Types of Market Structure

  • Perfect Competition

    • many firms each sell an identical product
  • Monopoly

    • a single firm sells a single, undifferentiated product
  • Oligopoly

    • a few firms (usually 2-4) selling either identical or an undifferentiated product (ie. steel or cigarettes)
  • Monopolistic Competition

    • many firms each sell differentiated products

Many firms Differentiated products One firm Monopoly (Chapter 15) •
Tap water • cable TV • • Number of Firms? Few firms Oligopoly (Chapter 1
7) Tennis balls Cigarettes • • Monopolistic Competition (Chapter 16)
Novels Movies Type of Products? Identical products Perfect Competition
(Chapter 14) Wheat • • Milk

Short-run industry supply curve

  • Definition

    • relationship between the price of a good and the total output of the industry as a whole
  • When the market price equals or exceed the shut-down price, firms will continue to produce at the point which the price equals marginal cost

  • At any price above the AVC, the short-run individual supply curve is the firm's marginal cost (MC) curve

Price, cost of tree $26 22 Market 18 pnce 14 Shut-down 10 pnce 2,000
3,000 4,000 MKT 5,000 Short-run industry supply curve, S 6,000 7,000
Quantity of trees

  • The short-run industry supply curve, S, is the industry curve.

  • Below the shut-down price of $10, no producer wants to produce in the short run.

  • Above $10, the short-run industry supply curve slopes upward, as each producer increases output as price increases.

  • It interescts the demand curve, D, at point EMKT, the point of short-run market equilibrium, correspongding to a market price of $18 and a quantity of 5000 trees.

Firm ATC p \> AVC p AVC Marke+ D,

Long-run industry supply curve

  • Meaning

    • shows how the quantity supplied responds to the price once producers enter or exit the industry
  • Profits cause more firms to enter, which shifts the supply curve to the right, resulting in lower prices and higher industry output.

  • However, individual output by firms decreases as does profit until there is no economic profit.

FIGURE 12-6 Price of tree $18 16 14 The Long-Run Market Equilibrium
(a) Market (b) Individual Firm MKT 5,000 7,500 MKT' 10,000 Quantity of
trees Price, cost of tree $18 16 14.40 Break- 14 pnce o 30 c 40 45 MC z
50 ATC 60 Point EMKT0f panel (a) shows the initial short-run market
equilibrium. Each of the 100 existing producers makes an economic
profit, illustrated in panel (b) by the green rectangle labeled A, the
profit of an existing firm. Profits induce entry by additional
producers, shifting the short-run industry supply curve outward from Sl
to S2 in panel (a), resulting in a new short-run equilibrium at point
DMKT, at a lower market price of $16 and higher industry output.
Existing firms reduce output Quantity of trees and profit falls to the
area given by the striped rectangle labeled B in panel (b). Entry
continues to shift out the short- run industry supply curve, as price
falls and industry output increases yet again. Entry of new firms ceases
at point CMKT on supply curve Sa in panel (a). Here market price is
equal to the break-even price; existing producers make zero economic
profits, and there is no incentive for entry or exit. So CMKTis also a
long-run market equilibrium.


  • Profit = Total Revenue - Total Cost = Price * Quantity - Average Total Cost * Quantity

The Effect of an Increase in Demand

  • An increase in the demand for a product causes the equilibrium price and quantity to increase in the market.

  • An increase in demand raises price and profit, which causes more suppliers to enter the market

  • Higher industry output from new entrants drives price and profit back down to its original equilibrium

