGINAL REVENUE : (MR) is the change in
total revenue from selling another unit of
output MR=price in PC

• MARGINAL COST : (MC) , is the change in total

cost resulting from producing another unit of
output

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 Extract of cost and revenue data
PRICE= TOTAL TOTAL MC TR-TC situation
QTY MR
REVENUE COST =ECONO
MIC
PROFIT
OR LOSS
0 $5 $0 $15 -$15

1 $5 $5 $19.75 $4.75 -$14.75 MR>MC

10 $5 $50 $40.00 2.75 $10.00 MR>MC

11 $5 $55 $43.25 3.25 $11.75 MR>MC

12 $5 $60 $48 4.75 $12.00 MR>MC

13 $5 $65 $54.50 6.50 $10.50 MR<MC

• So as long as MR>MC the firm will increase
quantity supplied as each additional unit adds
more to total revenue than to total cost .Q
increases till the qty where MR=MC
 MARKET
STRUCTURE

SHORT RUN
 What Is Perfect Competition?
– Perfect competition is an industry in which
 Many firms sell identical products to many buyers.
 There are no restrictions to entry into the industry.
 Established firms have no advantages over new ones.
 Sellers and buyers are well informed about prices.

Michael Parkin (8th edition)

 What Is Perfect Competition?
• How Perfect Competition Arises
– Perfect competition arises:
 When firm’s minimum efficient scale is small relative to
market demand so there is room for many firms in the
industry.
 And when each firm is perceived to produce a good or service
that has no unique characteristics, so consumers don’t care
which firm they buy from.

Michael Parkin (8th edition)

 What Is Perfect Competition?
• Economic Profit and Revenue
– The goal of each firm is to maximize economic profit,
which equals total revenue minus total cost.
– Total cost is the opportunity cost of production, which
includes normal profit.
– A firm’s total revenue equals price, P, multiplied by
quantity sold, Q, or P  Q.
– A firm’s marginal revenue is the change in total revenue
that results from a one-unit increase in the quantity sold.

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 GRAPHS
– Figure illustrates firm’s revenue concepts.
– Part (a) shows that market demand and market supply
determine the market price that the firm must take.
– Figure (b) shows the firm’s total revenue curve (TR)—the
relationship between total revenue and quantity sold.
– Figure (c) shows the marginal revenue curve (MR).
– The firm can sell any quantity it chooses at the market
price, so marginal revenue equals price and the demand
curve for the firm’s product is horizontal at the market
price.
The Firm’s Decisions in Perfect
Competition
A perfectly competitive firm faces two constraints:
1. A market constraint summarized by the market price
and the firm’s revenue curves.
2. A technology constraint summarized by firm’s product
curves and cost curves.
The goal of the firm is to make maximum economic profit,
given the constraints it faces.
So the firm must make four decisions: Two in the short run
and two in the long run.

www.theshortrun.com
 Definition Of Short Run
• Period during which only some factors or variables can be
changed because there is not enough time to change the
others.

• In economics, the concept of the short-run refers to the

decision-making time frame of a firm in which at least one
factor of production is fixed. Costs which are fixed in the
short-run have no impact on a firms decisions.

en.wikipedia.org/wiki/short-run
www.crfonline.org/glossary
 Example
• Helen Cookie Factory
• Helen, the owner of the firm, buys all the necessaries and
ingredients to make cookies. As we assume that the size of
Helen’s factory is fixed and that she can vary the quantity of
cookies produced only by changing the number of workers.
This example is realistic in the short run but not in long run.
• The Reason For This:
• Is that she cannot build a larger factory overnight, but she
can do so within a year or two.

N. Gregory Mankiw (India Edition)

 Example
• Daniel Mall adjustment
• Daniel, the owner of the plot wants to make more shops as the demand for
his shop is increasing in that area for which he need the more space with
resources as he have fixed price of shops and space as he can add for items in
his shops so as this show short run analysis.

The Reason For This:

• He can not extend his space of plot within a year because he need two
to three years of time to buildup mall in a more space of plot.

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The Firm’s Decisions in Perfect
Competition

– Short-Run Decisions

– In the short run, the firm must decide:

– 1. Whether to produce or to shut down temporarily.
– 2. If the decision is to produce, what quantity to produce.

