Summary of Lecture: Introduction To Accounting and Economics

Topic 3 – Market Structure and Competition Introduction to Accounting and Economics
Introduction to Accounting
and Economics
Topic 3: Market Structure and
Competition
V2.0 © NCC Education Limited
Market Structure and Competition Topic 3 - 3.‹#›
Summary of Lecture
• Words you must know
• How costs affect supply
• Long and short run costs
• Economies of scale
• Average cost and marginal cost
• More about short run costs
• Perfect and imperfect competition
• Why are there different types of market structure?
• Review of the topic
V2.0 Visuals Handout – Page 1

Words You Must Know

Economies of Scale: Reductions in average costs due to a high level of
output.
Long run total cost: The total cost of producing goods and services
where a firm has time to produce its output as
cheaply as possible.
Long run average cost: The average cost of producing goods and
services in the long term.
Short run average cost: The average cost of producing goods and
services in the short term.
Competition: The efforts of individuals and firms to capture a
share of the market.
Words You Must Know

Perfect A situation where the actions of individual
Competition: buyers and sellers have no effect on the
market price.
Imperfect A situation where the conditions for perfect

Competition: competition are not satisfied. There are
many forms of imperfect competition.
Monopoly: A form of imperfect competition where there

is only one supplier.

Words You Must Know

Oligopoly: A form of imperfect competition where there are few
suppliers.
Monopolistic A form of imperfect competition where there are

Competition: many suppliers producing goods that are
differentiated. In other words the suppliers produce
goods that are not substitutes for one another.
Market Structure: The features of a market in terms of barriers to entry,

the number of suppliers, and the ability of buyers and
sellers to affect price.
How Costs Affect Supply

• Costs can be either short term or long term
• These are the costs a producer faces when deciding to

produce goods or services
• These will include:

- The costs of raw materials
- Labour costs
- Administration costs
- Transport costs
- Marketing costs
- Research and development costs

•Economists tend to be pretty imprecise

about the ‘short term’ and the ‘long term’
•A Working definition:
- Short term – up to one year
- Long term – longer than one year

Why a year?
• A year should be long enough for most
businesses to make major changes in their
operating capacity
• For example, in one year it should be

possible to shut down a factory, move to a
new site or to acquire additional premises

Long and Short Run Costs

• Long run total cost is the total cost of
production at each level of output
• “The total cost of making each output level

when a firm has plenty of time to adjust fully
and produce this output level by the
cheapest possible means.” (Begg 2009, p.326)
Long and Short Run Costs

More definitions of long terms costs:
• Long run marginal cost – the rise in total if

output rises permanently by one unit
• Long run average cost – the total cost

divided by the level of output

Example: Long Run Average Cost Curve

Figure 3.1 Long run average cost curve
12
10
8
Average cost
6
2 A
0
0 1 2 3 4 5 6 7 8 9
Output
• Many firms have a long run average cost curve that is a ‘U’ shape
• The long run average cost falls up to point A and then increases
• Up to point A, the firm is becoming more efficient as output rises
• It can be said to be benefiting from economies of scale
• After point A there are negative economies (diseconomies) of scale
Economies of Scale
• Why do economies of scale exist?
• Why does it become cheaper for a firm to

produce units of products and services as
output rises?

Economies of Scale
• Not all costs rise as output rises (e.g. fixed costs)
• People in the firm become better at their jobs
• At high levels of output, it is possible to arrange

production facilities in a way that is extremely
efficient (e.g. production line of the car factory)
Economies of Scale
• It is also possible for diseconomies of scale to exist
• Once a firm becomes very large, it can become

difficult to manage
- Many more layers of managers are required
- The supply chain becomes more complex to manage
- Quality control problems emerge

Average Cost and Marginal Cost

• The marginal cost is the cost of making one extra
unit
• The long run marginal cost is the rise in total cost if

output permanently rises by one unit
• A firm can use this information to decide on its long

run output decision
How does a firm choose its output

level in the long run?
• First look at marginal cost and marginal revenue to
determine the output level that maximises profit
(where MC=MR)
• This level of output must be at a point where

revenue exceeds long run average total cost
• If these conditions can’t be fulfilled, the firm should

leave the market

More about Short Run Costs

• In the short run, some costs are fixed
• This is because it takes time to set up and run a production or

retail unit
• If you decided to open a shop you would have to agree to rent

the shop for a minimum period of time. You would have to
pay rent no matter how many items you sold
• On the other hand the cost of the items you sell will rise as
your sales rise
• Therefore there are some fixed costs and some variable

costs
More about Short Run Costs

• Short run average total cost can be broken
down into short run average fixed cost and
short run average variable cost
• This allows us to come up with some

decision rules to enable a firm to choose its
output level in the short run

How does a firm choose its output

level in the short run?
• First look at marginal cost and marginal revenue to
determine the output level that maximises profit
(where marginal revenue = short run marginal cost)
• This level of output must be where revenue

exceeds short run average variable cost
• A firm can stay in business in the short term as

long as it covers its variable costs
Perfect Competition
• A market can be said to exhibit perfect competition
when the acts of individual buyers and sellers have
no effect on the market price
• A good example of a firm in this position is a fruit