(a) Existing Firm Response to Price, cost $18 14 Price (b) Short-Run
and Long-Run Market Response to Increase in Demand Long-run industry
supply curve, LRS (c) Existing Firm Response to Increase in Demand An
increase in demand rmses pnce and profit. x Price, cost New Entrants
Higher industry output from new entrants dhves price and profit back
down. MC ATC Quantity MKT MKT QxQr •ZMkT D Qz Quantity MC ATC Quantity
Increase in output from new entrants Panel (b) shows how an industry
adjusts in the short and long run to an increase in demand; panels (a)
and (c) show the corresponding adjustments by an existing firm.
Initially the market is at point XMKT in panel (b), a short-run and
long-run equilibrium at a price of $14 and industry output of Qx. An
existing firm makes zero economic profit, operating at point X in panel
(a) at minimum average total cost. Demand increases as DI shifts
rightward to D2 in panel (b), raising the market price to $18. Existing
firms increase their output, and industry output moves along the
short-run industry supply curve Sl to a short-run equilibrium at YMKT.
Correspondingly, the existing firm in panel (a) moves from point X to
point Y. But at a price of $18 existing firms are profitable. As shown
in panel (b), in the long run new entrants arrive and the short-run
industry supply curve shifts rightward, from Sl to S2. There is a new
equilibrium at point ZMKT, at a lower price of $14 and higher industry
output of Qz. An existing firm responds by moving from Y to Z in panel
(c), returning to its initial output level and zero economic profit.
Production by new entrants accounts for the total increase in industry
output, Qz— Qx. Like XMKT, ZMKTis also a short-run and long-run
equilibrium: with existing firms earning zero economic profit, there is
no incentive for any firms to enter or exit the industry. The horizontal
line passing through XMKT and ZMKT, LRS, is the long-run industry supply
curve: at the break-even price of $14, producers will produce any amount
that consumers demand in the long run.


Perfect Competition

  • Price-taking firm

    • the actions of the firm has no impact on the market price of the product
  • Price-taking consumer

    • what consumers do have no bearing on the price of the product that is purchased
  • Perfectly competitive market

    • all participants are referred to as price takers, taking whatever the markets gives them
  • Three characteristics of perfect competition

    • Many firms. No individual firm can have a disproportionately large market share

    • Item sold is a commodity, or a product that is the same no matter who sells or buys it

    • Free entry and exit. If there's profit, firms enter. If there's loss, firms exit.

  • Optimal output rule

    • producing the quantity of output at which the market price is equal to the marginal cost of the last unit produced
  • Equation

    • Marginal Cost = Marginal Revenue = Price = Average Revenue = Demand

    • How to remember: Mc= Mr. Pard

Price, cost of tree $24 20 Market MR = P 18 pnce 16 12 8 6 10 20
Optimal point 30 40 50 60 MC 70 Quantity of trees Profit-maximizing


  • small q for quantity of a firm

Perfect Competition in Long-Run Equilibrium

  • Long-run competitive equilibrium

    • All firms in an industry are maximizing profit, no firm has an incentive to enter or exit, and price is such that quantity supplied equals quantity demanded
  • Conditions

    • There is no economic profit

    • No firms enter or leave

  • The market is always right

  • Label all points correctly!

mc MRzpeARZD

Perfect Competition and Short-Run Market Price

  • Making Short-Run Profit

    • MR = P = AR = D is above the ATC curve

    • Make sure the ATC and MC intersect at the minimum ATC

    • The market is always right!

    • Economic Profit shaded in green


  • Incurring Short-Run Loss

    • MR = P = AR = D is below the ATC curve

    • Make sure the ATC and MC intersect at the minimum ATC

    • The market is always right!

    • Economic Loss shaded in red


  • Summary

    Price, cost of tree 518 14.40 Break- even pnce Price, cost of tree
514.67 (a) Market Price Minimum average total cost c - $18 z Profit
Loss (b) Market Price — SIO Minimum average total cost c Break- even
pnce 10 ATC Quantity of trees MC ATC Quantity of trees

Summary of Profitability and Production

  • Long-run (Profitability)

Profitability condition (minimum ATC = break-even price) P \> minimum
ATC P = minimum ATC P < minimum ATC Result Firm profitable. Entry into
industry in the long run. Firm breaks even. No entry into or exit from
industry in the long run. Firm unprofitable. Exit from industry in the
long run.

  • Short-run (Production)

Production condition (minimum AVC = shut-down price) P \> minimum AVC
P = minimum AVC P < minimum AVC Result Firm produces in the short run.
If P < minimum ATC, firm covers variable cost and some but not all of
fixed cost. If P \> minimum ATC, firm covers all variable cost and fixed
cost. Firm indifferent between producing in the short run or not. Just
covers variable cost. Firm shuts down in the short run. Does not cover
variable cost.

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