Lecture 6: Firms’ Supply and market’s
structure
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Firm’s supply related to market structure
Factors determining product’s supply.
The sense of cost
Equation between marginal revenue and marginal cost.
In real markets there are:
More than one firms
Substitute products
The power of consumers’ negotiations.
• Firm’s supply is subject to the market structure
 Totally competitive market (too many firms
produce exactly the same product).
 Monopoly (there is just one firm in the market)
 Monopolistic competitiveness (too many firms
produce diversified products).
 Oligopoly (few firms produce products for many
consumers).
Conditions for a total competitive market
• For producers exist that:
 They produce exactly the same product.
 There are too many producers.
• For consumers exist that:
 They want the specific product.
 They do not have any preferences concerning the
producer.
 All participants share the same information.
Diagram 1
• None producer will charge a price higher than p*.
• None producer will charge a price lower than p*.
• Firms in total competitive markets are known as price
takers.
• The quantity’s change in such markets is too low
(marginally null) due to two conditions:
 There are too many firms in the market (the market share
of each firm is too low).
 There is not excessive potential productivity (Nobody can
increase the production).
 There is free entrance and exit of firms in the branch (no
legal limits or obstacles).
Main condition for supply decision
•The main condition of each firm is directly linked to profit
maximization.
• Profit maximization exists in the quantity of equation
between marginal revenue (MR) and marginal cost (MC).
•Firms in totally competitive markets can not affect the
prices as they ate price takers.
•The price is always given and taking this into account
the firm is trying to maximize its profits.
•TR(q) = p*q
•MR(q) = p*
Diagram 2
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Supply Function and Competitive firms’ cost
MC(q) = p*
There is discrimination in the cost according to the
existence of fixed cost.
Supply Function with the existence of fixed cost
T(q)>0 for q>=0.
Only for short – term time period.
• Diagram 3
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For prices less than p*, firm does not produce (q=0).
In this price firm does not cover its variable cost.
For prices higher than p*, firm produces (q>0).
For prices between p* and p** firm will keep producing
in short – term time period.
• For prices higher than p**, firm produces (q>0), as it
covers all cost and creates profits.
• S(p) = 0 for p<p* and S(p)>0 for p>p*.
• Supply curve’s condition: MC(q) > AVC(q)
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Supply Function without fixed cost
T(q)=0 for q=0 and T(q)>0 for q>0
This exist in long – tern time period.
AC = AVC
MC(q) > AC(q)
• Diagram 4
Market Supply Function
• MC(s(p*)) = p*.
• How the market is modulated when we move from one’ s
firm supply to the market supply?
• S(p*)=s1(p*) + s2(p*) + …+ Sn(p*).
• This is illustrated as the sum of each firm’s supply.
• Diagram 5
Market Equivalence and Demand changes
• D(p*) = S(p*)
• Diagram 6
Diagram 7
• Which will be the effect in case of change of
demand in market.
• The pair (price, quantity) = (p**, q**) in short – term
period.
• The pair (price, quantity) = (p***, q***) in
intermediate– term period.
• In such case: p*** < p** and q*** > q**
• This happens because in the intermediate – term
period firms increase their product till the point of
exhaustion of the surplus potential productivity.
• The increase of the supply will reduce price.
Long – term equivalence and the decision of firm’s
entry in the market
• Changes in long – term period need special
management.
• In long – run period there is the parameter of free
firms’ entry.
• Diagram 8
• p***>p*. That means that the already operating firms
have positive profits.
• This will lead new firms to that branch and the supply
will increase.
• This increase will stop at the point where p***=p*.
• After this point none firm will enter to the branch, as
they will have negative profits.
• Free firms entry in competitive markets secure that in
long – rum firms profit will be null.
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The usefulness of the competitive market model
It is very difficult to meet such markets in the real
economy.
i.e. agricultural products, financial markets, labor
market etc.
Competitive markets are useful as reference point for
other markets.
Price theory
The case of specific firms (i.e. the case of electricity)
and its connection with the monopoly structure.
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Monopolistic Competition
Too many firms produce a diversified product.
Consumers prefer exclusively this specific product.
Consumers modulate their demand according to
product’s price.
Characteristics from both monopoly and competitive
market.
Prices relative to this of firms’ competitors.