CHAPTER 6: MARKET

STRUCTURES

Nguyen Thi Minh Thu, FIE, FTU

Nguyen Thi Minh Thu

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CHAPTER OUTLINE

1. PERFECT COMPETITION

PURE MONOPOLY

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2.

3. MONOPOLISTIC COMPETITION

4. OLIGOPOLY

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PERFECT COMPETITION
A perfectly competitive market
features:

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- Many buyers and sellers
- Identical/ Standardized product
Buyers and sellers are price takers
- Free entry/ exit
- Perfect information

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PERFECT COMPETITION

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S

Firm’s
P* P* demand

Market A typical firm

PERFECT COMPETITION
 TR= P* x Q
MR = TR’(Q) = P*

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Marginal revenue is constant.
The demand curve is also the
marginal revenue curve

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PERFECT COMPETITION
 Profit maximization
General principle: MR = MC

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Perfectly competitive firm: MR = P
 MC = P

MC < P : Increase output

MC > P : Decrease output
MC = P : Optimal level of output

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 Nguyen Thi Minh Thu, FIE, FTU
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MR

ATC
MC

Q
Q*
Profit

0
P

P*
PERFECT COMPETITION
 Break-even point
π=0  (P-ATC)Q = 0

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 P = ATC
We also have MC = P
 MC = P = ATC

ATCmin

 A Competitive firm breaks even when the

market price equals its minimum average
cost.
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PERFECT COMPETITION
P

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MC
ATC

P0 MR

TR = TC ATCmin

0 Q* Q 9
 Measuring profit
If P > ATC

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

 Profit = TR – TC = (P – ATC) ˣ Q

 If P < ATC
 Loss = TC - TR = (ATC – P) ˣ Q

= Negative profit
PERFECT COMPETITION
P
M
C

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ATC

Loss MR
P0

TR

0 Q* Q 11
PERFECT COMPETITION

 Shut down vs. Exit

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- Shut down: A short-run decision. When a
firm shuts down, its fixed cost is sunk

- Exit: A long-run decision

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PERFECT COMPETITION

 If the firm shuts down

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TC = FC
TR = 0

 loss= FC

A Competitive firm should shut down if

its loss is greater than fixed cost.
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PERFECT COMPETITION

 Loss = FC

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 TC – TR =FC

 TC – FC = TR

 VC= TR

AVC = P

At the same time we have MC = P

 P = MC = AVCmin

Firms shut down when the market price is 14

less than its minimum average variable

 PERFECT COMPETITION
P
MC
ATC

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AVC
FC

P0 MR

0 Q* Q 15
 PERFECT COMPETITION
Individual firm’s supply curve

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P
M
C
P2

P1 AVC

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0 Q1 Q2 Q
PERFECT COMPETITION

 Market supply: the horizontal sum of

individual firm’s supply curves.

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 Market supply curve slopes upwards

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 SHORT-RUN MARKET SUPPLY
(a) Individual firm supply (b) Market supply
Price Price
MC Supply

$2.00 $2.00

1.00 1.00

0 100 200 Quantity 0 100,000 200,000 Quantity

(firm) (market)

In the short run, the number of firms in the market is fixed. As a result, the market supply curve,
shown in panel (b), reflects the individual firms’ marginal-cost curves, shown in panel (a). Here,
in a market of 1,000 firms, the quantity of output supplied to the market is 1,000 times the
quantity supplied by each firm. 18
LONG-RUN DECISION

 For long run equilibrium, firms have no desire to

enter or leave industry
 Recall: Relationship between economic profit and
incentive to enter and exit market
- Accounting profit: Difference between firm’s revenues
and direct costs
- Economic profit: Difference between firm’s revenues
and direct and indirect costs
LONG-RUN DECISION
 Profits
will attract other producers
More producers increase industry supply
 lowers market price
economic profits decreases
LONG-RUN DECISION
 Losses will drive some producers out of
business
Fewer producers reduce industry supply,
 increases market price
economic profits increases
 No firm has incentive to enter or when earning
zero economic profits
 Zero-Profit

- Firm earning normal return on its investment

- Doing as well as it could by investing elsewhere
- Normal return is firm’s opportunity cost of using
money to buy capital instead of investing
elsewhere
 LONG-RUN EQUILIBRIUM

LMC
P P

S LAC

P0
P0
E0

0 Q 0 q* Q
Market Firm
PERFECT COMPETITION
 Suppose Bella's Birkenstocks produces sandals in
the perfectly competitive sandal market. The
total cost of production in the short run is TC =

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64 + q2.
 What are ATC and MC?

 If the price of sandals is $32, what is Bella's

production? What is her profit?
 If the price for sandals were $8, what is Bella's
production? What is her profit?
 What is Bella's short run supply curve?

