The selling environment in which a firm produces and sells its product is called a market structure.* Defined by three characteristics: The number of firms in the market The ease of entry and exit of firms The degree of product differentiation

1. Market Structure

2. Market Structure
• The selling environment in which a firm
produces and sells its product is called a
market structure.
• Defined by three characteristics:
–The number of firms in the market
–The ease of entry and exit of firms
–The degree of product differentiation

3. Introduction
• Perfect competition, with an infinite
number of firms, and monopoly, with a
single firm, are polar opposites.
• Monopolistic competition and oligopoly lie
between these two extremes.

4. Perfect Competition
A perfectly competitive market has
the following characteristics:
There are many buyers and sellers in the
market.
The goods offered by the various sellers
are largely the same.
Firms can freely enter or exit the market.

5. The Meaning of Competition
As a result of its characteristics, the
perfectly competitive market has the
following outcomes:
The actions of any single buyer or
seller in the market have a negligible
impact on the market price.
Each buyer and seller takes the market
price as given.
Thus, each buyer and seller is a price taker.

6. Perfect Competition

7. Profit-Maximizing Level of
Output
• The goal of the firm is to maximize
profits.
• Profit is the difference between total
revenue and total cost.

8. Revenue of a Competitive Firm
Total revenue for a firm is the
selling price times the quantity
sold.
TR = (P X Q)

9. Revenue of a Competitive Firm
Marginal revenue is the change in
total revenue from an additional
unit sold.
MR =∆TR/ ∆Q

10. Revenue of a Competitive Firm
For competitive firms, marginal
revenue equals the price of the
good.

11. Total, Average, and Marginal
Revenue for a Competitive Firm
Quant it y
(Q)
Price
(P)
Tot al Revenue
(TR= PxQ)
Average Revenue
(AR= TR/ Q)
Marginal Revenue
(MR= )
1 $6.00 $6.00 $6.00
2 $6.00 $12.00 $6.00 $6.00
3 $6.00 $18.00 $6.00 $6.00
4 $6.00 $24.00 $6.00 $6.00
5 $6.00 $30.00 $6.00 $6.00
6 $6.00 $36.00 $6.00 $6.00
7 $6.00 $42.00 $6.00 $6.00
8 $6.00 $48.00 $6.00 $6.00
QTR ∆∆ /

12. TC TR
0
Totalcost,revenue
$385
350
315
280
245
210
175
140
105
70
35
Quantity1 2 3 4 5 6 7 8 9
Profit Determination Using Total
Cost and Revenue Curves
Maximum profit =$81
$130
Loss
Loss
Profit
Profit =$45
McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.

13. Profit Maximization Using
Total Revenue and Total Cost
• Profit is maximized where the vertical
distance between total revenue and
total cost is greatest.
• At that output, MR (the slope of the
total revenue curve) and MC (the slope
of the total cost curve) are equal.

14. Profit-Maximizing Level of
Output
• Marginal revenue (MR) – the change
in total revenue associated with a
change in quantity.
• Marginal cost (MC) – the change in
total cost associated with a change in
quantity.
• A firm maximizes profit when MC = MR.

15. How to Maximize Profit
• If marginal revenue does not equal
marginal cost, a firm can increase profit
by changing output.
• The supplier will continue to produce as
long as marginal cost is less than
marginal revenue.

16. How to Maximize Profit
• The supplier will cut back on production
if marginal cost is greater than marginal
revenue.
• Thus, the profit-maximizing condition of a
competitive firm is MC = MR = P.

17. Again! MR=MC
• Profit is maximized when MR=MC.
– If the cost of producing one more unit is
less than the revenue it generates, then a
profit is available for the firm that
increases production by one unit.
– If the cost of producing one more unit is
more than the revenue it generates, then
increasing production reduces profit.

