1. Market Structures Importance Importance Importance Importance
Pure Competition
Monopolistic Competition
Oligopoly
Monopoly
Number of Firms
Many small
Many small
A few large
one
Considers action or reaction of other firms
Importance
Diff or Homog
Product type
Homogeneous
Differentiated
one
Need to stress differences?
Importance
Barriers to Entry
none
none
large
large
Long run profits possible?
Importance
Price Taker/Maker
taker
taker/seeker
maker
maker
Importance
Ability to influence market price?
Non-price Competition no
yes
yes
yes
As important as price?
Importance

2. Characteristics? Perfect Competition 1. Many Sellers
2. Identical Products
3. Easy Entry and Exit
4. No Non-Price competition
5. SR profits/losses, no LR profits
6. Price Taker

3. Perfect Competition Market supply & demand determine price.
The firm’s demand will be perfectly elastic.
Firms can sell as much as they want at P
Above P, they lose business
Below P they lose revenue.
Output
Price
Firm
Output
Price
Market
Market demand
Firms must take the market price
Market supply P P
Firm’s demand

4. Marcia’s Marginal Cost and Marginal Revenue
$120
110
100 90 80 70 60 50 40 30 20 10
Losses
Marginal Cost and Marginal Revenue
Profits
Number of Cakes

5. Long-run Equilibrium Ssr MC ATC d1 D
The two conditions necessary for long-run equilibrium in a price-taker market are depicted here.
The quantity supplied and the quantity demanded must be equal in the market, as shown below at P1 with output Q1.
At the price established in the market, firms in the industry earn zero economic profit
Firm
Output
Price
Market P1 D
Ssr Q1
Price MC
ATC P1 d1
Output q1

6. Earn economic profit MR > ATC MR Normal Profit MR = ATC
Output
Price
Firm MC
ATC
AVC
Short Run Profits
Earn economic profit MR > ATC MR P3
Normal Profit
MR = ATC
Short Run Losses
Firm covers AVC, but not AFC:
MR < ATC, but MR > AVC
Shut Down
Firm can’t cover AVC, minimize losses by shutting down
MR < AVC

7. The Supply Curve
The marginal cost curve (MC) is the firm’s supply curve.
Below MC = AVC, the firm will shut down Output = 0 below P1,,
At P2 MR = MC at q2.
At P3 MR = MC at q3.
Output
Price
Firm MC
ATC
AVC
MC is the firm’s Supply Curve P3 P2 P1 q1 q2 q3

8. An Increase in Market Demand
Consider the market for toothpicks. A new candy that sticks to teeth causes the market demand for toothpicks to increase from D1 to D2 …
market price increases to P2 …
shifting the firm’s demand curve upward. At the higher price, firms expand output to q2 and earn short-run profits.
Economic profits will draw competitors into the industry, shifting the market supply curve from S1 to S2.
Firm
Market
Price
Price S1 MC S2 D2
ATC P2 d2 P2 P1 d1 P1 D1
Output
Output q1 q2 Q1 Q2

9. The Adjustment S1 MC S2 ATC d2 d1 Slr d1 D1 D2
After the increase in market supply, a new equilibrium is established at the original market price P1 and a larger rate of output (Q3).
As the market price returns to P1, the demand curve facing the firm returns to its original level.
In the long-run, economic profits are driven down to zero.
Firm
Market
Price
Price S1 MC S2
ATC P2 d2 P2 d1
Slr P1 d1 P1 D1 D2
Output
Output q1 q2 Q1 Q2 Q3

10. A Decrease in Demand S2 S1 MC ATC d1 d2 D2 D1
If, instead, something causes market demand for toothpicks to decrease from D1 to D2 …
the market price falls to P2
shifting the firm’s demand curve downward, leading to a reduction in output to q2. The firm is now making losses.
Short-run losses cause some competitors to exit the market, and others to reduce the scale of their operation, shifting the market supply curve from S1 to S2.
Firm S2
Market
Price
Price S1 MC
ATC D2 P1 d1 P1 d2 P2 P2 D1
Output
Output q2 q1 Q2 Q1

11. The Adjustment: S2 S1 MC ATC Slr d1 d1 d2 D2 D1
After the decrease in market supply, a new equilibrium is established at the original market price P1 and a smaller rate of output Q3.
As the market price returns to P1, the demand curve facing the firm returns to its original level.
In the long-run, economic profit returns to zero.
Note the long-run market supply curve is flat Slr.
Firm S2
Market
Price
Price S1 MC
ATC
Slr P1 d1 d1 P1 P2 d2 P2 D2 D1
Output
Output q2 q1 Q3 Q2 Q1

12. 1. One Seller
2. One Product
3. Blocked Entry (and exit?)
4. Non-Price competition
5. LR profits/losses
6. Price Maker (to maximize profits)