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 MONOPOLY
 Monopoly is a market structure in
which:

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 There is a sole firm selling a product
without close substitutes
 Price maker
 Barriers to entry
Monopoly resources

Government regulation

The production process

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 MONOPOLY
 Monopoly resources: A key resource required
for production is owned by a single firm
 Higher price

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 Government regulation

- Government gives a single firm the exclusive

right to produce some good or service
- Government-created monopolies

Patent and copyright laws

Higher prices; Higher profits

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 MONOPOLY
 The production process
 A single firm can produce output at a lower

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cost than can a larger number of producers
 Natural monopoly

 Arises because a single firm can supply a

good or service to an entire market
 At a smaller cost than could two or more
firms
 Economies of scale over the relevant range
of output 31
 MONOPOLY

 Demand curve: As the firm is the sole

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producer, it faces the whole market
demand curve

 The monopolist’s demand curve slopes

downward.

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 MONOPOLY
 MR = ΔTR/ ΔQ = (PΔQ + QΔP) / ΔQ

= P + Q. P/ Q

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= P( 1 + Q/P . P/ Q)

= P [1+ 1/ (Q/P . P/Q)]

= P ( 1 + 1/Ep)

 MR <P

MR can be negative
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 MONOPOLY

Profit P
MC
maximization

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Π max : MR = MC
P > MC
P* ATC

Profit

D
MR 34
0 Q
Q*
 MONOPOLY
Monopolist’s supply curve?
MC

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P P
MC
D1
D1
P* P1
D2

P2
MR2
D2

MR2
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0 Q 0 Q* Q
Q1 Q2 MR1 MR1
 MONOPOLY
Market power

= (P – MC) / P

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L

= [P – P(1+1/E)]/ P

= - 1/ E

0 <L<1

 Monopolist produces at the elastic section of the

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demand curve.
PERFECT COMPETITION VS.
MONOPOLY
Competition Monopoly
Many buyers and sellers Sole seller

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Identical products Single product without close
substitutes
Horizontal demand curve Downward sloping demand
curve
Price takers Price maker
Free entry/exit High barrier to entry
MC = P MC < P
Zero profit in the long run Can earn positive profit
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MONOPOLISTIC COMPETITION
 Monopolisticcompetition
 Many sellers

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 Product differentiation
 Not price takers
Facing downward sloping demand
curve
 Free entry and exit
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 MONOPOLISTIC COMPETITION

 Monopolistically
competitive firms
are mini monopolist of their own

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product.
 Theirdemand curves also slopes
downward. Thus their marginal
revenues are less than price.

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MONOPOLISTIC COMPETITION

MC
P

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P* ATC

profit

D
MR 40
0 Q
Q*
MONOPOLISTIC COMPETITION
P > ATC : Profit
 P < ATC : Loss

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 If firms are making profit

 New firms - incentive to enter the

market
 Increase number of products
 Reduces demand faced by each firm
Demand curve shifts left

 Each firm’s profit – declines until: zero 41

economic profit
MONOPOLISTIC COMPETITION
 Iffirms are making losses in short
run

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 Firms - incentive to exit the
market
 Decrease number of products
 Increases demand faced by each
firm. Demand curve shifts right
 Each firm’s loss – declines until:
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zero economic profit
MONOPOLISTIC COMPETITION
 The long run equilibrium:
Monopolisitically competitive firms

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earn zero economic profit (normal
profit)
P = ATC  The average total cost
curve is tangent with the demand
curve
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 MONOPOLISTIC COMPETITION VS. PERFECT
COMPETITION

MC LM
P P C

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ATC LAC
P*
P0

MR
Efficient scale
D
Nguy
en
Thi
0 Q 0 Q* Minh Q
Q* Thu,
Efficient scale FIE,
FTU
 MONOPOLISTIC COMPETITION
Perfect Monopolistic Monopoly
competition competition

Goal Profit Profit Profit

maximization maximization maximization

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Rule MC = MR = P MC = MR < P MC = MR < P

Market power No Limited High

Market entry/ Free Almost free High barrier

exit
Profit in the long Zero Zero Can be positive
run

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 OLIGOPOLY

 Oligopoly

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 Only a few sellers

 Offer similar or identical products

 Interdependent

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 OLIGOPOLY
A small group of sellers
 Tension between cooperation and self-

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interest
 Is best off cooperating
 Each - cares only about its own profit
Powerful incentives not to cooperate

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 OLIGOPOLY

 The equilibrium for an oligopoly

Nash equilibrium

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

 Economic actors interacting with one another

 Each choose their best strategy

 Given the strategies that all the other actors have chosen

 No actor enjoy better outcome if it unilaterally change its

strategy

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 OLIGOPOLY
 The prisoners’ dilemma
 Particular “game” between two captured prisoners

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 Illustrates why cooperation is difficult to maintain
even when it is mutually beneficial
 Dominant strategy
 Strategy that is best for a player in a game
 Regardless of the strategies chosen by the other
players

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 The prisoners’ dilemma

In this game between two criminals suspected of committing a crime, the sentence
that each receives depends both on his or her decision whether to confess or
remain silent and on the decision made by the other
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 Nguyen Thi Minh Thu, FIE, FTU
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OLIGOPOLY
 OLIGOPOLY
 Oligopolistic firms face the same dilemma when
they consider which strategy to apply: to
advertise or not to advertise, to monitor or not to

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monitor, charge high price or low price, etc.
 Cooperation between firms can be caught by
Anti-Trust Law
 Cooperation can make firms better off as long as
all competitors respect the agreement.

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