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 The Firm’s Decisions in Perfect
Competition

• Profit-Maximizing Output
– A perfectly competitive firm chooses the output that
maximizes its economic profit.
– One way to find the profit-maximizing output is to look at
the firm’s the total revenue and total cost curves.
– Figure on the next slide looks at these curves along with
the firm’s total profit curve.

www.economics.about.com/shortrun/profit
 Example

– Part (a) shows the total

revenue, TR, curve.

Part (a) also shows

the total cost
curve, TC.
Total revenue minus total
cost is economic profit (or
loss), shown by the curve EP
in part (b).
Michael Parkin (8th edition)
 Revenue (Sales) and Costs of a
Perfectly Competitive Firm

OUTPUT PRICE TOTAL REVENUE TOTAL COST PROFIT

0 20 0 24 -24
1 20 20 28 -8
2 20 40 30 10
3 20 60 34 26
4 20 80 40 40
5 20 100 50 50
6 20 120 70 50
7 20 140 100 40
8 20 160 162 -2
 Example
– At low output levels,
the firm incurs an
economic loss—it can’t
cover its fixed costs.

At intermediate output
levels, the firm makes an
economic profit.

Michael Parkin (8th edition)

 The Firm’s Decisions in Perfect
Competition
• Marginal Analysis
– The firm can use marginal analysis to determine the profit-
maximizing output.
– Because marginal revenue is constant and marginal cost
eventually increases as output increases, profit is
maximized by producing the output at which marginal
revenue, MR, equals marginal cost, MC.
– Figure on the next slide shows the marginal analysis that
determines the profit-maximizing output.

www.e-elgar-economics.com
 The Firm’s Decisions in Perfect
Competition
– If MR > MC, economic
profit increases if
output increases.
If MR < MC, economic profit
decreases if output
increases.
If MR = MC, economic profit
decreases if output changes
in either direction, so
economic profit is
maximized.
Michael Parkin (8th edition)
 The Firm’s Decisions in Perfect
Competition
• Profits and Losses in the Short Run
Maximum profit is not always a positive economic profit.
To determine whether a firm is making an economic profit
or incurring an economic loss, we compare the firm’s
average total cost at the profit-maximizing output with the
market price.
Figure on the next slide shows the three possible profit
outcomes.

www.referenceforbusiness.com/encyclopedia
 The Firm’s Decisions in Perfect
Competition
– In part (a)
price equals
average total
cost and the
firm makes zero
economic profit
(breaks even).
 The Firm’s Decisions in Perfect
Competition
• In part (b), price exceeds average total cost and the firm makes a positive economic profit.
• In part (c) price is less than average total cost and the firm incurs an economic loss—economic profit is negative.

wps.prenhall.com/bp_case_econ_8/
 The Firm’s Decisions in Perfect
Competition
• The Firm’s Short-Run Supply Curve
– A perfectly competitive firm’s short run supply curve
shows how the firm’s profit-maximizing output varies as
the market price varies, other things remaining the same.
– Because the firm produces the output at which marginal
cost equals marginal revenue, and because marginal
revenue equals price, the firm’s supply curve is linked to
its marginal cost curve.
– But there is a price below which the firm produces
nothing and shuts down temporarily.
www.britannica.com
 The Firm’s Decisions in Perfect
Competition
• Temporary Plant Shutdown
• Example:
– If price is less than the minimum average variable cost, the
firm shuts down temporarily and incurs an economic loss
equal to total fixed cost.
– This economic loss is the largest that the firm must bear.
– If the firm were to produce just 1 unit of output at a price
below minimum average variable cost, it would incur an
additional (and avoidable) loss.
www.uwyo.edu
Short-Run Supply
Curve
Figure shows how the
firm’s short-run supply
curve is constructed.
If price equals minimum
average variable cost, $17
in this example, the firm is
indifferent between
producing nothing and
producing at the shutdown
point, T.

Michael Parkin (8th edition)

 Example
– If the price is $25, the firm
produces 9 sweaters a
day, the quantity at which
P = MC.