and vegetable stall
• A firm in a perfectly competitive industry faces a

horizontal demand curve


Figure 3.2 A firm in a perfectly competitive industry
10
Price 5
0
0 1 2 3 4 5 6 7 8
Output
• The firm can sell all its output at the market price (in this case 4).
• The firm in this position as a price taker. It has to sell at the price dictated
by the market. If it raises its price above 4 it will lose all its customers.
• A perfectly competitive industry must have the following conditions:
- Many small firms in the industry
- The product must be standardised so that buyers can immediately
switch from one supplier to another.
- All firms produce the same product for which they charge the same
price.
- There is free entry and exit from the industry.
Perfect Competition
• To determine its supply decision, a firm in a
perfectly competitive industry can use MC=MR to
find the best level of output and then check
whether the price for this output covers average
cost
• However marginal revenue (MR) will equal the

price dictated by the market
• If the firm cannot supply at this price it will be

forced to leave the industry

Imperfect Competition
• A market can be said to exhibit imperfect
competition when the conditions required for
perfect competition are not met
• Most markets exhibit imperfect competition
Imperfect Market Competition

Economists pay particular attention to the
following types of imperfect conditions:
• Monopoly
• Oligopoly
• Monopolistic competition

Monopoly
• A monopoly is the opposite extreme to perfect
competition; there is only one supplier in the
market
• This supplier is a price setter
• A monopolist may also be able to charge different

prices to different customers
• This is known as price discrimination
Monopoly: Example
• An airline company:
- It can charge higher prices to business passengers who
require precisely scheduled flights
- It can offer lower prices to tourists who are prepared to be
more flexible in their travel arrangements
• Price discrimination often applies to service

industries as price discrimination on standardised
goods will not work

Oligopoly
• An oligopoly is an industry with a few independent
producers
• One problem is that the firms in the industry may

be tempted to make agreements to push up prices
and/or to restrict supply
• In general governments try to prevent oligopolists

from making such agreements
Monopolistic Competition
• Many producers that produce close but not perfect
substitutes
• Thus buyers cannot get exactly the same product

somewhere else
• The restaurant business

- The combination of menus and services is unique to each
restaurant
- The location of the restaurant also plays a part
- A good restaurant can attract a loyal customer base and
charge higher prices without losing all of its customers

Why are there Different Types

of Market Structure?
Factors which affect market structure:

• The number of firms in the market
• Barriers to entry
• Economies of scale
• Product differentiation
Review of the topic

• This topic has looked at the supply decision and
the factors that determine the structure of a market
• You should be aware of the affect of costs on the
supply decision and the different ways in which
firms can determine their level of output under
perfect competition
• You should be aware of the different types of
imperfect competition and the conditions for their
existence but do not need to study detailed issues
of cost and revenue underlying the supply decision.

Topic 3
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Topic 3 – Market Structure and Competition Introduction to Accounting and Economics

V2.0 © NCC Education Limited

Market Structure and Competition Topic 3 - 3.‹#›

V2.0 © NCC Education Limited

V2.0 Visuals Handout – Page 1

Market Structure and Competition Topic 3 - 3.‹#›

Words You Must Know

V2.0 © NCC Education Limited

Market Structure and Competition Topic 3 - 3.‹#›

Words You Must Know

Imperfect A situation where the conditions for perfect

Monopoly: A form of imperfect competition where there

V2.0 © NCC Education Limited

V2.0 Visuals Handout – Page 2

Market Structure and Competition Topic 3 - 3.‹#›

Words You Must Know

Monopolistic A form of imperfect competition where there are

Market Structure: The features of a market in terms of barriers to entry,

V2.0 © NCC Education Limited

Market Structure and Competition Topic 3 - 3.‹#›

How Costs Affect Supply

• These are the costs a producer faces when deciding to

• These will include:

V2.0 © NCC Education Limited

V2.0 Visuals Handout – Page 3

Market Structure and Competition Topic 3 - 3.‹#›

How Costs Affect Supply

•Economists tend to be pretty imprecise

V2.0 © NCC Education Limited

Market Structure and Competition Topic 3 - 3.‹#›

How Costs Affect Supply

• For example, in one year it should be

V2.0 © NCC Education Limited

V2.0 Visuals Handout – Page 4

Market Structure and Competition Topic 3 - 3.‹#›

Long and Short Run Costs

• “The total cost of making each output level

V2.0 © NCC Education Limited

Market Structure and Competition Topic 3 - 3.‹#›

Long and Short Run Costs

• Long run marginal cost – the rise in total if

• Long run average cost – the total cost

V2.0 © NCC Education Limited

V2.0 Visuals Handout – Page 5

Market Structure and Competition Topic 3 - 3.‹#›

Example: Long Run Average Cost Curve

V2.0 © NCC Education Limited

Market Structure and Competition Topic 3 - 3.‹#›

• Why does it become cheaper for a firm to

V2.0 © NCC Education Limited

V2.0 Visuals Handout – Page 6

Market Structure and Competition Topic 3 - 3.‹#›

• Not all costs rise as output rises (e.g. fixed costs)

• People in the firm become better at their jobs

• At high levels of output, it is possible to arrange

V2.0 © NCC Education Limited

Market Structure and Competition Topic 3 - 3.‹#›

• Once a firm becomes very large, it can become