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Lecture 11 Market Structure. Market and Competition. Marke t is the transaction between two parties where goods or services are transferred from seller to buyer in exchange of money.
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Market and Competition • Market is the transaction between two parties where goods or services are transferred from seller to buyer in exchange of money. • We can classify different markets depending on the degree of competition. To determine structure of any particular market, we begin by asking • How many buyers and sellers are there in the market? • Is each seller offering a standardized product, more or less indistinguishable from that offered by other sellers -Or are there significant differences between the products of different firms? • Are there any barriers to entry or exit, or can outsiders easily enter and leave this market? • Answers to these questions help us to classify a market into two basic types of market • Perfect competition • Imperfect competition There can be three types of markets based on the degree of imperfection. • Monopoly • Oligopoly • Monopolistic
Perfect Competition • A perfectly competitive market must meet the following requirements: • Large number of buyers and sellers • The firms' products are identical • Both buyers and sellers are price takers • Free entry and exit from the market for the firm
1) A Large Number of Buyers and Sellers • In perfect competition, there must be many buyers and sellers • How many? • Number must be so large that no individual decision maker can significantly affect price of the product by changing quantity it buys or sells
2) The firms' products are identical • Buyers do not perceive significant differences between products of two different sellers • For instance, buyers of rice do not prefer one farmer’s rice over another
3) Both buyers and sellers are price takers • A price taker is a firm or individual who takes the market price as given. That means he cannot influence or change the price. • A price maker is a firm or individual who can influence or change the market price. • In perfect competition both buyers and sellers are price takers. • A seller is a price taker in perfect competition because there is a large number of seller in the market and so a single seller cannot influence the market price for example by increasing or decreasing the amount it is selling. • A buyer is a price taker in perfect competition because there is a large number of buyer in the market and so his decision about buying or not buying a product do not affect the market price.
4) Free entry and exit from the market for the firm • In perfect competition there will be no barrier to entry for a new firm. Entry into a market by a new firm is rarely free—a new seller must always incur some costs to set up shop and begin production • But perfectly competitive market has no significant barriers (for example start up cost is low) to discourage new entrants • Any firm wishing to enter can do business on the same terms as firms that are already there • Perfect competition is also characterized by easy exit • A firm suffering a long-run loss must be able to sell off its plant and equipment and leave the industry for good.
3. The typical firm can sell output as much as it wants at the market price… 1. The intersection of the market supply and the market demand curve… Price Price Quantity Quantity 4. so it faces a horizontal demand curve 2. determine the equilibrium market price The Competitive Industry and Firm Market Firm S $400 $400 Demand Curve Facing the Firm D 100
The Demand Curve Facing a Perfectly Competitive Firm • We can see that the demand curve of a industry or market is downward sloping ( left graph). But thedemand curve facing by a firm is horizontal, or perfectly elastic ( right graph). • Why is the demand curve faced by a firm horizontal ? • In perfect competition products sold by different firms are identical • As there are many firms so a single firm is producing a tiny fraction of the total market supply. So a single firm cannot affect market price by increasing or decreasing production. So a firm can sell as much as it wants at the given market price. That is it faces an infinite demand of its product and that’s why the demand curve faced by a firm is horizontal.
For a competitive firm, marginal revenue at each quantity is the same as the market price. • Example: • So we can write • P=MR • For this reason, marginal revenue (MR) curve and demand curve facing firm are the same • So the demand curve/ MR curve is a horizontal line at the market price
Profit and Loss in the Short Run and Long run • A competitive firm can make either profit or loss in the short run. • But in the long run a firm can only make zero profit that means no profit, no loss. • Why? • As there is free exit and entry in perfect competition that’s why the firms make zero profit in the long run. • In the short run if a firm make a loss it might still continue to operate because it cannot sell off its plant and equipment in short period of time . But in the long run if the firm keep making a loss then it will exit the market/ industry eventually. So the total number of firms that remains in the industry decreases and those firms that remains in the industry will make zero profit. • In the short run if firms make a profit then new firms will enter the industry. As the number of firms increases the profit of each firm will go down and become zero in the long run.