If the price is $31, the firm

produces 10 sweaters a day,
the quantity at which P =
MC.
The blue curve in part (b)
traces the firm’s short-run
supply curve.
www.elearning-board.com
 The Firm’s Decisions in Perfect
Competition

• Short-Run Industry Supply Curve

The short-run industry supply curve shows the
quantity supplied by the industry at each price when
the plant size of each firm and the number of firms
remain constant.

www.economicshelp.com/supply/curve
The Firm’s Decisions in Perfect
Competition
Figure shows the
supply curve for an
industry that has 1,000
firms like Cindy’s.
The quantity supplied
by the industry at any
given price is the sum
of the quantities
supplied by all the firms
in the industry at that
price.

www.pearson.ch/.../Econom
ics/Microeconomics
 Output, Price, and Profit in Perfect
Competition
•Short-Run Equilibrium

–Short-run industry
supply and industry
demand determine the
market price and output.
–Figure shows a short-
run equilibrium.

www.amosweb.com
 MARKET
STRUCTURE

Long-Run
 PERFECT COMPETITION, LONG-RUN
PRODUCTION ANALYSIS:
• In the long run, a perfectly competitive firm adjusts plant
size, or the quantity of capital, to maximize long-run profit.

• In addition, the entry and exit of firms into and out of a

perfectly competitive market guarantees that each perfectly
competitive firm earns nothing more or less than a normal
profit.

• As a perfectly competitive industry reacts to changes in

demand, it traces out positive, negative, or horizontal long-
run supply curve due to increasing, decreasing, or constant
cost.

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s=wpd&c=dsp&k=perfect+competition,+long-run+production+analysis
Long-Run Adjustment

– http://www.amosweb.com
Long-Run Industry Supply Curve
The Zucchini Market

 
The Zucchini Market

 
                                                                                        

                      

                                                                                                  

            

http://www.amosweb.com
 Long-Run Industry Supply Curve
• Increasing-Cost Industry:
The Zucchini Market

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s=wpd&c=dsp&k=perfect+competition,+long-run+production+analysis
 Long-Run Industry Supply Curve
• Decreasing-Cost Industry:
The Zucchini Market

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s=wpd&c=dsp&k=perfect+competition,+long-run+production+analysis
 Long-Run Industry Supply Curve
• Constant-Cost Industry:
The Zucchini Market

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s=wpd&c=dsp&k=perfect+competition,+long-run+production+analysis
 Long Run – Permanent Change in Demand

• A permanent increase in demand creates short term

economic profits, but encourage new firms to enter the
market

• A permanent decrease in demand triggers a similar response

except in the opposite direction – incurring economic losses
encourages firms to exit the industry

http://www.MCCD.EDU
 Graphing Demand & Marginal Revenue
Marginal revenue is the increase in total revenue when
output sold goes up by one unit

Output Price Total Revenue Marginal Revenue

1 $5 $ 5 $5
2 5 10 5
3 5 15 5
4 5 20 5
5 5 25 5

6 5 30 5

http://www.MCCD.EDU
 Graphing Demand & Marginal Revenue

Output Price Total Revenue Marginal Revenue

1 $5 $ 5 $5 6
2 5 10 5 5 D,MR
3 5 15 5
4
4 5 20 5
3
5 5 25 5
2
6 5 30 5
1

0
0 1 2 3 4 5 6
Output

http://www.MCCD.EDU
 The Perfect Competitor’s Demand Curve
Firm Industry S
9

6 D,MR 6

5 5

4 4 D

3 3

2 2

1 1

5 10 15 20 25 30 1 2 3 4 5 6 7
Output Output (in millions)

The intersection of the industry supply and demand curve set the
price that is taken by the individual firm, in this case $6
http://www.MCCD.EDU
 The Perfect Competitor in the Long Run
24
MC
23

22 ATC

21

20

19
Price = ATC D,MR
18

17
The most profitable level of 16
output is 11.1
15

5 10 15 20
Output

In the long run the firm breaks even

The ATC curve is tangent to the demand curve at the point where MC = MR.
ATC will equal price at the break-even point (the minimum point on the ATC
curve) http://www.MCCD.EDU
 PERFECT COMPETITION, LONG-RUN
EQUILIBRIUM CONDITIONS:
• The long-run equilibrium of a perfectly competitive
industry generates six specific equilibrium
conditions, including:

• economic efficiency (P = MC).

