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The way a firm behaves (what to produce and for what P), depends upon the structure of the market for that product. The major characteristic of market structure is the degree of competition in the market. Structures in the real world range from monopolistic competition through oligopoly to monopoly. Economists identify four market types: 1. Perfect competition. 2. Monopolistic competition. 3. Oligopoly. 4. Monopoly. 1. Perfect competition arises when there are many firms each selling an identical product (perfect subs.) with little control over the price (no possibility to collude and fix the price), many buyers, and no restrictions on the entry of new firms into the industry so that profit is quickly eroded by new entrants. Sellers have little control over the price of the product. Monopolistic competition is a market structure in which a large number of firms compete by making similar but slightly different products. In the US for example four companies b/w them produce all of the huge variety of breakfast cereals. Similar patterns are found with cigarettes, soft drinks, toothpastes and razor blades. The market for many of these products are better explained by a mode of oligopoly. Some of best examples of monopolistic competition are to be found in retailing. Different shops selling very similar products compete fiercely emphasizing small differences a customer might like, such as opening at unsociable hours, personal service, home delivery etc. Restaurants offer different menus and different atmosphere but at the same time remain price competitive. Product differentiation gives a monopolistically competitive firm an element of monopoly power. It is easy for new firms to enter and leave this industry. Oligopoly is a market structure in which a few number of firms compete. High barriers to entry such as technological like the high R&D costs of pharmaceutical drugs market. High production cost of the automobile and aero plane market; or high marketing costs of perfumes, chocolate & soft drinks. The important characteristic is inter-dependent behavior. Firms see themselves as rivals, and consider the reaction of other firms when making their own decisions. This theory of their behavior came from Game Theory. The interdependence of such firms helps to explain why many product markets exhibits long periods of price stability. It also helps to explain why price competition is replaced by non-price competition. Firms know if they price compete both will be worse off, so they may compete by branding and advertising and stressing their product differentiation. A monopoly is an industry that produces a good or service for which no close substitute exists and in which there is one supplier that is protected from competition by a barrier (sometimes legal) preventing the entry of new firms. Alternatively there could be a selling agreement b/w companies know as a cartel agreement. Some times monopoly is positive for the society. If there are large economies of scale to be gained in an industry, a monopoly might lead to greater output and lower prices than keeping several firms competing in the industry. It is possible that only a monopoly would be financially able and willing to undertake R&D and to introduce new products. However, there are major reasons why the public should remain suspicious of monopoly. It can be shown that very often monopolists charge higher prices and produce lower outputs than under competition. The absence of competition can also lead to the firm operating inefficiently. Government, therefore, maintain an eye on the monopoly to see if it is in the public interest to allow monopoly to exist in the industry. It is common fallacy that monopolies have total market power i.e. over the price and output. They cannot b/c although they control S, they do not control D. Therefore, if a monopolist sets a particular price for a product, the quantity sold is determined by the D curve. Nevertheless, monopoly has the greatest power over P or output among all the market structures. Monopoly is the situation with the greatest producer sovereignty. Consumer sovereignty is found where market are very competitive. The more choice that consumers have b/w sellers, the more power they have over P and output. The greater the restrictions in the market, the more power resides with producers. Monopsony is a market structure where there is only one buyer of the product or just a few large buyers. Hence, the consumer can be extraordinarily powerful compared to the sellers. Hence, consumer sovereignty. In some cases the govt. may be the only buyer, e.g. defense weapons or of the services of teachers or policemen. Also some primary product are produced by a large number of sellers in LDC and
Economies of scope exist when a firm uses specialized resources to produce a range of goods and services. Transactions costs are the costs arising from finding someone with whom to do business. coffee. Therefore. the total rate of interest that this capital could earn in another firm with the same degree of risk is its opp. The most important of these is the opp. the return that is earned when 2 .e. int. cereals Local water S Fact: The U. Economies of scale exist when the cost of producing a unit of a good falls as output increases. It is that level of profit which will just keep the firm in the industry. TR can also be graphed against output as a straight line through the origin. energy. corn Food. Economic costs include any further opp. The cost of using your capital. Profit: TR – TC. cost to the firm in addition to accounting costs. Firms can lower transaction costs by reducing the number of individual transactions undertaken. rent. 3. cost. economy became more competitive between 1939 and 1980. Accounting Cost: are the costs which have a money value like raw materials. Tea. i. your own time to run your business is known in economics as Normal profit. TR rises steadily with the Q sold. As well as your own time running your own business has an opp.the seller are a small number of large multi-national companies (MNCs) located in MDC. 4. A production process in which the individuals in a group specialize in mutually supportive tasks is team production Aim & Objective of Firms: Total Revenue (TR): P*Q.e. Characteristics Perfect Monopolistic Oligopoly Monopoly Competition Competition # of firms in Many Many Few One industry Product Identical Differentiated Either identical or No Close Substitute Differentiated Barriers None None Moderate High to entry Firm’s None Some Considerable Considerable or control over P regulated Examples Wheat. clothing Automobiles. Coordinating Production Both markets and firms coordinate production. Hence. cocoa and uranium are examples of such products. of reaching an agreement about the price and other aspects of the exchange. it is represented by the area under a D C. cost of capital employed in production. What determines whether it is a firm or markets that will coordinate a particular set of activities? The more economically efficient system wins! There are four key reasons for which firms are sometimes more efficient coordinators of economic activity: • Lower transactions costs • Economies of scale • Economies of scope • Economies of team production 1.S. a risk premium must be added to the bank rate. if the P of the product is constant. and of ensuring that the terms of the agreement are fulfilled. In Accounting profit = TR – Total accounting cost. 2. Normal profit: is the amount of profit that must be earned by a firm to cover its opp cost. Using this capital in business means loosing the interest that could’ve been earned if this capital was deposited at a bank and also it has a risk element. cost. and wages. I.
the firm is making econ profit from that last unit b/c MC include also normal profit.e. Which the amount of revenue that exceeds opp cost. One way to max profit is to have the largest possible gap b/w TR & TC. the firm can close down. Any extra profit is know as Super normal profit. the firm should expand (MC increase b/c of the LDR). Any lower amount of profit is not worthwhile. Profit Maximizing Equilibrium: main objective of the firm is to maximize profit. Thus. till it reaches the point of equilibrium at which producing the last unit gives MR = MC . Firms usually strive to earn more than normal profit. or Excess profit. 3 . i. the firm must look at the cost and revenue of producing the last unit. Economic profit.TR = total opp cost. It is making a loss on that unit and it would be more profitable not to produce it. the firm should not produce that last unit. A second way is to look at MR & MC. If the MR<MC. Thus. lend its money out and earn higher interest than running the business. Acct profit = econ + normal profit. And if MR>MC. econ cost = acct cost + normal profit. Abnormal profit.
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