Economicsslide C10

Chapter 10:
Market structure 1:
Overview and perfect
competition
CHAPTER OVERVIEW
LEARNING OUTCOMES
10.1 MARKET STRUCTURE: AN OVERVIEW
10.2 THE EQUILIBRIUM CONDITIONS (FOR ANY FIRM)
10.3 PERFECT COMPETITION
10.4 THE DEMAND FOR THE PRODUCT OF THE FIRM
10.5 THE EQUILIBRIUM OF THE FIRM UNDER PERFECT COMPETITION
10.6 THE SUPPLY CURVE OF THE FIRM AND THE MARKET SUPPLY CURVE
10.7
LONG-RUN EQUILIBRIUM OF THE FIRM AND THE INDUSTRY UNDER PERF
ECT COMPETITION
10.8 PERFECT COMPETITION AS A BENCHMARK
IMPORTANT CONCEPTS
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Master ECONOMICS FOR SOUTH AFRICAN STUDENTS
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CHAPTER 5: DEMAND AND SUPPLY IN ACTION
LEARNING OUTCOMES
Once you have studied this chapter you should be able to

• explain the theoretical differences between the four market structures
• explain the equilibrium conditions for any firm
• list the conditions which have to be met for perfect competition to exist
• explain the demand curve facing the firm under perfect competition
• explain the short-run equilibrium of the firm under perfect competition
• explain the long-run equilibrium of the firm and the industry under perfect
competition
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INTRODUCTION
• Profit = revenue – cost
• Assumption: firms aim to maximise profit
• TR = P x Q
• Price of the product is dependent on the market structure
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LO: Explain the theoretical differences between the four market structures
10.1 MARKET STRUCTURE: AN

OVERVIEW
Four different types of market structures
Figure 10-1 Market structures (Textbook page 164)
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LO: Explain the theoretical differences between the four market
MARKET STRUCTURE: AN OVERVIEW
structures
Market structure
The major organisational features of the market in which a firm sells its
products. These include the number and relative sizes of sellers and buyers,
the degree of product differentiation, the availability of information and the
barriers to entry and exit.
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LO: Explain the theoretical differences between the four market
MARKET STRUCTURE: AN OVERVIEW
structures
Features of market structure

• Number of firms
• Nature of the product
• Entry
• Information
• Collusion
• Firm’s control over the price of the product
• Demand curve for the firm’s product
• Long-run economic profit
Let’s look at each feature per market structure in more detail.
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MARKET STRUCTURE: AN OVERVIEW LO: Explain the theoretical differences between the four market structures
Click on the number for more detail for each of the features
PERFECT COMPETITION Click on the number again to hide
1 Number of firms So many that no firm

2 Nature of the product can influence the market
Homogeneous/
price
standardised
3 Entry Completely free
4 Information Complete
5 Collusion Impossible
6 Firm’s control over the price of the product
None
7 Demand curve for the firm’s product Horizontal (perfectly
8 Long-run economic profit elastic)
Zero (normal profit only)
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MONOPOLISTIC COMPETITION
Click on the number again to hide
1 Number of firms So many that each firm

2 Nature of the product thinks others will not
Heterogeneous/
detect its actions
differentiated
3 Entry Free
4 Information Incomplete
5 Collusion Impossible
6 Firm’s control over the price of the product
Some
7 Demand curve for the firm’s product
Downward sloping
8 Long-run economic profit Zero (normal profit only)
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OLIGOPOLY Click on the number again to hide
1 Number of firms So few that each firm

2 Nature of the product must consider the
Homogeneous or others’
actions and reactions
heterogeneous
3 Entry Varies from free to
4 Information restricted
Incomplete
5 Collusion Possible
6 Firm’s control over the price of the product Considerable, but less
7 Demand curve for the firm’s product than in monopoly
Downward-sloping, may
8 Long-run economic profit be
Maykinked
be positive
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MONOPOLY Click on the number again to hide
1 Number of firms
One
2 Nature of the product A unique product with no
3 Entry close substitutes
Completely blocked
4 Information Complete
5 Collusion Irrelevant
6 Firm’s control over the price of the product Considerable, but limited
7 Demand curve for the firm’s product by market demand
Equals
and themarket
goal ofdemand
profit
8 Long-run economic profit curve:
May bedownward-sloping
positive
maximisation
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Click on the number for a comparison of features between market structures

