1. Firms in Markets

2. The Four Types of Market Structure
Number of Firms?
One
firm
Few
firms
Many
firms
Type of Products?
Differentiated
products
Identical
products •
Novels
Movies
Monopolistic
Competition
Perfect •
Wheat
Milk
Competition •
Tap water
Cable TV
Monopoly •
Tennis balls
Crude oil
Oligopoly

3. WHAT IS A COMPETITIVE MARKET
A perfectly competitive market has the following characteristics:
There are many buyers and sellers in the market.
The goods offered by the various sellers are largely the same.
Firms can freely enter or exit the market.

4. WHAT IS A COMPETITIVE MARKET
As a result of its characteristics, the perfectly competitive market has the following outcomes:
The actions of any single buyer or seller in the market have a negligible impact on the market price.
Each buyer and seller takes the market price as given.

5. WHAT IS A COMPETITIVE MARKET
A competitive market has many buyers and sellers trading identical products so that each buyer and seller is a price taker.
Buyers and sellers must accept the price determined by the market.

6. The Revenue of a Competitive Firm
Total revenue for a firm is the selling price times the quantity sold.
TR = (P  Q)
Total revenue is proportional to the amount of output.
Average revenue tells us how much revenue a firm receives for the typical unit sold.
Average revenue is total revenue divided by the quantity sold.

7. The Revenue of a Competitive Firm
In perfect competition, average revenue equals the price of the good.

8. The Revenue of a Competitive Firm
Marginal revenue is the change in total revenue from an additional unit sold.
For competitive firms, marginal revenue equals the price of the good.
MR =TR/ Q

9. Table 14-1: Total, Average, and Marginal Revenue for a Competitive Firm
Quantity (in litres)
Price
Total Revenue
Average Revenue
Marginal Revenue
(Q)
(P)
(TR = P x Q)
(AR = TR/ Q)
(MR = ∆TR/∆Q)
$ 6 1
$ 6 6 12 2 6 18 3 6 24 4 6 48 8 42 7 36 30 5

10. PROFIT MAXIMIZATION AND THE COMPETITIVE FIRM’S SUPPLY CURVE
The goal of a competitive firm is to maximize profit, which equals total revenue minus total cost.
This means that the firm will want to produce the quantity that maximizes the difference between total revenue and total cost.

11. Table 14-2: Profit Maximization: A Numerical Example
Quantity (in litres)
Total Revenue
Total Cost
Profit
Marginal Revenue
Marginal Cost
Change in Profit
(Q)
(TR)
(TC)
(TR - TC)
(MR = ∆TR/∆Q)
(MC = ∆TC/∆Q)
(MR - MC)
- $ 3
$ 3
$ 0
$ 4
$ 2
$ 6 1 5 6 3 6 4 8 12 2 2 4 6 12 18 3
- 3
- 2
- 1 1 9 6 47 48 8 4 38 42 7 30 36 23 5 17 24

12. Figure 14-1: Profit Maximization for a Competitive Firm
The firm maximizes
profit by producing
the quantity at which
marginal cost equals
marginal revenue.
Costs and Revenue MC MC 2 Q
ATC P = MR 1 2 Q
MAX
AVC MC 1 Q
Quantity

15. MONOPOLY
While a competitive firm is a price taker, a monopoly firm is a price maker.
A firm is considered a monopoly if . . .
it is the sole seller of its product.
its product does not have close substitutes.

16. Why Monopolies Arise
The fundamental cause of monopoly is barriers to entry.
Barriers to entry have three sources:
Ownership of a key resource.
The government gives a single firm the exclusive right to produce some good.
Costs of production make a single producer more efficient than a large number of producers.

17. Figure 15-1: Economies of Scale as a Cause of Monopoly
Cost
Average
total
cost
Quantity of Output

18. Pricing and Production Decisions
Monopoly versus Competition
Monopoly
Is the sole producer
Faces a downward-sloping demand curve
Is a price maker
Reduces price to increase sales
Competitive Firm
Is one of many producers
Faces a horizontal demand curve
Is a price taker
Sells as much or as little at same price

19. Figure 15-2: Demand Curves for Competitive and Monopoly Firms
(a) Competitive Firm
(b) Monopoly
Price
Price
Demand
Demand
Quantity of Output
Quantity of Output

20. A Monopoly’s Revenue Total Revenue P  Q = TR Average Revenue
TR/Q = AR = P
Marginal Revenue
TR/Q = MR

21. Table 15-1: A Monopoly’s Total, Average, and Marginal Revenue.
Quantity of Water
Price
Total Revenue
Average Revenue
Marginal Revenue
(Q)
(P)
(TR = P x Q)
(AR = P x Q)
(MR = ∆TR/∆Q)
------
$ 0
$ 11
$ 10 10 1 8 9 18 2
- 4 3 24 8
- 2 4 28 7 5 30 6 2

22. A Monopoly’s Revenue A Monopoly’s Marginal Revenue
A monopolist’s marginal revenue is always less than the price of its good.
The demand curve is downward sloping.
When a monopoly drops the price to sell one more unit, the revenue received from previously sold units also decreases.

