Topic:

Market Structure

Perfectly Competitive Markets

 Market
Market is a mechanism which buyer and sellers interact to
determine prices and exchanges goods/services
Market Structure

 How a firm/company are differentiated and categorized based on types of goods they sell
(homogeneous/heterogenous) and their operations are affected by external factors.

 It help us to understand the characteristics of diverse markets.

Topic Outline

1. Perfectly Competitive Markets

2. How a Firm Maximizes Profit in a Perfectly Competitive Market
3. Deciding Whether to Produce or to Shut Down in the Short Run
4. The Entry and Exit of Firms in the Long Run
 Classification of Market

Perfect Monopolistic
Competition Competition Oligopoly Monopoly

 Large number buyers and sellers  Many buyers and sellers  Few sellers  Single (One) seller

 Homogeneous product  Differentiated product  Homogeneous or Differentiated product

 Unique product
 Perfect substitute available  Close substitute available  Substitute may or may not be available  No close substitute available
 Free entry and exit  Relatively Free entry and exit  Very difficult entry and exit  Impossible entry
 Example: Agricultural product,  Example: Taxi’s, Clothing, Hotels,  Example: mobile phone, TV, gas, etc.  Example: Google, FB, oil etc.
online shopping, foreign restaurants etc.
exchange market etc.

Each market structure will be applicable to different

real-world markets, and will give us insight into how
firms in certain types of markets behave.
 Market

Market is a mechanism which buyer and sellers interact to determine prices and exchanges goods/services

Market Structure

How a firm/company are differentiated and categorized based on types of goods they sell (homogeneous/heterogenous) and their
operations are affected by external factors. It help us to understand the characteristics of diverse markets.
P = MR = AR
Classification of Market
Demand shows how (which is also the D
many consumers buy at curve for the firm’s
varying prices, a mirror product – perfectly
Perfect of what AR shows elastic demand)
Competition
It must “take” the equilibrium market price

 Example: Agricultural product, online

shopping, foreign exchange market
 How Firm Maximize Profit
Perfect
Quantity Market Total Average Marginal Total Profit
Competition
(Q) Price Revenue Revenue Revenue Cost (TR - TC)
(P) (TR) (AR) (MR) (TC)

0 7 0 0 0 10.00 -10.00
A firm’s total revenue TR = P  Q
1 7 7 7 7 14.00 -7.00
𝑻𝑹
2 7 14 7 7 16.50 -2.50 A firm’s average revenue AR = 𝑸
3 7 21 7 7 18.50 2.50
A firm’s marginal revenue MR = ∆𝑻𝑹
4 7 28 7 7 21.00 7.00 ∆𝑸
5 7 35 7 7 24.50 10.50

6 7 42 7 7 29.00 13.00

7 7 49 7 7 35.50 13.50

8 7 56 7 7 44.50 11.50

9 7 63 7 7 56.50 6.50 It must “take” the equilibrium market price

10 7 70 7 7 72.00 -2.00

For a firm in
a perfectly
competitive
market,
price P = MR = AR
 How Firm Maximize Profit
Perfect
Quantity Market Total Average Marginal Total Profit
Competition
(Q) Price Revenue Revenue Revenue Cost (TR - TC)
(P) (TR) (AR) (MR) (TC)

0 7 0 0 0 10.00 -10.00
A firm’s total revenue TR = P  Q
1 7 7 7 7 14.00 -7.00
𝑻𝑹
2 7 14 7 7 16.50 -2.50 A firm’s average revenue AR = 𝑸
3 7 21 7 7 18.50 2.50
A firm’s marginal revenue MR = ∆𝑻𝑹
4 7 28 7 7 21.00 7.00 ∆𝑸
5 7 35 7 7 24.50 10.50

6 7 42 7 7 29.00 13.00

7 7 49 7 7 35.50 13.50

8 7 56 7 7 44.50 11.50

9 7 63 7 7 56.50 6.50

10 7 70 7 7 72.00 -2.00

 First, Condition for maximization of profit is where TR-TC is greatest

 How Firm Maximize Profit
Perfect
Number of Market Total Average Marginal Total Profit Marginal
Competition
Bushels Price Revenue Revenue Revenue Cost (TR - TC) Cost
(Q) (P) (TR) (AR) (MR) (TC) (MC)
A firm’s total revenue TR = P  Q
0 7 0 0 0 10.00 -10.00 0
A firm’s Profit P = TR - TC
1 7 7 7 7 14.00 -7.00 4.00 𝑻𝑹
A firm’s average revenue AR = 𝑸
2 7 14 7 7 16.50 -2.50 2.50

3 7 21 7 7 18.50 2.50 2.00

A firm’s marginal revenue MR = ∆𝑻𝑹
∆𝑸
4 7 28 7 7 21.00 7.00 2.50
∆𝑻𝑪
5 7 35 7 7 24.50 10.50 3.50 A firm’s marginal cost MC =
∆𝑸
6 7 42 7 7 29.00 13.00 4.50

7 7 49 7 7 35.50 13.50 6.50

8 7 56 7 7 44.50 11.50 9.00

9 7 63 7 7 56.50 6.50 12.00

10 7 70 7 7 72.00 -2.00 15.50

P
 Second, Profit is maximized by producing as long as MR > MC; or until MR=MC, if that is possible

Condition for maximization of profit is MR= MC (the closest if equal is not possible).

