Market StructureSlide 2The Three Requirements of Perfect CompetitionA Large Number of Buyers and SellersA Standardized ProductFree Entry and ExitSlide 7Is Perfect Competition Realistic?The Perfectly Competitive FirmFigure 1: The Competitive Industry and FirmGoals and Constraints of the Competitive FirmThe Demand Curve Facing a Perfectly Competitive FirmSlide 13Cost and Revenue Data for a Competitive FirmFigure 2a: Profit Maximization in Perfect CompetitionFigure 2b: Profit Maximization in Perfect CompetitionThe Total Revenue and Total Cost ApproachThe Marginal Revenue and Marginal Cost ApproachHall & Leiberman; Economics: Principles And Applications, 2004 1Market Structure•Sellers want to sell at the highest possible price•Buyers want to buy at the lowest possible price•All trade is voluntary•Yet we see that different goods and services are sold in vastly different ways•One culprit is the market structure–Characteristics of a market that influence behavior of buyers and sellers when they come together to tradeHall & Leiberman; Economics: Principles And Applications, 2004 2Market Structure•To determine structure of any particular market, we begin by asking –How many buyers and sellers are there in the market?–Is the good homogeneous or differentiated?–Are there any barriers to entry or exit?•Answers to these questions help us to classify a market into one of four basic types–Perfect competition–Monopoly–Monopolistic–OligopolyHall & Leiberman; Economics: Principles And Applications, 2004 3The Three Requirements of Perfect Competition•Large numbers of buyers and sellers•Sellers offer a standardized product•Free entry and exitHall & Leiberman; Economics: Principles And Applications, 2004 4A Large Number of Buyers and Sellers•In perfect competition, there must be many buyers and sellers–How many?•Number must be so large that no individual decision maker can significantly affect price of the product by changing quantity it buys or sellsHall & Leiberman; Economics: Principles And Applications, 2004 5A Standardized Product •Buyers do not perceive significant differences between products of one seller and another–For instance, buyers of wheat do not prefer one farmer’s wheat over anotherHall & Leiberman; Economics: Principles And Applications, 2004 6Free Entry and Exit •A perfectly competitive market has no significant barriers to discourage new entrants•What are the common barriers to entry?•What are some of the industries that have barriers to entry?Hall & Leiberman; Economics: Principles And Applications, 2004 7Free Entry and Exit •Perfect competition is also characterized by easy exit–A firm suffering a long-run loss must be able to sell off its plant and equipment and leave the industry for good, without obstacles•Why is this important?•What are the industries where there are barriers to exit?Hall & Leiberman; Economics: Principles And Applications, 2004 8Is Perfect Competition Realistic?•NO!•The assumptions that a market must satisfy to be perfectly competitive are rather restrictive•But … remember what we said about models in the first lecture? •Economists use a model of perfectly competitive markets all the time.•Why?Hall & Leiberman; Economics: Principles And Applications, 2004 9The Perfectly Competitive Firm•When we examine a competitive market from a distance, we get one view of what is occurring–When we closely examine the individual competitive firm, we get an entirely different picture•In learning about competitive firm, must also discuss competitive market in which it operatesHall & Leiberman; Economics: Principles And Applications, 2004 10Figure 1: The Competitive Industry and FirmOunces of Gold per DayPrice per OunceD$400SMarketDemand Curve Facing the Firm$400Firm1. The intersection of the market supply and the market demand curve…3. The typical firm can sell all it wants at the market price…Ounces of Gold per DayPrice per Ounce2. determine the equilibrium market price4. so it faces a horizontal demand curveHall & Leiberman; Economics: Principles And Applications, 2004 11Goals and Constraints of the Competitive Firm•Perfectly competitive firm faces a cost constraint like any other firm•Cost of producing any given level of output depends on –Firm’s production technology –Prices it must pay for its inputsHall & Leiberman; Economics: Principles And Applications, 2004 12The Demand Curve Facing a Perfectly Competitive Firm•Notice the demand curve for the firm in Fig(1) is different from the demand curve for the industry. •It’s not downward sloping•It’s horizontal, or infinitely price elastic•Why???Hall & Leiberman; Economics: Principles And Applications, 2004 13The Demand Curve Facing a Perfectly Competitive Firm•Means Small Time has no control over the price of its output–Simply accepts market price as given•Since a competitive firm takes the market price as given–Its only decision is how much output to produce and sellHall & Leiberman; Economics: Principles And Applications, 2004 14Cost and Revenue Data for a Competitive Firm•For a competitive firm, marginal revenue at each quantity is the same as the market price•For this reason, marginal revenue curve and demand curve facing firm are the same–A horizontal line at the market priceHall & Leiberman; Economics: Principles And Applications, 2004 15Figure 2a: Profit Maximization in Perfect CompetitionTR550$2,8002,100TCSlope = 400Ounces of Gold per DayDollars1 2 3 4 5 6 7 8 9 10Maximum Profit per Day = $700Hall & Leiberman; Economics: Principles And Applications, 2004 16Figure 2b: Profit Maximization in Perfect CompetitionMC$400D = MROunces of Gold per DayDollars1 2 3 4 5 6 7 8 9 10Hall & Leiberman; Economics: Principles And Applications, 2004 17The Total Revenue and Total Cost Approach•Most direct way of viewing firm’s search for the profit-maximizing output level•At each output level, subtract total cost from total revenue to get total profit at that output level–Total Profit = TR - TCHall & Leiberman; Economics: Principles And Applications, 2004 18The Marginal Revenue and Marginal Cost Approach•Firm should continue to increase output as long as marginal revenue __ marginal cost•Profit-maximizing output is found where MC curve crosses MR curve from
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