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MARKET STRUCTURE Define market structure. What factors are considered in determining the market structure of a particular industry?
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Market structure:
Market refers to a place or medium where buyers and sellers trade their goods. Market structure refers to the characteristic features of the market that is determined by the behavior of the market.
• Perfect competition refers to the market structure with the features of more number of sellers and buyers in the market. Firms sell homogenous products. Price is fixed by the market demand and supply. Individual firm cannot change the price. Firms can easily enter or exit from the market. Firms and consumers are well informed about the market. Firms are competing with each other.
• Monopoly refers to the market structure with the features of a single seller and more buyers. Firms have full control over the market. Price is fixed by the monopoly producer. There is a restriction for entry of a firm.
• Oligopoly refers to the market structure with the features of a few sellers and more buyers. Firms are producing homogenous goods. Firms are competing with themselves. There is no easy entry into the market due to the huge investment. Information about the market is not available.• Monopolistic competition refers to the market structure with the features of more buyers and more sellers. Each firm sells the homogenous product with a different brand name. Firms can easily enter or exit from the market.
Following are the factors to determine the market structure:
• Number of buyers and sellers.
• Degree of uniformity.
• Easy entry into and exit from the market.
• Competition among the firms.
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THE SHORT-RUN FIRM SUPPLY CURVE Each of the following situations could exist for a perfectly competitive firm in the short run. In each case, indicate whether the firm should produce in the short run or shut down in the short run, or whether additional information is needed to determine what it should do in the short run.
a. Total cost exceeds total revenue at all output levels.
b. Total variable cost exceeds total revenue at all output levels.
c. Total revenue exceeds total fixed cost at all output levels.
d. Marginal revenue exceeds marginal cost at the current output level.
e. Price exceeds average total cost at all output levels.
f. Average variable cost exceeds price at all output levels.
g. Average total cost exceeds price at all output levels.
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Fixed cost:
Fixed cost refers to those costs which remain the same throughout the production. Examples such as, the building, machinery, rent, fire accident insurance etc. are considered as fixed costs. Even though a firm is not producing anything, it has to incur fixed cost.
Variable cost:
Variable cost refers to those costs which will vary in response to a change in the amount of goods produced. The variable costs are inversely proportional to the sale of goods. As the sale of goods or production of goods increases, the variable cost involved increases. Examples: raw materials, electricity bill.
Minimizing the loss:
Even though the price of the product is not covering the full production cost, a firm can continue its production if the price is more than its average variable cost. When the price is more than the average variable cost, then the excess amount will cover some of the fixed cost which minimizes the total cost.
a.Total cost exceeds total revenue:
In this situation, the additional information about variable cost and fixed cost is required to conclude whether the firm will continue its production or shut down.
If the firm's revenue exceeds the variable cost, then the firm can continue its production. Because when the revenue is more than the variable cost, then it covers some portion of the fixed cost, which in turn reduces the total cost. If the firm does not produce anything, then it has to pay all its fixed cost.
b.Total variable cost exceeds total revenue:
If the firm's total variable cost exceeds total revenue, then the revenue does not cover the variable cost. When the total variable cost is more than total revenue, then it covers some portion of the variable cost. Therefore, the firm has to pay all its fixed cost plus the remaining variable cost, which in turn maximizes the cost. If the firm does not produce, then it has to pay only its fixed cost which minimizes the cost. Hence, the firm should shut down in the short run.
c.Total revenue exceeds total fixed cost:
In this situation, the additional information about variable cost is required to conclude whether the firm will continue its production or shut down.
If the firm's revenue exceeds the variable cost, then the firm can continue its production. This is because when the revenue is more than the variable cost, then it covers some portion of the fixed cost, which in turn reduces the total cost. If the firm does not produce, then it has to pay all its fixed cost.
d.Marginal revenue exceeds marginal cost:
Additional information required to decide whether the firm can continue the production or not.
Even though a firm's marginal revenue exceeds marginal cost, there is a possibility of incurring loss. If the marginal cost exceeds the marginal benefit with greater amount, then it is possible to minimize the cost.
e.Price exceeds average total cost:
Average total cost refers to cost involved per unit. When the price is higher than the average total cost, then the price covers all the cost per unit. Hence, the firm can continue its production at the given price level.
f.Average variable cost exceeds price:
When the average variable cost exceeds the price, then the price does not cover the average variable cost. Hence, the firm has to pay the fixed cost and the remaining variable cost, which in turn maximizes the cost. If the firm does not produce anything, then it has to pay only its fixed cost which minimizes its cost. Hence, the firm should shut down the production in the short run.
g.Average total cost exceeds price:
In this situation, the additional information on variable cost and fixed cost is required to conclude whether the firm will continue its production or shut down.
