Competition
Chapter 6
McGraw-Hill/Irwin
Copyright © 2011 by The McGraw-Hill Companies, Inc. All Rights Reserved.
Market Structure
• The number and relative size of firms
in an industry.
• Most real-world firms fall somewhere
along a spectrum that stretches from
one extreme (powerless) to another
(powerful).
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Market Structure
Five common types of market structure:
• Perfect Competition
• Monopolistic Competition
• Oligopoly
• Duopoly
• Monopoly
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Figure 6.1
6-4
Competitive Firm
• A perfectly competitive firm is one
without market power.
– It is not able to alter the market price of
the good it produces.
– It is a price taker.
– It competes with many other firms selling
homogenous products.
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Monopoly
• A monopoly firm is one that produces
the entire market supply of a particular
good or service.
– It is a price setter, not a price taker.
– It has no direct competitors.
– It has complete market power; it can alter
the market price of a good or service.
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Imperfect Competition
• Other forms of imperfect competition lie
between the extremes of monopoly
and perfect competition.
– Duopoly: only two firms supply a product.
– Oligopoly: a few large firms supply all or most of
a particular product.
– Monopolistic competition: many firms supply
essentially the same product but each enjoys
significant brand loyalty.
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Perfect Competition
• Perfectly competitive firms are pretty
much faceless.
• They have no brand image, no real
market recognition.
• A perfectly competitive firm is one
whose output is so small in relation to
market volume that its output decisions
have no perceptible impact on price.
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Price Takers
• A perfectly competitive firm is a price
taker.
• An individual firm’s output decisions do
not affect the market price.
• An individual firm must take the market
price and do the best it can within
these constraints.
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Output and Revenues
• Total revenue is the price of a product
multiplied by the quantity sold in a
given time period:
Total revenue = price x quantity
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Revenues versus Profits
• Profit is the difference between total
revenue and total cost.
• Maximizing output or revenue is not the
way to maximize profits.
• Total profits depend on how both
revenue and cost increase as output
expands.
• A business is profitable only within a
certain range of output.
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Short-Run Decision Rules
for a Competitive Firm
Price > MC
Increase output rate
Price = MC
Maintain output rate
(Profits maximized)
Price < MC
Decrease output rate
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Total Profit
• Total profit can be computed in one of
two ways:
Total profit = total revenue – total cost
OR
Total profit = average profit (profit per
unit) x quantity sold
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Total Profit
• The profit-maximizing producer never
seeks to maximize per-unit profits.
• The profit-maximizing producer has no
particular desire to produce at that rate
of output where ATC is at a minimum.
• Total profits are maximized only where
p = MC.
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Figure 6.6
6-15
Entry
• Additional firms will enter the industry when
profits are plentiful.
• Economic profits attract firms.
– More firms enter the industry.
– The market supply curve shifts to the
right.
– The price decreases.
• Industry output increases and price falls
when firms enter an industry.
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Figure 6.8
6-17
Tendency Toward
Zero Economic Profits
• New firms continue to enter a competitive
industry so long as profits exist.
• Once price falls to the level of minimum
average cost, all economic profits
disappear.
• Entry is the force driving down market
prices.
• Price falls until there are no economic
profits.
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Exit
• Firms exit the industry when profit
opportunities look better elsewhere.
• Firms leave the industry if price falls
below average cost.
• As firms exit the industry, the market
supply curve shifts to the left.
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Equilibrium
• The existence of profits in a
competitive industry induces entry.
• The existence of losses in a
competitive industry induces exits.
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Characteristics of a
Competitive Market
• Many firms
• MC = p
• Identical products • Zero economic
profit
• Low entry barriers
• Perfect
information
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End of
Chapter 6