�8.0) Market Structure Analysis�8.1) Perfect Competition�8.2) Short-Run Decisions�8.3) Long-Run Decisions�8.4) Case Study�

Ch8. Perfect Competition

ECO 1002. Principles of Microeconomics

Week 9

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Dr. Christopher Paik

8.0) Market Structure Analysis

Five industry characteristics help determine market structures:

1. Number of firms
• Price taker vs. price maker

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• Product types
• Homogeneous product vs. heterogeneous product

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• Barriers to entry
• Does the industry require high costs to start a business?

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• Capability of controlling the market and price
• Pharmaceutical companies set their prices by filing patents

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• Long-run economic profit
• Degree of profitability for each market structure type

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8.0) Market Structure Analysis

Market structures:

• Perfect competition
1. Many buyers and sellers
2. Homogeneous (nearly identical) products
3. No barriers to entry
4. No control over price (no market power)
5. Zero long-run economic profit (high competition)

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• Monopolistic competition
• Many buyers and sellers
• Differentiated products
• Some barriers to entry
• Some control over price (limited market power)
• Zero long-run economic profit

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8.0) Market Structure Analysis

Market structures:

• Oligopoly
1. Fewer firms
2. Mutually interdependent decisions
3. Substantial barriers to entry
4. Shared market power and considerable control over price
5. Potential long-run economic profit

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• Monopoly
• One firm
• No close product substitutes
• High barriers to entry
• Substantial market power and control over price
• Potential long-run economic profit

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8.1) Perfect Competition

Perfect competition with four market structure categories

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• Numbers of Sellers

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• Substitutes Availability

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• Entry Barrier

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• Market Power

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Perfect Competition:

Each firm’s market share is too small to affect the market = price taker

Homogeneous goods

Easy entry and exit = many firms

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Perfect Competition

Monopolistic Competition

Oligopoly

Monopoly

Many sellers

One seller

Many substitutes

No substitutes

No entry barrier

Significant entry barrier

Price takers

Price maker

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8.1) Perfect Competition

Perfect Competition: The Market for Competitive Products

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8.2) Profit Maximization in Perfectly Competitive Markets (SR)

8.2) Profit Maximization in Perfectly Competitive Markets (SR)

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8.2) In-Class Exercise

How do firms maximize profit in perfectly competitive markets?

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8.2) In-Class Exercise

How do firms maximize profit in perfectly competitive markets?

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Profit

8.2) Perfect Competition: Short-Run Decisions

Operate or Shutdown?

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• What happens if the price falls to $160?

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• In the short run, at least one factor of production is fixed.

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• Fixed costs must still be paid (e.g., $1,000 for rent).

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• The shutdown point is the point where the price falls below the minimum point on the AVC curve (minimize losses).

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• If the price continues to fall below $160 per unit, the firm’s revenue won’t be able to cover variable costs, including wages.

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• The firm is indifferent to whether it operates or shuts down at the shutdown point – the firm must pay fixed costs either way.

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• Firms stay in the industry as long as they can cover their variable costs.

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• When deciding to shut down, find if MC hits the minimum point on the AVC.

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8.2) Perfect Competition: Short-run Decisions

The Short-Run Supply Curve for a Perfectly Competitive Firm

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Positive economic profit

Normal economic profit

Remain in operation (shutdown point)

8.3) Perfect Competition: Long-Run Decisions

Firms can adjust all factors, even to the point of leaving an industry, while other firms can enter in the long run.

• Adjusting to profits and losses in the short run:
• Economic profits attract other firms into the industry.
• More suppliers shift the supply curve, and the price decreases until economic profit = 0.

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8.3) Perfect Competition: Long-Run Decisions

Firms can adjust all factors, even to the point of leaving an industry, while other firms can enter in the long run.

• Adjusting to profits and losses in the short run
• Economic losses causes firms to leave the industry.
• Less suppliers shift the supply curve, and the price increases until economic profit = 0.

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8.3) Perfect Competition: Long-Run Decisions

Firms can adjust all factors, even to the point of leaving an industry, while other firms can enter in the long run.

• Q. Suppose that the strawberry industry is perfectly competitive. The price per box is $3. If the long-run minimum ATC is $2 per box, how much is the long-run price for a box of strawberries?

P = MR = SRATC_min = LRATC_min

• Production efficiency
• Lowest possible cost (MC = SRATC_min)
• Allocative efficiency
• Firms are spending as much as consumer value (P = MR = MC)
• The market ensures that the goods produced are those that consumers want

Competition is good!

8.4) Case Study