18. Profit Maximization: Using MR
and MC curves

19. Profit Maximization: The
Numbers
Q P TR TC TR-TC MR MC ATC
0 $1 $0 $1.00 -$1.00 $1
1 $1 $1 $2.00 -$1.00 $1 $1.00 $2.00
2 $1 $2 $2.80 -$0.80 $1 $0.80 $1.40
3 $1 $3 $3.50 -$0.50 $1 $0.70 $1.17
4 $1 $4 $4.00 $0.00 $1 $0.50 $1.00
5 $1 $5 $4.50 $0.50 $1 $0.50 $0.90
6 $1 $6 $5.20 $0.80 $1 $0.70 $0.87
7 $1 $7 $6.00 $1.00 $1 $0.80 $0.86
8 $1 $8 $6.86 $1.14 $1 $0.86 $0.86
9 $1 $9 $7.86 $1.14 $1 $1.00 $0.87
10 $1 $10 $9.36 $0.64 $1 $1.50 $0.94
11 $1 $11 $12.00 -$1.00 $1 $2.64 $1.09
MR=MCMR=MC

20. The Marginal Cost Curve Is
the Supply Curve
• The marginal cost curve is the firm's
supply curve above the point where
price exceeds average variable cost.
• The MC curve tells the competitive firm
how much it should produce at a given
price.

21. The Interaction of Firms and Markets
FirmFirm MarketMarketPricePrice
AndAnd
CostsCosts
PricePrice
qqFF QQMM
aa
bb
cc
dd
AA
BB
qq11qq22qq33qq44 QQ11 QQ22
MCMC
P=MRP=MR00
ATCATC
P=MRP=MR11
AVCAVC
SS11
SS22
DD00
$10$10
ATCATC
=$7=$7
10 units10 units

22. The Marginal-Cost Curve and the
Firm’s Supply Decision...
Quantity0
Costs
and
Revenue
MC
ATC
AVC
Q1
P1
P2
Q2
This section of the
firm’s MC curve is
also the firm’s
supply curve (long-
run).

23. Determining Profit and Loss
• Find output where MC = MR.
– The intersection of MC = MR (P)
determines the quantity the firm will
produce if it wishes to maximize profits.
• Find profit per unit where MC = MR.
– Drop a line down from where MC equals MR,
and then to the ATC curve.
– This is the profit per unit.
– Extend a line back to the vertical axis to
identify total profit.

24. Determining Profit and Loss
• The firm makes a profit when the ATC
curve is below the MR curve.
• The firm incurs a loss when the ATC curve
is above the MR curve.

25. Determining Profit and Loss
From a Graph
• Zero profit or loss where MC=MR.
– Firms can earn zero profit or even a loss
where MC = MR.
– Even though economic profit is zero, all
resources, including entrepreneurs, are being
paid their opportunity costs.

26. (a) Profit case (b) Zero profit case (c) Loss case
Determining Profits Graphically
Quantity Quantity Quantity
Price
65
60
55
50
45
40
35
30
25
20
15
10
5
0
65
60
55
50
45
40
35
30
25
20
15
10
5
0
1 2 3 4 5 6 7 8 910 12 1 2 3 4 5 6 7 8 910 12
D
MC
A P = MR
B ATC
AVC
E
Profit
C
MC
ATC
AVC
MC
ATC
AVC
Loss
65
60
55
50
45
40
35
30
25
20
15
10
5
0
1 2 3 4 5 6 7 8 910 12
P = MR
P = MR
Price Price
© The McGraw-Hill Companies, Inc., 2000Irwin/McGraw-Hill

27. Loss Minimization
Average cost of a unit of outputAverage cost of a unit of output
RevenueRevenue
generated by agenerated by a
unit of outputunit of output
MarketMarket
priceprice
fallsfalls

28. The Firm’s Short-Run
Decision to Shut Down
The firm shuts down if the revenue it
gets from producing is less than the
variable cost of production.
Shut down if TR < VC
Shut down if TR/Q < VC/Q
Shut down if P < AVC

29. The Shutdown Point
• If total revenue is more than total
variable cost, the firm’s best strategy is
to temporarily produce at a loss.
• It is taking less of a loss than it would by
shutting down.

30. MC
P = MR
2 4 6 8 Quantity
Price
60
50
40
30
20
10
0
ATC
AVC
Loss
A$17.80
The Shutdown Decision

31. The Firm’s Long-Run Decision
to Exit or Enter a Market
In the long-run, the firm exits if the
revenue it would get from producing is
less than its total cost.
Exit if TR < TC
Exit if TR/Q < TC/Q
Exit if P < ATC

32. The Firm’s Long-Run Decision
to Exit or Enter a Market
A firm will enter the industry if such an
action would be profitable.
Enter if TR > TC
Enter if TR/Q > TC/Q
Enter if P > ATC