Click on the number again to hide
1 2 3 4 5 6 7 8
(1)
(2)
(8)
(7)
(3) Number
Nature
Long-run
Demand
Entry ofof firms
the product
economic
curve for theprofit
firm’s product
(4)
(6) Information
(5) Firm’s
Collusioncontrol over the price of the product
Perfect
Perfect
Perfect
Perfect
Perfect Monopolistic
Monopolistic
Monopolistic
Monopolistic
Monopolistic Oligopoly
Oligopoly
Oligopoly
Oligopoly
Oligopoly Monopoly
Monopoly
Monopoly
Monopoly
Perfect
Perfect
competition Monopolistic
Monopolistic
competition Oligopoly
Oligopoly Monopoly
Monopoly
competition
competition
competition
competition
competition competition
competition
competition
competition
competition
So many
Homogeneous/
Zero that
(normal
Horizontal
Completely no Free
free So many
Zero that
Heterogeneous/
(normal
Downward- So
Mayfewbethat
Homogeneous
Downward-
Varies from each
or
positive
free One
AMay
unique
be
Equals
Completely product
positive
market
Complete
Impossible
None
firm can Incomplete
influence Some Impossible
each firm Incomplete
Possible
Considerable,
thinks tofirm mustmaybut Complete
Irrelevant
Considerable, but
standardised
profit only)
(perfectly differentiated
profit only)
sloping heterogeneous
sloping,
restricted be with no close
demand
blocked curve:
the market price others will not less than
consider in
the limited by market
substitutes
elastic) kinked downward-
detect its actions monopoly
others’ demand and the
sloping
actions and goal of profit
reactions maximisation
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LO: Explain the equilibrium conditions for any firm
10.2 THE EQUILIBRIUM

CONDITIONS
(FOR ANY FIRM)
Two decisions:
• Should we produce?
• If yes, how much?
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THE EQUILIBRIUM CONDITIONS (FOR ANY FIRM) LO: Explain the equilibrium conditions for any firm
Shut down rule

• The shut-down rule
– produce only if total revenue is equal to, or greater than, total variable
cost
– TR ≥ TVC
OR
– produce only if average total revenue is equal to, or greater than, average
total variable cost
– AR ≥ AVC
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Profit-maximising rules
1. Profits are maximised where the positive difference between total
revenue and total cost is the greatest
2. Profit is maximised where marginal revenue is equal to marginal cost
MR = MC
Different possibilities
• If MR > MC, output should be expanded
• If MR = MC, profits are maximised
• If MR < MC, output should be reduced
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Short-run decisions of a firm, the irrelevance of sunk costs and the

importance of the marginal principle
• Sunk cost = cost incurred that cannot be recovered

• Margin principle: always look at the marginal costs and marginal benefits of
decisions and ignore past or sunk costs
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LO: List the conditions which have to be met for perfect competition to exist
10.3 PERFECT COMPETITION

• Perfect competition occurs when none of the individual market participants
can influence the price of the product
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LO: List the conditions which have to be met for perfect
PERFECT COMPETITION
competition to exist
Requirements
• Large number of buyers and sellers
• Identical products (homogeneous)
• Complete freedom of entry and exit
• Perfect knowledge of market conditions
• No collusion
• No market participant can influence the price of the product and no
government intervention
• Horizontal (perfectly elastic)
• Zero (normal profit only)
OTHER
All factors of production must be perfectly mobile
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LO: List the conditions which have to be met for perfect
PERFECT COMPETITION
competition to exist
Relevance
Why study perfect competition?
• We may apply our knowledge to markets where many of the requirements
for perfect competition are met.
• A useful starting point for analysing the determination of price and output.
• Represents a standard or norm against which other markets can be
compared.
• Knowledge of perfectly competitive markets with knowledge about a
particular market can be sufficient for analysis of that market.
• Perfect doesn’t equal most desirable form of competition

• Perfect equals highest degree of competition
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LO: Explain the demand curve facing the firm under perfect competition
10.4 THE DEMAND FOR THE