13. Barriers to Entry economies of scale government licensing Patents
4. control over an essential resource

14. A Natural Monopoly Graph
Average Cost
One firm producing Q1 has average cost C1
If two firms share the market, each produces Q0.5 and has average cost C0.5
If three firms share the market, each produces Q0.33 has average cost C0.33
C0.33
C0.5 C1
ATC Q
Q0.33
Q0.5 Q1

15. Marginal Revenue of a Monopolist
Initial price P1 & output q Total revenue (TR) = P1 * q1.
Price
Reduction in Total Revenue
1. As price falls from P1 to P2, output increases from q1 to q2,
two conflicting influences on TR.
Increase in Total Revenue P1
1. TR will rise because of an increase in the number of units sold (q2 - q1) * P2. P2
2. TR will decline [(P1 - P2) * q1] as q1 units once sold at the higher price (P1) are now sold at the lower price (P2). d
Depending on the size of the shaded regions, total revenue may increase or decrease. MR
Quantity/time q1 q2

16. The Welfare Loss from a Monopoly
The welfare loss from a monopoly is represented by the triangles B and D
The rectangle C is a transfer of surplus from the consumer to the monopolist
The area A represents the opportunity cost of diverted resources, which is not a loss to society P MC PM C D
PPC B D A MR Q QM
QPC

17. Price and Output Under Monopoly
Quantity/time
Expand output as long as MR > MC. (P goes down) MC
Economic profits
Output level q will result …
with price determined by the height of the demand curve at that level of output, P.
ATC A P B
At q the average total cost per unit for that scale of output is C. C d
MR < MC
As P > C (price > ATC) the firm is making economic profits equal to the area PABC.
MR > MC MR q

18. When a Monopolist Incurs Losses
Price
Quantity/time
A monopolist will set output equal to q, where MR = MC MC
At this level of output, the price that the monopolist charges does not cover the average total cost of producing the output ( P < C ).
ATC A C
Short-run losses P B
Whenever the ATC curve lies always above the demand curve, the monopolist will incur short-run losses.
In this diagram the firm is making economic losses equal to the shaded area, CABP. d MR q

19. Regulation of a Monopolist
An unregulated monopolist produces where MR = MC (Q0) and charge price P0.
Price
From an efficiency viewpoint, this output is too small and the price is too high.
Average cost pricing
Marginal cost pricing P0
average cost pricing
The monopolist is forced to reduce its price to P1 the expand output to Q1.
LRATC P1 MC
2. marginal cost pricing
Force output to be expanded to Q2 where P = MC
P = cost to produce
Forces LR losses. P2 D MR Q0 Q1 Q2
Quantity/time

20. Price Discrimination
Sellers may gain from price discrimination by charging:
higher prices to groups of customers with more inelastic demand
lower prices to groups of customers with more elastic demand
Price discrimination generally leads to more output and additional gains from trade.

21. The Economics of Price Discrimination
Consider a hypothetical market for airline travel where the Marginal Cost per traveler is $100.
If the airline charges all customers the same price, profits will be maximized where MC = MR. Here the airline charges everyone $400 and sells 100 seats.
This generates Net Operating Revenue of $30,000 or (total revenues) $40,000 – (operating costs) $10,000.
Price
$700
Net operating revenue ($300*100) = $30,000
$600
$500
$400
$300
$200 MC
$100 MR D
100
Quantity/time
Single price

22. The Economics of Price Discrimination
By charging higher prices to consumers with less elastic demand and lower prices to those with more elastic demand it will increase net operating revenue.
If the airline charges $600 to business travelers (who have a highly inelastic demand) and $300 to other travelers (who have a more elastic demand), it can increase its Net Operating Revenue to $42,000.
Price
Price
Net operating revenue from business travelers ($500*60) = $30,000
$700
Net operating revenue ($300*100) = $30,000
$700
Net operating revenue from all others ($200*60) = $12,000
$600
$600
$500
$500
$400
$400
$300
$300
$200
$200 MC MC
$100
$100 MR D D
100
Quantity/time 60
120
Quantity/time
Single price
Price Discrim.

23. Monopolistic Competition
Firms face low entry barriers
Differentiated Products
-they face a downward sloping demand curve
-no Long Run Profits
-Non-price Competition
Price Taker
Many Small Firms

24. Product Differentiation
Price-searchers produce differentiated products – products that differ in design, dependability, location, ease of purchase, etc.
Rival firms produce similar products (good substitutes) and therefore each firm confronts a highly elastic demand curve.
The goals of advertising are to increase demand and make demand more inelastic
Advertising increases ATC
The increase in cost of a monopolistically competitive product is the cost of “differentness”

25. Price and Output
A profit-maximizing price searcher will expand output as long as marginal revenue exceeds marginal cost.
Price will be lowered and output expanded until MR = MC
The price charged by a price searcher will be greater than its marginal cost.

