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Market 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 trade
Hall & Leiberman;
Economics: Principles
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Market 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
Oligopoly
Hall & Leiberman;
Economics: Principles
2
The Three Requirements of Perfect
Competition
• Large numbers of buyers and sellers
• Sellers offer a standardized product
• Free entry and exit
Hall & Leiberman;
Economics: Principles
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A 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 sells
Hall & Leiberman;
Economics: Principles
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A 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 another
Hall & Leiberman;
Economics: Principles
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Free 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
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Free 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
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Is 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
8
The 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
operates
Hall & Leiberman;
Economics: Principles
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Figure 1: The Competitive Industry
and Firm
1. The intersection of the market supply
and the market demand curve…
Price per
Ounce
Market
3. The typical firm can sell all it
wants at the market price…
Price per
Ounce
Firm
S
$400
$400
D
Ounces of Gold per Day
2. determine the equilibrium
market price
Hall & Leiberman;
Economics: Principles
Demand
Curve Facing
the Firm
Ounces of Gold per Day
4. so it faces a horizontal
demand curve
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Goals 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 inputs
Hall & Leiberman;
Economics: Principles
11
The 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
12
The 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 sell
Hall & Leiberman;
Economics: Principles
13
Cost 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 price
Hall & Leiberman;
Economics: Principles
14
Figure 2a: Profit Maximization in
Perfect Competition
Dollars
TR
$2,800
TC
Maximum Profit
per Day = $700
2,100
550
Slope = 400
1
Hall & Leiberman;
Economics: Principles
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Ounces of Gold per Day
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Figure 2b: Profit Maximization in
Perfect Competition
Dollars
MC
$400
D = MR
1
Hall & Leiberman;
Economics: Principles
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Ounces of Gold per Day
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The 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 - TC
Hall & Leiberman;
Economics: Principles
17
The 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 below
Hall & Leiberman;
Economics: Principles
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