• profit maximization (MR = MC).
• perfect competition (MR = AR = P).
• breakeven output (P = AR = ATC).
• minimum production cost (MC = ATC).
• minimum efficient scale (MC = ATC = LRAC = LRMC).
http://www.amosweb.com
•In the long-run, how much will a competitive
firm produce?

•Free-entry implies that economic profits are

driven down to zero in the long run.

•Price has to be equal to average costs if

profits are zero.

• WWW.GOOGLE.COM (COMPETITION.PPT)
• In fact, since the firm can produce any output it
wants at the market price, price has to be equal to
the lowest value of its long-run average cost curve.

• In addition, since the firm maximizes profits, price

has to equal its marginal cost as well.

• The equilibrium is illustrated with the following

slide

•WWW.GOOGLE.COM (COMPETITION.PPT)
Long-run Equilibrium for a Perfectly
Competitive Firm

•WWW.GOOGLE.COM (COMPETITION.PPT)
• WWW.GOOGLE.COM (COMPETITION.PPT)
• WWW.GOOGLE.COM (COMPETITION.PPT)
MARGINAL FACTOR COST CURVE, PERFECT
COMPETITION
• The change in total factor cost resulting from a
change in the quantity of factor input employed by
a perfectly competitive firm.
• Marginal factor cost, abbreviated MFC, indicates
how total factor cost changes with the employment
of one more input. It is found by dividing the change
in total factor cost by the change in the quantity of
input used.
• Marginal factor cost is compared with marginal
revenue product to identify the profit-maximizing
quantity of input to hire.
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Marginal Factor Cost,
Perfect Competition

WWW.AMOSWEB.COM
Marginal Factor Cost Curve,
Perfect Competition

                                                                                                    

            

WWW.AMOSWEB.COM
MARGINAL REVENUE CURVE, PERFECT
COMPETITION
• A curve that graphically represents the relation between the
marginal revenue received by a perfectly competitive firm for
selling its output and the quantity of output sold.

• Because a perfectly competitive firm is a price taker and faces

a horizontal demand curve, its marginal revenue curve is also
horizontal and coincides with its average revenue (and
demand) curve.

• A perfectly competitive firm maximizes profit by producing

the quantity of output found at the intersection of the
marginal revenue curve and marginal cost curve.
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Marginal Revenue Curve,
Perfect Competition

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 MARKET
STRUCTURE

Nature of Demand Curve in

“Perfect Competition”
 Perfect Competition
• Definition • Definition
A Market structure A perfectly competitive
characterized by market is one in which
homogeneous products in economic forces operate
which there are so many unimpeded.
buyers and sellers that none
has a significant influence on
price.

South western, a division of Thomson learning McGraw Hill/Irwin

 A Perfectly Competitive Market
• A perfectly competitive market must meet the
following requirements:
– Both buyers and sellers are price takers.
– The number of firms is large.
– There are no barriers to entry or exit.
– The firms’ products are identical.
– There is complete information.
– Firms are profit maximizers
 Perfectly Elastic Demand

• Quantity demanded changes infinitely with

any change in price.

• Price elasticity of demand is infinite

 Graph of Perfectly Elastic Demand

Price
1. At any price
above $10, quantity
demanded is zero.

$10 Demand

2. At exactly $10,
consumers will buy
any quantity

Quality
3. At a price below $10, quantity
demanded is infinite
 Demand Curves for the Firm and the
Industry
• The demand curves facing the firm is different
from the industry demand curve.
• A perfectly competitive firm’s demand
schedule is perfectly elastic even though the
demand curve for the market is downward
sloping.
 Perfectly Competitive Market
having Perfectly Elastic Curve
Market Firm
Price Market supply Price
$10 $10
8 8 Individual firm
6 6 demand
4 Market 4
2 demand 2
0 0
1,000 3,000 Quantity 10 20 30 Quantity
McGraw Hill / Irwin
Examples of Perfect Competition
– eBay auctions can be often seen as perfectly
competitive.

– There are very low barriers to entry.

– Presence of many seller of common products and

many potential buyers
Examples of Perfect Competition
– Paper clips produced by Dollar company

– These are standard, run-of-the-mill, nothing fancy,

metal paper clips, just like those offered by
hundreds of companies.