As we know that P = MR = AR
 Third, the profit-maximizing level of output is also where P = MC
 Profit or Loss
Perfect
Quantity Market Total Average Marginal Total Profit Marginal Average Profit / Loss
Competition
(Q) Price Revenue Revenue Revenue Cost (TR - TC) Cost Total Cost
(P) (TR) (AR) (MR) (TC) (MC) (ATC) [ 𝑃 − 𝐴𝑇𝐶 × 𝑄 ]
Total revenue TR = P  Q
0 7 0 0 0 10.00 -10.00 0 0 0
Profit P = TR - TC
1 7 7 7 7 14.00 -7.00 4.00 14 -7.00 𝑻𝑹
Average revenue AR =
2 7 14 7 7 16.50 -2.50 2.50 8.25 -2.25 𝑸
3 7 21 7 7 18.50 2.50 2.00 6.17 2.49 ∆𝑻𝑹
Marginal revenue MR =
∆𝑸
4 7 28 7 7 21.00 7.00 2.50 5.25 7
∆𝑻𝑪
5 7 35 7 7 24.50 10.50 3.50 4.90 10.50 Marginal cost MC =
∆𝑸
6 7 42 7 7 29.00 13.00 4.50 4.84 12.96
𝑻𝑪
7 7 49 7 7 35.50 13.50 6.50 5.08 13.44 Average total cost ATC = 𝑸

8 7 56 7 7 44.50 11.50 9.00 5.56 11.52

9 7 63 7 7 56.50 6.50 12.00 6.28 6.48

10 7 70 7 7 72.00 -2.00 15.50 7.20 -2.00

Total revenue TR = P  Q Maximizes at which MR = MC

Profit P = TR - TC
Difference between Price and ATC
P = (P  Q) - TC is profit per unit
Divide both sides by Q, P 𝑃×𝑄 𝑇𝐶 P
= − , = 𝑃 − 𝐴𝑇𝐶
𝑄 𝑄 𝑄 𝑄 Total profit = Profit per unit  the amount of output
𝑃 = 𝑃 − 𝐴𝑇𝐶 × 𝑄
 Profit or Loss
Perfect
Quantity Market Total Average Marginal Total Profit Marginal Average Profit / Loss
Competition
(Q) Price Revenue Revenue Revenue Cost (TR - TC) Cost Total Cost
(P) (TR) (AR) (MR) (TC) (MC) (ATC) [ 𝑃 − 𝐴𝑇𝐶 × 𝑄 ]
Total revenue TR = P  Q
0 7 0 0 0 10.00 -10.00 0 0 0
Profit P = TR - TC
1 7 7 7 7 14.00 -7.00 4.00 14 -7.00 𝑻𝑹
Average revenue AR =
2 7 14 7 7 16.50 -2.50 2.50 8.25 -2.25 𝑸
3 7 21 7 7 18.50 2.50 2.00 6.17 2.49 ∆𝑻𝑹
Marginal revenue MR =
∆𝑸
4 7 28 7 7 21.00 7.00 2.50 5.25 7
∆𝑻𝑪
5 7 35 7 7 24.50 10.50 3.50 4.90 10.50 Marginal cost MC =
∆𝑸
6 7 42 7 7 29.00 13.00 4.50 4.84 12.96
𝑻𝑪
7 7 49 7 7 35.50 13.50 6.50 5.08 13.44 Average total cost ATC = 𝑸

8 7 56 7 7 44.50 11.50 9.00 5.56 11.52

9 7 63 7 7 56.50 6.50 12.00 6.28 6.48

10 7 70 7 7 72.00 -2.00 15.50 7.20 -2.00

Total revenue TR = P  Q Maximizes at which MR = MC

Profit P = TR - TC
P = (P  Q) - TC Difference between Price and ATC
is loss per unit
Divide both sides by Q, P 𝑃×𝑄 𝑇𝐶 P
= − , = 𝑃 − 𝐴𝑇𝐶
𝑄 𝑄 𝑄 𝑄 Price is lower than ATC, so make a loss.
𝑃 = 𝑃 − 𝐴𝑇𝐶 × 𝑄
 Profit or Loss - Break Even
Perfect
Quantity Market Total Average Marginal Total Profit Marginal Average Profit / Loss
Competition
(Q) Price Revenue Revenue Revenue Cost (TR - TC) Cost Total Cost
(P) (TR) (AR) (MR) (TC) (MC) (ATC) [ 𝑃 − 𝐴𝑇𝐶 × 𝑄 ]
Total revenue TR = P  Q
0 7 0 0 0 10.00 -10.00 0 0 0
Profit P = TR - TC
1 7 7 7 7 14.00 -7.00 4.00 14 -7.00 𝑻𝑹
Average revenue AR =
2 7 14 7 7 16.50 -2.50 2.50 8.25 -2.25 𝑸
3 7 21 7 7 18.50 2.50 2.00 6.17 2.49 ∆𝑻𝑹
Marginal revenue MR =
∆𝑸
4 7 28 7 7 21.00 7.00 2.50 5.25 7
∆𝑻𝑪
5 7 35 7 7 24.50 10.50 3.50 4.90 10.50 Marginal cost MC =
∆𝑸
6 7 42 7 7 29.00 13.00 4.50 4.84 12.96
𝑻𝑪
7 7 49 7 7 35.50 13.50 6.50 5.08 13.44 Average total cost ATC = 𝑸

