Market Structure and

Equilibrium
We will consider the two extreme cases

Perfect Competition
Monopoly
 Market Efficiency

• Decision makers in a market behave

rationally and have full access to all
relevant behavior.
• Consumer and producer surplus is
maximized
Determinants of Market Structure
• Number and size of buyers, sellers, and
potential entrants,
• Degree of product differentiation
• Amount and cost information about product
price and quality, and
• Conditions for entry into and exit from a
market
 Market Equilibrium
Perfect Competition

• Supply forces (producers) P Demand

and demand forces curve
(consumers) seek a
balance
• Price below perceived Pe
value increases demand
• Price above ATC
provides pure profit, an
incentive to increase Supply
supply curve Q
 Individual Firm’s Demand
and MR Curve
P
Highly elastic demand
One firm’s change in Q has little effect on price

Pe

∆P

∆Q Q
 Market Equilibrium
Perfect Competition

Individual Firm • Price above ATC

provides pure profit,
Price (P)
MC an incentive to
ATC
increase output
P1
P2 • Pure profit equals
(P1 x Q1) – (P2 x Q2)

Q2 Q1
 Market Equilibrium
Perfect Competition
• All firms are price takers
Individual Firm • Market price (P1) equals
Price (P)
marginal revenue (MR) and
MC average revenue (AR)
ATC
P1 • Optimal level of output is
P2 where MR = MC = P1
• In long-run P will go to P2
where pure profit is
eliminated
Q2 Q1
 Market Supply Curve

Summation of supply curves for individual firms

Q Demand
Market supply curve
=
Qm
Sum vertically

Qj Janet’s sawmill
+
Qt Tracy’s sawmill
+
Qp Pete’s sawmill
+
Qj Joe’s sawmill
Pm (same P for all firms and market) P
 Perfect Competition - Example
• Given supply and demand functions,
Qs = 30 + 55 P
Qd = 230 – 45 P
• Determine marginal revenue, MR, i.e. Pe, from supply and
demand curves for total market. Calculate Pe from market supply
equals demand equilibrium condition,
Qs = Qd
30 + 55 P = 230 – 45 P
100 P = 200
P = 2 = MR
• Use P to get equilibrium quantity, Qe
Qe = 230 – 45 x 2 = 230 –90 = 140
Apply Market Price to Individual
Firm – “Pete’s Sawmill”

P = $2 from market equilibrium

Determine quantity Pete should produce

from Pete’s marginal cost (MC) curve,
which is,
Qs = 5 + 5.8 P
= 5 + 5.8 x 2
= 16.6
 Market Equilibrium
Monopoly
• Only one producer
– Producer is a price “setter”, not a price
taker
• Demand curve restricts ability to set price
– Demand curve determines marginal
revenue (MR)
• Only way to change quantity sold is to
change market price
• Marginal revenue (MR) is not constant
• What forces lead to a monopoly
 Market Equilibrium
Monopoly
P
Monopolists
MC curve
Pe
Up & over to
get P MC = MR to max. profit

Market
Down
to
demand curve
get Monopolists
Q MR curve Q
e stands for Qe determine fist, then get P from demand curve
equilibrium
 Marginal Revenue Curve
• TR = P x Q
• Demand curve – P = a – bQ
• TR = (a – bQ ) x Q
= aQ – bQ2
• MR = dTR/dQ = a – 2b Q
• Same intercept and 2x slope of demand
curve
 Market Equilibrium
Monopoly compared to competitive equilibrium
P
Monopolists
MC curve

Pm m – monopoly equilibrium
Pc
c – competitive equilibrium

Market
demand curve
Monopolists
MR curve Q
Qm Qc
 Market Equilibrium
Monopoly

Compared to competitive
market equilibrium –

Monopolist produces (sells)

smaller quantity at higher price
 Monopoly – Example
Given, same supply and demand curves as in
competitive example,
Qd = 230 – 45 P (given), or
P = 5.11 – 1/45 Q
Qs = 30 + 55 P (given), or
P = 0.545 + 1/55 Q
Determine marginal revenue curve:
Revenue = P x Q
= Q (5.11 – 0.022 Q)
= 5.11 Q – 0.022 Q2
MR = 5.11 – 0.044 Q
 Monopoly – Example, cont.
Equate MC and MR to determine Q:
5.11 – 0.044 Q = 0.545 + 0.018 Q
4.57 = 0.062 Q
Q = 74
Substitute Q into demand curve to get P,
P = 5.11 – 0.022 x 74 = 3.48

Compare the solutions for the two types of markets,

Competition: P = 2.00, Q = 130
Monopoly: P = 3.48, Q = 74
 Monopsony
• One buyer and many sellers
• Common in forest products markets
– Bulky and heavy commodity
– High transportation cost
– Limits haul distance
• How can sellers gain market power?