Market Structure

Managerial Economics
 Perfect Competition
Number and size distribution of Many small sellers. No seller is
sellers able to exert a significant
influence over price.
Number and size distribution of Many small buyers. No buyer is
buyers able to exert a significant
influence over price.
Product differentiation Product undifferentiated.
Decisions to buy are made on
the basis of price
Condition of entry and exit Easy entry and exit. Resources
are easily transferable among
industries.
 Perfect Competition
TC = 1000 + 2Q + 0.01Q2
MC = dTC/ dQ = 2 + 0.02Q
In perfect competition, Price = MC
Price = 10 = Demand
Therefore, 10 = 2 + 0.02Q
Q = 400
Economic Profit
TR = PQ
TR – TC = 10 (400) – [1000 + 2(400) + 0.01
(400) 2] =600
Perfect Competition (Contd.)
 Perfect Competition (contd.)
Only Question:
• How much output to produce?

• The profit-maximizing output is determined where the extra revenue

generated by selling the last unit (market price) just equals the marginal
cost of producing that unit.

• The firm in perfect competition maximizes profit by producing at the

rate of output where price equals marginal cost,
• In the short run, managers of a firm should shut down the operation
if price is below average variable cost,
• If price is greater than average variable cost but less than average
total cost, the firm should continue to produce in the short run because a
contribution can be made to fixed costs.
Shut down Price and Consumer
Surplus
CONSUMERS’ Surplus
 Calculate Shut down Price
• Example:
Find out when price is 40 should a firm be shutdown or
not given the total cost function:
TVC = 150Q – 20 Q2 +Q3
__________

AVC = 150 – 20Q + Q2

MC = 150 -40Q +3Q2
AVC = MC
150 – 20Q + Q2 = 150 -40Q +3Q2
Or, 20Q – 2Q2 = 0 or Q = 0 and
Q =10
 Perfect Competition (contd.)
• In the long run, economic profit is eliminated by the
entry of new firms. The profit maximizing rate of
output occurs where price equals both marginal and
average cost.
• Consumers who would have been willing to pay more
than the market price receive a consumer surplus
when they buy the product,
• In perfectly competitive markets (1) the value of the
last unit exchanged equals the opportunity cost of
producing it, (2) capital moves to its highest valued
use, and (3) production takes place at the minimum
point on the average cost curve.
 Monopoly
Monopoly

Number and size distribution single seller

of sellers

Number and size distribution Unspecified

of buyers

Product differentiation No close substitute

Condition of entry and exit Entry prohibited or difficult.

Monopoly (contd.)
 Monopoly (contd.)
TC = 500 + 20Q2
Demand P = 400 – 20 Q
TR = PQ = 400Q – 20Q2
Find out the profit maximizing price and quantity
•
MR = dTR/dQ = 400 – 40 Q
MC = dTC/dQ = 40 Q
MR = MC
400 – 40 Q = 40 Q
Therefore, P = 300 Q = 5
 Monopoly (Contd.)
• As the only seller, a monopolist faces the market demand curve.
The profit maximizing output is determined by the point where
marginal revenue equals marginal cost,
• If entry by other firms is difficult, even in the long run, the
monopolist can earn economic profit.
• Monopoly pricing results in allocative inefficiency because not
enough output is produced,
• Monopoly pricing also causes a redistribution of income from
consumers to the owners of the monopoly.
• If a firm has market power and there is separation of ownership
from control, technical inefficiency may result because of the failure
of managers to minimize costs,
• Rent seeking involves the use of resources to acquire or maintain
monopoly profits. Rent seeking involves a deadweight loss to
society because no additional goods and services are produced.
Monopolistic Competition: What it is?
In between monopoly and perfect competition there are other forms
of market. One important kind is Monopolistic Competition.

In the monopolistic market there are large number of sellers but the
product of the firms are rarely homogenous.

Example can be Shoe business. There are hundreds of shoe stores in a

city. Product differentials are done reflecting
• a. Materials
• b. Design and craftsmanship
• c. Advertisement
• d. Selling style
• e. Location
 Market Structure: Characteristics of
Monopolistic Competition

Number and Size of Sellers Many Sellers. Actions of One

seller is not noted by others.
Number and Size of Buyers Many Small Buyers
Product Dif erentiation Slightly dif erentiated
Conditions for Entry and Exit Easy Entry and Exit
 SHORT RUN
Profit Maximizing Price and Output
Once Advertising and Product Attributes are determined,
Profit Maximizing rate of output and Price are to be decided by
Managers.

In the short run monopolistic competition is similar to

Monopoly..

The output will be determined where MR = MC curves.

Price will be determined by the Demand Curve (D = AR)

In the short run the firm earns ECONOMIC Profit (= per unit price
- average cost)
Short Term Monopolistic
 LONG RUN
Profit Maximizing Price and Output
Once Advertising and Product Attributes are determined,

Profit Maximizing rate of output and Price are to be decided by

Managers.

In the long run monopolistic competition is similar to Perfect

Competition.
• As entry is easy.
• The output and Price will be determined where D curve is tangent
to AC curves.

Therefore, P (AR) = AC
So there is no economic Profit (= per unit price - average cost).
Long Run Monopolistic
 An Example
• Find out what is long run equilibrium price and quantity and how
much economic profit will be earned under monopolistic
competition?

• Demand Equation P = 309.75 -Q

• Long run TC = 400Q - 20Q2 + Q3

• We know in long run P =AC

• Therefore,
• 309.75-Q = 400 - 20Q + Q2
• Q2 -19Q + 90.25 = 0
• This has a single solution Q =9.5
• Thereby, P = 300.25