PRODUCT OF THE FIRM
• Under perfect competition
– Price of a product is determined by supply and demand
– The individual firm is a price taker
• The demand curve for the product of the firm is horizontal (perfectly elastic)
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LO: Explain the demand curve facing the firm under
THE DEMAND FOR THE PRODUCT OF THE FIRM
perfect competition
Figure 10-2 The demand curve for the product of the firm under perfect competition
(Textbook page 169)
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LO: Explain the demand curve facing the firm under
THE DEMAND FOR THE PRODUCT OF THE FIRM
perfect competition
Total, marginal and average revenue under perfect competition: a

numerical example
MR = AR = AP
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LO: Explain the short-run equilibrium of the firm under perfect competition
10.5 THE EQUILIBRIUM OF THE

FIRM UNDER PERFECT
COMPETITION
REMEMBER:
Profit-maximising rules
• Profits are maximised where the positive difference between total
revenue and total cost is the greatest
• Profit is maximised where marginal revenue is equal to marginal cost
MR = MC
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LO: Explain the short-run equilibrium of the firm
THE EQUILIBRIUM OF THE FIRM UNDER PERFECT COMPETITION
under perfect competition
MARGINAL COST AND PROFIT MAXIMISATION

• Profits are maximised along
the rising part of the cost
curve
See Box 10-3 Marginal cost and profit

maximisation (Textbook page 172)
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• The demand curve for the product of the firm is horizontal (perfectly elastic)
• The firm is a price taker
• The firm can only choose the output at which it can maximise its profits or
minimise its loses
• That quantity is where the positive difference between total revenue TR and
total cost TC is at a maximum OR
• Where marginal revenue MR is equal to marginal cost MC, provided, of
course, that average revenue AR (= P) is at least equal to short-run average
variable cost AVC (the shut-down rule).
• A firm maximises its profit where MR = MC
• P = MC
• The marginal cost is u-shaped
• Only the rising part of the MC is relevant to our analysis
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1
Under perfect competition:
Price of a product is determined 2
by supply revenue
Marginal and demand
(MR)&=the
individual firm is a price taker. 3
Total revenue (TR) = Q × P 4
The
Total
If
Atwe marginal
Profit
know
lower cost
(TP)
what
levels of MC of
=total
Total the
cost is,fourth
Revenue
production, we canunit
(TR)
profit produced
–calculate
canTotal Cost is R10,
marginal
(TC)
be increased indicated
bycost (MC):
expanding 7
by point d inIfFigure
production. more 10-3.
than 4This
unitsis equal
of theto marginal
product arerevenue MRprofit
produced, (the
price
startsof the product). At this point, profit is maximised.
falling. RESET
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Figure 10-3 Marginal revenue and

marginal cost of a firm operating in a
perfectly competitive market
(Textbook page 171)
Q P MR MC TP
0 10 -5
1 10 10 4 1
2 10 10 6 5
3 10 10 8 7
4 10 10 10 7
5 10 10 12 5
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Figure 10-4 Different possible short-run equilibrium positions of the firm under perfect competition
(Textbook page 173)
Click on the letter to reveal the graph

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a Economic profit
b Normal profit only
c Economic loss
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The equilibrium condition of the firm under perfect competition: Profit is

maximised (or loss minimised) when a firm produces an output where
marginal revenue equals marginal cost, provided marginal cost is rising and
lies above minimum average variable cost.
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LO: explain the long-run equilibrium of the firm and the industry under perfect competition
10.6 THE SUPPLY CURVE OF THE

FIRM AND THE MARKET
SUPPLY CURVE
• Firm’s supply curve – the rising part of the firm’s MC curve above the
minimum of AVC
• Market supply curve – add the supply curves of the individual firms
horizontally
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THE SUPPLY CURVE OF THE FIRM AND THE MARKET LO: explain the long-run equilibrium of the firm
SUPPLY CURVE and the industry under perfect competition
Figure 10-5 The supply curve of the

firm (Textbook page 174)
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LO: explain the long-run equilibrium of the firm and the industry under perfect competition
10.7 LONG-RUN EQUILIBRIUM OF