8 7 56 7 7 44.50 11.50 9.00 5.56 11.52

9 7 63 7 7 56.50 6.50 12.00 6.28 6.48

10 7 70 7 7 72.00 -2.00 15.50 7.20 -2.00

Total revenue TR = P  Q Maximizes at which MR = MC

Profit P = TR - TC
P = (P  Q) - TC Price never exceeds average cost,
so the firm could not make a profit.
Divide both sides by Q, P 𝑃×𝑄 𝑇𝐶 P
= − , = 𝑃 − 𝐴𝑇𝐶
𝑄 𝑄 𝑄 𝑄 Best option, break even.
No profit, no loss
𝑃 = 𝑃 − 𝐴𝑇𝐶 × 𝑄
 Profit or Loss - Shut Down in the Short Run
Perfect
Quantity Market Total Average Marginal Total Profit Marginal Average Profit / Loss
Competition
(Q) Price Revenue Revenue Revenue Cost (TR - TC) Cost Total Cost
(P) (TR) (AR) (MR) (TC) (MC) (ATC) [ 𝑃 − 𝐴𝑇𝐶 × 𝑄 ]
Total revenue TR = P  Q
0 7 0 0 0 10.00 -10.00 0 0 0
Profit P = TR - TC
1 7 7 7 7 14.00 -7.00 4.00 14 -7.00 𝑻𝑹
Average revenue AR =
2 7 14 7 7 16.50 -2.50 2.50 8.25 -2.25 𝑸
3 7 21 7 7 18.50 2.50 2.00 6.17 2.49 ∆𝑻𝑹
Marginal revenue MR =
∆𝑸
4 7 28 7 7 21.00 7.00 2.50 5.25 7
∆𝑻𝑪
5 7 35 7 7 24.50 10.50 3.50 4.90 10.50 Marginal cost MC =
∆𝑸
6 7 42 7 7 29.00 13.00 4.50 4.84 12.96
𝑻𝑪
7 7 49 7 7 35.50 13.50 6.50 5.08 13.44 Average total cost ATC = 𝑸

8 7 56 7 7 44.50 11.50 9.00 5.56 11.52

9 7 63 7 7 56.50 6.50 12.00 6.28 6.48

10 7 70 7 7 72.00 -2.00 15.50 7.20 -2.00

The firm’s shut down decision is based on its variable costs;

Fixed costs should be ignored because they are sunk costs,
If, P < AVC should not produce costs that have already been paid and cannot be recovered.

If, P ≥ AVC should produce as MC=MR / P=MC

So, if the price is below the minimum point of AVC,
the firm will produce nothing at all.
 Profit or Loss - Long Run
Perfect
Competition
 In short-run equilibrium, a firm might make an economic profit,
break even, or incur an economic loss.

 Only one of them is a long-run equilibrium because firms can

enter or exit the market.

• If firms are making an economic profit, additional firms enter

the market, driving down price to the break-even level.

• If firms are making an economic loss, existing firms exit the

market, driving price up to the break-even level.

Long-run competitive equilibrium: The situation in which the entry and exit of firms
has resulted in the typical firm breaking even. At this point, resources are used efficiently.
Tutorial Question-1
Table below shows the short-run cost data of a perfectly competitive firm that produces plastic camera cases. Assume that output can
only be increased in batches of 100 units.
Variable
Total Cost
Quantity Cost ATC AFC AVC MC MR AR
(dollars)
(dollars)
0 $1,000 $0 - - - - - -
100 1,360 360 13.6 10 3.6 3.6 8 8
200 1,560 560 7.8 5 2.8 2 8 8
300 1,960 960 6.53 3.33 3.2 4 8 8
400 2,760 1,760 6.9 2.5 4.4 8 8 8
500 4,000 3,000 8 2 6 12.4 8 8
600 5,800 4,800 9.67 1.67 8 18 8 8

a. What is the fixed cost of production?

b. If the market price of each camera case is $8, what is the profit-maximizing quantity?
c. If the market price of each camera case is $8, what is the firm's total revenue?
d. If the market price of each camera case is $8 and the firm maximizes profit, what is the amount of the firm's profit or loss?
e. Suppose the fixed cost of production rises by $500 and the price per unit is still $8. What happens to the firm's profit-
maximizing output level?
f. What is the firm’s shut down price?