Even though a firm's total cost exceeds price, if the firm's revenue exceeds the variable cost, then the firm can continue its production. Because, when the revenue is more than the variable cost, then it covers some portion of the fixed cost, which in turn minimizes the total cost. If the firm does not produce, then it has to pay all its fixed cost.
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SHORT-RUN PROFIT MAXIMIZATION A perfectly competitive firm has the following fixed and variable costs in the short run. The market price for the firm's product is $150.
a. Complete the table.
b. At what output rate does the firm maximize profit or minimize loss?
c. What is the firm's marginal revenue at each positive rate of output? Its average revenue?
d. What can you say about the relationship between marginal revenue and marginal cost for output rates below the profit-maximizing (or loss-minimizing) rate? For output rates above the profit-maximizing (or loss-minimizing) rate?
a. Complete the table.
b. At what output rate does the firm maximize profit or minimize loss?
c. What is the firm's marginal revenue at each positive rate of output? Its average revenue?
d. What can you say about the relationship between marginal revenue and marginal cost for output rates below the profit-maximizing (or loss-minimizing) rate? For output rates above the profit-maximizing (or loss-minimizing) rate? Free
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Fixed cost:
Fixed cost refers to those costs which remains same throughout the production.
Examples: rent, fire accident insurance, etc.Variable cost:
Variable cost refers to those costs which are varying in response to change in production. Examples: raw materials, electricity bill, etc.Total cost:
Total cost is the summation of all costs which are involved in the production. Determine the total cost using the formula:
Total revenue:
Total revenue refers to the revenue generated by selling total output at a given price. Determine the total revenue using the formula:
Profit and loss:
Profit refers to the value of revenue exceeding the cost. On the other hand, loss refers to the cost exceeding the revenue. Determine the profit using the formula:
a)Prepare a complete table using the formulas of total cost, total revenue, and total profit: (All amounts are in $):
b)From Table it is observed that the maximum profit $60 is obtained at the
unit of output.
c)Marginal revenue refers to the additional revenue made to the total revenue by selling one more unit of good. Determine the marginal revenue using the formula:
Average revenue refers to per unit revenue. Determine the average revenue using the formula:
Following table shows the marginal and average revenue: (All amounts are in $):
d)First, determine the marginal cost using the equation:
Prepare a table to find the marginal cost: (All amounts are in $):
Analysis:
Conclusion:
• The marginal revenue is constant over the sales.
• Marginal cost is decreasing up to the
unit and then starts increasing.• The marginal cost is less than the marginal revenue till the
unit.
• The marginal cost is greater than the marginal revenue after the
unit.
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Profit in the Short Run Look back at Exhibit 3, panel (b), in this chapter. Why doesn't the firm choose the output that maximizes average profit (i.e., the output where average cost is the lowest)?
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Case Study: Auction Markets Which of the characteristics of the perfectly competitive market structure are found in FloraHolland Aalsmeer?
Reference Case Study:
World of Business
Auction Markets Flower markets are global. About three-quarters of flowers purchased in the United States are imported. More than half the world's cut flowers move through the auction system in the Netherlands. Five days a week, in a huge building 10 miles outside Amsterdam, some 2,500 buyers gather to participate in FloraHolland Aalsmeer, the largest auction of its kind in the world. Every day over 20 million flowers and plants from thousands of growers around the globe are auctioned off in the world's largest roofed building, spread across the equivalent of 100 football fields. Flowers are grouped and auctioned off by type-long-stemmed roses, tulips, and so on. Hundreds of buyers sit in theater settings with their fingers on buttons. Nearly as many buyers bid online from remote locations. Once the flowers are presented, a clock-like instrument starts ticking off descending prices until a buyer pushes a button. The winning bidder gets to choose how many and which items to take. The clock starts again until another buyer stops it, and so on, until all flowers are sold. Auctions occur rapidly-on average a transaction takes place every 4 seconds.
This is an example of a Dutch auction, which starts at a high price and works down. Dutch auctions are more common when selling multiple lots of similar, though not identical, items, such as flowers in Amsterdam, tobacco in Canada, and fish in seaports around the world. Because there is some difference among the products for sale in a given market-for example, some flower lots are in better condition than others-this is not quite perfect competition because perfectly competitive markets sell identical products.
More common than the Dutch auction is the English open outcry auction, where bidding starts at a low price and moves up until only one buyer remains. Products sold this way include stocks, bonds, wine, art (think Sotheby's and Christie's), antiques, and livestock. On markets such as the Chicago Board of Trade, prices for commodities such as wheat, gold, and coffee beans are continuously determined in the trading pits using variations of an open outcry auction.
The birth of the Internet has breathed new life into auctions. Web sites such as eBay, uBid, and hundreds more hold online auctions for old maps, used computers, wine, airline tickets, antiques, military memorabilia, comic books, paperweights- you name it. The largest online site, eBay, offers over 2,000 categories in a forum that mimics a live auction. Internet auctions allow specialized sellers to reach a world of customers. A listing on eBay, for example, could reach millions of people in more than 100 countries.