– As such, the demand for these paper clips is

perfectly elastic.
Examples of Perfect Competition
– The company sells all of the paper clips that it
wants at a specific price

– If the firm lowers the price of its paper clips by a

small amount, then an infinite number of buyers
who might have bought the other paper clips buy
Dollar paper clips instead.
Examples of Perfect Competition
– If the company should raise the price of its paper
clips by a small amount, then buyers will buy paper
clips made by other companies.

– Of course, they have no reason to raise their price

because they can sell all that they want at the
existing price.
 Demand Curves for the Firm and the
Industry
• Individual firms will increase their output in
response to an increase in demand even
though that will cause the price to fall thus
making all firms collectively worse off.
 The Definition of Supply and Perfect
Competition
• If all the necessary conditions for perfect
competition exist, we can talk formally about
the supply of a produced good.
 The Definition of Supply and Perfect
Competition
• Supply is a schedule of quantities of goods
that will be offered to the market at various
prices.
• When a firm operates in a perfectly
competitive market, it’s supply curve is that
portion of its short-run marginal cost curve
above average variable cost.

McGraw Hill / Irwin

 Conclusion
• Under Perfect Competition
– The firm faces a horizontal demand curve
– Can sell any quantity desired at the market price,
– But cannot sell anything above the market price.
 MARKET
STRUCTURE

“The nature of demand curve in

monopolistic competition and monopoly”
 Price elasticity of Demand

• Price elasticity of demand (PED) is defined as

the measure of responsiveness in the quantity
demanded for a commodity as a result of
change in price of the same commodity. It is a
measure of how consumers react to a change
in price.
• Elastic
Where the quantity demand change s by a larger
percentage than price,

• Inelastic
Where the quantity demand changes by a smaller
percentage than price.

(http://economics.about.com/cs/micfrohelp/a/priceelasticity.ht
m)
 MONOPOLY
• A firm is considered monopoly if it has the
following characteristics:
– it is the sole seller of its product.
– it produces a unique product (i.e. it does not have close
substitutes)
– it has some ability to influence the market price of its
product.

• Is KESC a monopoly? YES, it is!!

 Price Elasticity of Demand and
Monopoly
• So what happens when KESC increases tariff?
– Naturally, consumers decrease their usage of
electricity to adjust for higher prices.
– Which means that the demand is inelastic for
electricity.
– Since the consumers decrease their usage of
electricity by a slight margin, demand is definitely
NOT perfectly inelastic (nor is it any other type of
elasticity).
 • The demand curve is
relatively inelastic as
there are no substitutes
available.

(http://images.google.com.pk/imgres?
imgurl=http://www.revisionguru.co.uk/graphics/diagrams/economics/unit4/monopoly1.gif&imgrefurl=http://www.revisiong
uru.co.uk/economics/monopoly.htm&usg=_)
• Following graph shows that an increase in price
results in decrease in demand. Since this is not an
extreme case, product has elastic demand.
 MONOPOLISTIC COMPETITION
• A market is considered monopolistic competition
if it has the following characteristics:
– There are many producers and many consumers in a given
market, and no business has total control over the market
price.
– Consumers perceive that there are non-price differences
among the competitors' products.
– Many competing producers sell products that
are differentiated from one another (i.e. the products
are substitutes, but are not exactly alike)
• So, are pizza restaurants in monopolistic
competition? Yes, because:
– they offer substitute goods (i.e. identical goods)
– producers have a degree of control over price

• Demand is elastic because if one producer

increases price, consumers might shift to any
other producer.
 • Demand is relatively elastic in
monopolistic competition
because each firm faces
competition from a large number
of very, very close substitutes.

• The output of each firm is slightly

different from that of other firms.
Monopolistically competitive
goods are close substitutes, but
not perfect substitutes.

(http://www.amosweb.com/cgi-bin/awb_nav.pl?s=wpd&c=dsp&k=monopolistic+competition)
 Monopolistic competition Elastic
• In monopolistic Competition a
consumer can switch to other
alternatives,

• For instance, the price of milk

pack increases and you switch to
olpers. This increase in price of
milk pack will therefore decrease
the demand, that is how the
demand curve is elastic in this
case.

(http://www.absoluteastronomy.com/discussionpost
/Examples_of_monopolistic_competition_1405
0)
THE END