2 1 reading 15 the firm and market structures pdf

LOS Economics • Topics in Demand and Supply Analysis • The Firm and Market Structures • Aggregate Output, Prices, And Economic Growth • Understanding Business Cycles • Monetary and Fiscal Policy • International Trade and Capital Flows • Currency Exchange Rates LOS LOS Describe characteristics of perfect competition, monopolistic competition, oligopoly, and pure monopoly There are four types of economic market structures: i Monopoly Less competition ii Oligopoly iii Monopolistic Competition iv Perfect Competition More competition LOS LOS Describe characteristics of perfect competition, monopolistic competition, oligopoly, and pure monopoly Monopoly • A monopoly is a profit maximizer • Monopolies are price makers • There are very high barriers to entry for other firms • There is a single seller that controls the whole market • Price discrimination- Monopolies can change both the price and quality of their products • Pure monopolies are regulated by the government  Examples: Providers of water, natural gas, telecommunications, and electricity are often granted exclusive rights to service LOS LOS Describe characteristics of perfect competition, monopolistic competition, oligopoly, and pure monopoly Oligopoly • Profit maximization is a condition in this market • Monopolies set their own prices • Barriers to entry are high Few firms operate in the market • Make abnormal profits in the long-run • Products may be homogeneous • A relatively small number of firms supply the market  Example: Industries like oil & gas, airline, automakers, etc LOS LOS Describe characteristics of perfect competition, monopolistic competition, oligopoly, and pure monopoly Monopolistic Competition • Multiples buyers and sellers in the market • Sellers use branding and differentiation to gain market share • Sellers have some control over pricing • Few barriers to entry  Examples: Fast food chains, clothing, etc LOS LOS Describe characteristics of perfect competition, monopolistic competition, oligopoly, and pure monopoly Perfect Competition • Very large number of buyers ands sellers in the market • Homogeneous products • Perfect information • Firms accepts prices (“Price Taker”) • No barriers to entry • Profit maximization of sellers • No single seller/producer is large enough to influence the market price  Examples: Agricultural products LOS LOS Explain relationships between price, marginal revenue, marginal cost, economic profit, and the elasticity of demand under each market structure Monopoly • Maximizes profit at point where: Marginal Revenue = Marginal Cost • Firm can adjust price or quantity to meet this condition • Very inelastic demand LOS LOS Explain relationships between price, marginal revenue, marginal cost, economic profit, and the elasticity of demand under each market structure Oligopoly • Some control over prices • Asymmetric demand elasticity Demand very elastic to price increases Demand inelastic to price decreases LOS LOS Explain relationships between price, marginal revenue, marginal cost, economic profit, and the elasticity of demand under each market structure Monopolistic Competition • Elasticity to price changes High demand: firms raise prices to increase profits Low demand: firms lower prices to increase market share LOS LOS Explain relationships between price, marginal revenue, marginal cost, economic profit, and the elasticity of demand under each market structure Perfect Competition • Extreme elasticity of prices • Firms have no control over pricing • The demand function is: Total Revenue = Price * Quantity Firms sets quantity at level where marginal revenue = LOS LOS Describe a firm’s supply function under each market structure • Monopoly No supply function, MR=MC • Oligopoly Similar to a monopoly • Monopolistic Competition Not well defined, quantity set by demand in market • Perfect Competition Positive sloping Equal to the marginal cost curve LOS LOS Describe and determine the optimal price and output for firms under each market structure Monopoly • The relationship between MR and price elasticity, Ep, is: 𝑴𝑹 = 𝑷[𝟏 + 𝟏/ 𝑬𝒑] • In a monopoly, MR = MC thus: 𝟏 𝑷 𝟏+ = 𝑴𝑪 𝑬𝒑  A firm informed of its cost structure can use this relationship to work out its profit-maximizing price Oligopoly • Similar to a monopoly: 𝑴𝑪 = 𝑴𝑹 LOS LOS Describe and determine the optimal price and output for firms under each market structure Monopolistic Competition • The short-run profit-maximizing choice occurs at the point where Marginal Revenue is equal to Marginal Cost 𝑻𝑹 = ì ã Total cost is calculated as the product of average cost and total quantity 𝑻𝑪 = 𝑪 × 𝑸 • The economic profit is calculated as the difference between Total Revenue and Total cost i.e 𝚷 = 𝑻𝑹 – 𝑻𝑪 Perfect Competition • Any profit-maximizing producers has a market price that is equal to its marginal cost, i.e., P = MC Example >> LOS LOS Describe and determine the optimal price and output for firms under each market structure Example In a perfectly competitive market: • P = 20 – Q; and • MC = + 2Q What is the profit maximizing price and output? Solution We need to equate P = MC: 20 – Q = + 2Q 3Q = 15 Q = 15/3 = Substituting Q into the price function: P = 20 – = 15  The profit maximizing price and output are 15 and 5, respectively LOS LOS Describe and determine the optimal price and output for firms under each market structure Example In a perfectly competitive market: • P = 20 – Q; and • MC = + 2Q What is the profit maximizing price and output? Solution We need to equate P = MC: 20 – Q = + 2Q 3Q = 15 Q = 15/3 = Substituting Q into the price function: P = 20 – = 15  The profit maximizing price and output are 15 and 5, respectively LOS LOS Explain factors affecting long-run equilibrium under each market structure Monopoly • Maintains barriers to new entrants Oligopoly • Profits attract new entrants • Dominant firms declining profitability over time Monopolistic Competition • Long run declining profitability • Firms use innovation to gain profit/market share Perfect Competition • Long-run zero economic profit LOS LOS Describe pricing strategy under each market structure Monopoly • Avoid raising prices high enough to attract competitors Oligopoly • Pricing set based on the actions of competitors Monopolistic Competition • Companies control own pricing, but will use branding and differentiation to maintain/build market shares Perfect Competition • Firms accept prices set by market LOS LOS Describe the use and limitations of concentration measures in identifying market structure Concentration Ratio • It’s the sum of market share for largest firms in industry • Usually calculated for largest 3, 4, or firms • Value between 0% (Perfect Competition) and 100% (Monopoly) Herfindahl-Hirschman Index • It’s the sum of squares of top market share companies • Highest value of for monopoly Example If the top suppliers in a market each hold 20% and 30% of the market share, then: • The concentration ratio is a sum of the two suppliers’ market share: 20% + 30% = 50% • For the HHI, we take 0.202 × 0.302 = 0.0036 LOS LOS Identify the type of market structure within which a firm operates • Number of firms in market More firms = More competitive • Concentration Ratio Higher ratio = More competitive • Level of product differentiation More differentiation = Monopolistic competition • Level of demand elasticity More elasticity = More competitive LOS Economics • Topics in Demand and Supply Analysis • The Firm and Market Structures  Aggregate Output, Prices, And Economic Growth • Understanding Business Cycles • Monetary and Fiscal Policy • International Trade and Capital Flows • Currency Exchange Rates ... competitive market: • P = 20 – Q; and • MC = + 2Q What is the profit maximizing price and output? Solution We need to equate P = MC: 20 – Q = + 2Q 3Q = 15 Q = 15 /3 = Substituting Q into the price... price function: P = 20 – = 15  The profit maximizing price and output are 15 and 5, respectively LOS LOS Describe and determine the optimal price and output for firms under each market structure... competitive market: • P = 20 – Q; and • MC = + 2Q What is the profit maximizing price and output? Solution We need to equate P = MC: 20 – Q = + 2Q 3Q = 15 Q = 15 /3 = Substituting Q into the price