26. Price and Output: Short Run Profit
A monopolistic competitor maximizes profits by producing where MR = MC, at output level q
Price MC
Economic Profits
and charges a price P along the demand curve for that output level.
ATC P
At q the average total cost is C. C
What impact will economic profits have if this is a typical firm? d
Because the price is greater than the average total cost per unit (P > C) the firm is making economic profits equal to the area ( [ P - C ] * q ) MR
Quantity/time q

27. Price and Output: Long Run
Because entry and exit are free, competition will eventually drive prices down to the level of ATC.
Price MC
When profits (losses) are present, the demand curve will shift inward (outward) until the zero profit equilibrium is restored.
ATC
C = P P
The price searcher establishes its output level where MC = MR.
At q the average total cost is equal to the market price. Zero economic profit is present. No incentive for firms to either enter or exit the market is present. d MR
Quantity/time q

28. Determining Profits Graphically: Monopolistic CompetitionMC
ATCLosses
ATCL
ATCBreak even
Losses
ATCProfits
Break even P
ATCP
A monopolistic firm can earn profits, losses, or break even in the short run D MR Q Q

29. Comparing Markets LR equilibrium for both.
P = ATC and there are no economic profits.
In monopolistic competition, firms face a downward-sloping demand curve, its profit-maximizing price exceeds MC.
In Monopolistic Competition, output is too small to minimize ATC in long-run equilibrium.
Price
Quantity/Time
Pure Comp
Mono comp MC MC
ATC
ATC P2 P1 d d MR q1 q2

30. Comparing Price Taker Markets
Even though the two markets have the same cost structure, the price in the monopolistic competitor’s market is higher than that in the price-taker’s market ( P2 > P1 ).
Some consider this price discrepancy a sign of inefficiency; others perceive it as a premium society pays for variety and convenience (product differentiation).
Price
Quantity/Time
Pure Comp
Mono comp
Price
Price MC MC
ATC
ATC P2 d P1 d MR q1 q2

31. Characteristics? Oligopoly 1. Few Sellers
4/26/2017
Oligopoly
Characteristics?
1. Few Sellers
2. Differentiated or Identical Products
3. Difficult Entry and Exit
4. Non-Price competition
5. LR profits/losses
6. Price Maker

32. Oligopolies are made up of a small number of firms in an industry
In any decision a firm makes, it must take into account the expected reaction of other firms
Oligopolistic firms are mutually interdependent
Oligopolies can be collusive or noncollusive
Firms may engage in strategic decision making where each firm takes explicit account of a rival’s expected response to a decision it is making
16-32

33. Empirical Measures of Industry Structure
The concentration ratio is a firm’s percentage of total industry sales
concentration ratio
The Herfindahl index is the sum of the squared value of the a firm’s share in the industry
Herfindahl index
This gives more weight to firms with large market shares than does the concentration ratio measure

34. Game Theory or Strategic Interaction
A non-cooperative game is a game in which each player is out for him- or herself and agreements are either not possible or not enforceable
Cooperative games are games in which players can form coalitions and can enforce the will of the coalition on its members
Sequential games are games where players make decisions one after another, chess, for example
Simultaneous move games are games where players make their decisions at the same time as other players, for example, the prisoner’s dilemma

35. Strategic Decision Making Models
1. Payoff Matrix
high
low A B
$59
$57
high
$60
$55 C D
$55
$50
low
$69
$58

36. 2. Kinked Demand Curve . price elastic Current Price and Quantity P TR
inelastic
P TR
MC1
D=AR
MC2
MC3 Q
quantity MR

37. Collusion
Agreement to fix prices
and/or
divide market share
- helps reduce uncertainty
- increases profits
- keeps entry difficult

38. 1. Overt Collusion 2. Covert Collusion Types
a. Formal Agreement to set Prices
b. OPEC
2. Covert Collusion
a. Secret agreements
b. Electric switch makers in the 50s

39. 3. Gentlemen’s Agreements
Types
3. Gentlemen’s Agreements
a. Agree on price then use non-price competition
b. Types of agreements
1) Price Leadership - GM
-dominant firm set price
-others follow
2) Cost-Plus Pricing
- Set price based on ATC at 85% capacity

40. Obstacles to Collusion
1. More firms, more likely to cheat
2. Firms may cheat in non-price ways – free services
3. Requires barriers to remain high
4. Unstable demand/business cycles
5. Illegal - use Gentlemen’s agreements
6. Difficult to hold the price

41. Comparison of Market Structures
Monopoly
Oligopoly
Monopolistic Competition
Perfect Competition
No. of firms
One
Few
Many
Almost infinite
Barriers to entry
Significant
None
Pricing decisions
MC = MR
Strategic pricing
MC = MR = P
Output decisions
Most output restriction
Output restricted
Output restricted, product differentiation
No output restriction
Interdependence
No competitors
Interdependent decisions
Each firm independent
LR profit
Possible
P and MC
P > MC
P = MC