market structure
all features of a market that affect the behaviour and performance of firm
- number and size of sellers
- extent of knowledge about one another’s actions
- degree and freedom of entry
- degree of product differentiation
market power
- when firms can influence price of products
competitive market
- large number of sellers
- standardized product
- easy entry and exit
- price takers
price taker
- firm produces as much or as little as they want at the given price
- price doesnt depend on quantity produced and sold
- can keep increasing output without it affecting market price
demand curve for perfectly competitive market
horizontal demand curve even though industry demand curve is downward sloping
total revenue
the total amout received by the firm from the sale of a product
TR = P x Q
average revenue
AR = TR/Q
- amount received per unit sold
marginal revenue
MR = delta TR/delta Q
- additional revenue received if it increases production by 1 unit
- MR = P
- each 1 unit increase in Q causes revenue to rise by P
profit maximizing quantity
intersection of the price with MC curve
MC and firm’s supply decision
- MR = MC at profit maximizing Q
- MR > MC increase Q to raise profit
- MR < MC reduce Q to raise profit
- if price rises then profit maximizing quantity also rises
- MC curve determines firm’s Q at any price
MC curve is supply curve
zero economic profits
- firm just covering total costs
- P = ATC
positive economic profits
- P > ATC (atc below)
- area between 0, Q, P, ATC rectangle
negative economic profits
- P < ATC (atc above)
- area of rectangle between 0, Q, P, ATC
should firm produce at all?
- if produces nothing: operating loss = to fixed cost
- if produce: add vairable cost
- if revenue < variable cost, firm will lose more by producing than not
decision to produce
- shut down if TR < VC
- divide both sides by Q
- shut down if P < AVC
short run supply curve
- portion of MC curve above minumum AVC
- horizontal sum of MC curves (above AVC) of all firms in industry
short run equilibrium in a competitive market
- Qd = Qs
- each firm maximizing profits given market price
- competitive firms may be making losses, breaking even or making profits
effects of new entrants attracted by positive profit then
- new firms enter, short run market supply shifts right
- price falls reducing profits adn slowing entry
- entry stops when all firms just cover total costs
if existing firms incur losses
- some firms exit, short run market supply shifts left
- price rises, reducing some losses
long run equilibrium
- process of exit or entry is complete
- occurs when firms are earning zero profits
- zero economic profits when P = ATC
- produce where p = MR = MC so zero profit when P = MC = ATC
- p = minimum ATC
- break even price
why do firms stay in business if zero profits
- economic profit is revenue - all costs, including implicit costs
- in zero profit eqm firms earn through revenue to cover costs
- accounting profit is positive
short run and long run effect of increase in demand
- firm begins in long run but increase in demand raises p leading to SR profits
- over time profits induce entry shifting S to right, reducing P and driving profits to zero
- restores long run EQM