THE FIRM AND THE
INDUSTRY UNDER PERFECT
COMPETITION
There are two things that can change in the long-run:
• New firms can enter the industry and existing firms can leave
• All factors of production become variable
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LONG-RUN EQUILIBRIUM OF THE FIRM AND THE LO: explain the long-run equilibrium of the firm and the
INDUSTRY UNDER PERFECT COMPETITION industry under perfect competition
The impact of entry and exit on the equilibrium of the firm and the
industry
• The industry will be in equilibrium in
the long run only if all the firms are
making normal profits
Figure 10-6 The firm and industry in

long-run equilibrium (Textbook page 175)

a The firm
b The industry
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• If firms are making an economic profit – new firms enter the market
Figure 10-7 The individual firm and the

industry when the firm initially earns an
economic profit (Textbook page 175)

a The firm
b The industry
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• If firms are making an economic loss – existing firms exit the market
Figure 10-8 The individual firm and

the industry when the firm initially
makes an economic loss
(Textbook page 176)

a The firm
b The industry
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To summarise: economic profits in a competitive industry are a signal for the

entry of new firms; the industry will expand, pushing the price down until the
economic profits fall to zero (ie only normal profits are earned).
Economic losses in a competitive industry are a signal for the exit of loss-
making firms; the industry will contract, driving the market price up until the
remaining firms are covering their total costs (ie until normal profits are
earned).
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The impact of changes in the scale of production on the equilibrium

of the firm and the industry
• Until now we have assumed that the existing firms’ scale of production
remains unchanged.
• In the long run, however, all factors of production are variable and existing
firms can therefore change their scale of production.
• If an existing firm is earning an economic profit and it can realise economies
of scale (i.e. if average cost can be reduced), it will expand its scale of
production.
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Figure 10-9 Increasing the firm’s scale of

production to realise economies of scale
(Textbook page 177)
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10.8 PERFECT COMPETITION AS A
BENCHMARK
Allocative efficiency
Efficient allocation of resources; Achieved when the price of each product is
equal to its marginal cost in the long run.
Productive efficiency
Achieved when all the firms in the industry produce where their long-run
average (unit) costs (AC) are at a minimum.
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IMPORTANT CONCEPTS
• Market structure • Total revenue (TR)
• Perfect competition • Marginal revenue (MR)
• Monopoly • Average revenue (AR)
• Monopolistic competition • Shut-down rule
• Oligopoly • Profit-maximising rule
• Homogeneous (identical) products) • Total cost (TC)
• Heterogeneous products • Average cost (AC)
• Entry and exit • Average variable cost (AVC)
• Collusion • Marginal cost (MC)
• Price taker • Total profit
• Demand curve for the product of the firm • Normal profit
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IMPORTANT CONCEPTS
• Economic profit
• Break-even point
• Supply curve of the firm
• Industry (or market) supply
• Industry equilibrium
• Allocative efficiency
• Productive efficiency
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Economicsslide C10

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Chapter 10:

Once you have studied this chapter you should be able to

10.1 MARKET STRUCTURE: AN

Figure 10-1 Market structures (Textbook page 164)

Features of market structure

Let’s look at each feature per market structure in more detail.

PERFECT COMPETITION Click on the number again to hide

1 Number of firms So many that no firm

1 Number of firms So many that each firm

OLIGOPOLY Click on the number again to hide

1 Number of firms So few that each firm

MONOPOLY Click on the number again to hide

Click on the number for a comparison of features between market structures

10.2 THE EQUILIBRIUM

Shut down rule

Short-run decisions of a firm, the irrelevance of sunk costs and the

• Sunk cost = cost incurred that cannot be recovered

10.3 PERFECT COMPETITION

• Perfect doesn’t equal most desirable form of competition

10.4 THE DEMAND FOR THE

Total, marginal and average revenue under perfect competition: a

10.5 THE EQUILIBRIUM OF THE

MARGINAL COST AND PROFIT MAXIMISATION

See Box 10-3 Marginal cost and profit

Total revenue (TR) = Q × P 4

Figure 10-3 Marginal revenue and

Click on the letter to reveal the graph

The equilibrium condition of the firm under perfect competition: Profit is

10.6 THE SUPPLY CURVE OF THE

Figure 10-5 The supply curve of the

10.7 LONG-RUN EQUILIBRIUM OF

Figure 10-6 The firm and industry in

Click on the letter to reveal the graph

Figure 10-7 The individual firm and the

Click on the letter to reveal the graph

Figure 10-8 The individual firm and

Click on the letter to reveal the graph

To summarise: economic profits in a competitive industry are a signal for the

The impact of changes in the scale of production on the equilibrium

Figure 10-9 Increasing the firm’s scale of

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