23. A Monopoly’s Revenue A Monopoly’s Marginal Revenue
When a monopoly increases the amount it sells, it has two effects on total revenue (P  Q).
The output effect—more output is sold, so Q is higher.
The price effect—price falls, so P is lower.

24. Figure 15-3: The Demand and Marginal Revenue Curves for a Monopoly
Price 11
Marginal revenue
Demand (average revenue) 10 9 8 7 6 5 4 3 2 1 –1 1 2 3 4 5 6 7 8 –2 –3 –4
Quantity of Water

25. Profit Maximization
A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost.
It then uses the demand curve to find the price that will induce consumers to buy that quantity.

26. Figure 15-4: Profit Maximization for a Monopoly
Costs and Revenue
2. … and then the demand curve shows the price consistent with this quantity.
Monopoly price B
Marginal revenue
Demand
Average total cost
Marginal cost A
1. The intersection of the MR curve and the MC curve determines the profit maximizing quantity…
QMAX Q1 Q2
Quantity

27. Profit Maximization Comparing Monopoly and Competition
For a competitive firm, price equals marginal cost.
P = MR = MC
For a monopoly firm, price exceeds marginal cost.
P > MR = MC

28. A Monopoly’s Profit Profit equals total revenue minus total costs.
Profit = TR - TC
Profit = (TR/Q - TC/Q)  Q
Profit = (P - ATC)  Q
The monopolist will receive economic profits as long as price is greater than average total cost.

29. Figure 15-5: The Monopoly’s Profit
Costs and Revenue
Marginal cost
Marginal revenue
Demand
Average total cost
Monopoly price E B
Monopoly
profit C
Average total cost D
QMAX
Quantity

30. MONOPOLISTIC COMPETITION
Imperfect competition refers to those market structures that fall between perfect competition and pure monopoly.

31. MONOPOLISTIC COMPETITION
Types of Imperfectly Competitive Markets
Monopolistic Competition
Many firms selling products that are similar but not identical.
Markets that have some features of competition and some features of monopoly.
Oligopoly
Only a few sellers, each offering a similar or identical product to the others.

32. MONOPOLISTIC COMPETITION
Attributes of Monopolistic Competition
Many sellers
Product differentiation
Free entry and exit

33. MONOPOLISTIC COMPETITION
Many Sellers
There are many firms competing for the same group of customers.
Product examples include books, CDs, movies, computer games, restaurants, piano lessons, cookies, furniture, etc.
Product Differentiation
Each firm produces a product that is at least slightly different from those of other firms.
Rather than being a price taker, each firm faces a downward-sloping demand curve.

34. MONOPOLISTIC COMPETITION
Free Entry or Exit
Firms can enter or exit the market without restriction.
The number of firms in the market adjusts until economic profits are zero.

35. The Monopolistically Competitive Firm in the Short Run
Short-run economic profits encourage new firms to enter the market. This:
Increases the number of products offered.
Reduces demand faced by firms already in the market.
Incumbent firms’ demand curves shift to the left.
Demand for the incumbent firms’ products fall, and their profits decline.

36. The Monopolistically Competitive Firm in the Short Run
Short-run economic losses encourage firms to exit the market. This:
Decreases the number of products offered.
Increases demand faced by the remaining firms.
Shifts the remaining firms’ demand curves to the right.
Increases the remaining firms’ profits.

37. Figure 17-1: Monopolistic Competitors in the Short Run
(a) Firm Makes Profit
(b) Firm Makes Losses
Price
Price MC MC MR
Demand
ATC MR
Demand
ATC
Average total cost
Losses
Loss-minimizingquantity
Price
Profit
Profit-maximizingquantity
Price
Average total cost
Quantity
Quantity

38. Monopolistic Competition Versus Perfect Competition
There are two noteworthy differences between monopolistic and perfect competition—excess capacity and markup.

39. Figure 17-3: Monopolistic versus Perfect Competition
(a) Monopolistically Competitive Firm
(b) Perfectly Competitive Firm
Price
Price
ATC MC MC
ATC MR
Demand
Markup
Marginal cost
Price
Quantity produced
Efficient scale
P = MC
P = MR
Quantity produced = efficient scale
Quantity
Quantity