Computers are taking over markets in other ways. In New York, Chicago, Philadelphia, London, and Frankfurt, hand- waving traders in what seem like mosh pits are being replaced by electronic trading. The Nasdaq was the world's first virtual stock market. There is no Nasdaq trading floor as there is with the New York Stock Exchange. On the French futures exchange, after electronic trading was added as an option to the open-outcry system, electronic trading dominated within a matter of months. Computers reduce the transaction costs of market exchange.
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PERFECT COMPETITION AND EFFICIENCY Define productive efficiency and allocative efficiency. What conditions must be met to achieve them?
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THE SHORT-RUN FIRM SUPPLY CURVE Use the following data to answer the questions below:
a. Calculate the marginal cost and average variable cost for each rate of output.
b. How much would the firm produce if it could sell its product for $5? For $7? For $10?
c. Explain your answers.
d. Assuming that its fixed cost is $3, calculate the firm's economic profit at each output rate determined in part (b).
a. Calculate the marginal cost and average variable cost for each rate of output.
b. How much would the firm produce if it could sell its product for $5? For $7? For $10?
c. Explain your answers.
d. Assuming that its fixed cost is $3, calculate the firm's economic profit at each output rate determined in part (b). Essay
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Long-Run Industry Supply Why does the long-run industry supply curve for an increasing-cost industry slope upward? What increases costs in an increasing-cost industry?
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DEMAND UNDER PERFECT COMPETITION What type of demand curve does a perfectly competitive firm face? Why?
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THE LONG-RUN INDUSTRY SUPPLY CURVE The following graph shows possible long-run market supply curves for a perfectly competitive industry. Determine which supply curve indicates a constant-cost industry and which an increasing-cost industry.
a. Explain the difference between a constant-cost industry and an increasing-cost industry.
b. Distinguish between the long-run impact of an increase of market demand in a constant-cost industry and the impact in an increasing-cost industry.
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THE LONG-RUN INDUSTRY SUPPLY CURVE A normal good is being produced in a constant-cost, perfectly competitive industry. Initially, each firm is in long-run equilibrium.
a. Graphically illustrate and explain the short-run adjustments for the market and the firm to a decrease in consumer incomes. Be sure to discuss any changes in output levels, prices, profits, and the number of firms.
b. Next, show on your graph and explain the long-run adjustment to that income change. Be sure to discuss any changes in output levels, prices, profits, and the number of firms.
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WHAT'S SO PERFECT ABOUT PERFECT COMPETITION Use the following data to answer the questions.
a. For the product shown, assume that the minimum point of each firm's average variable cost curve is at $2. Construct a demand and supply diagram for the product and indicate the equilibrium price and quantity.
b. On the graph, label the area of consumer surplus as f. Label the area of producer surplus as g.
c. If the equilibrium price were $2, what would be the amount of producer surplus?
a. For the product shown, assume that the minimum point of each firm's average variable cost curve is at $2. Construct a demand and supply diagram for the product and indicate the equilibrium price and quantity.
b. On the graph, label the area of consumer surplus as f. Label the area of producer surplus as g.
c. If the equilibrium price were $2, what would be the amount of producer surplus? Essay
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PERFECT COMPETITION IN THE LONG RUN Draw the short-and long-run cost curves for a competitive firm in long-run equilibrium. Indicate the long-run equilibrium price and quantity.
a. Discuss the firm's short-run response to a reduction in the price of a variable resource.
b. Assuming that this is a constant-cost industry, describe the process by which the industry returns to long-run equilibrium following an increase of market demand.
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Login to www.cengagebrain.com and access the Global Economic Watch to do this exercise.
Global Economic Watch Go to the Global Economic Crisis Resource Center. Select Global Issues in Context. In the Basic Search box at the top of the page, enter the phrase "Green Shoots." On the Results page, go to the Magazines section. Click on the link for the March 13, 2010, article "Green Shoots; Agribusiness in India." As you read the article, concentrate on the fourth paragraph, which describes the traditional market structure for Indian agriculture. How well does the description fi t the four characteristics of perfect competition?
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Login to www.cengagebrain.com and access the Global Economic Watch to do this exercise.
Global Economic Watch Go to the Global Economic Crisis Resource Center. Select Global Issues in Context. In the Basic Search box at the top of the page, enter the term "perfect competition." Find three or four resources that discuss the economic definition of perfect competition. Writing in your own words, analyze whether the authors support or dispute the idea that perfect competition is realistic and applicable.
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THE SHORT-RUN FIRM SUPPLY CURVE An individual competitive firm's short-run supply curve is the portion of its marginal cost curve that equals and rises above the average variable cost. Explain why.
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Case Study: Experimental Economics
In Professor Vernon Smith's experiment, which "buyers" ended up with a surplus at the market-clearing price of $2? Which "sellers" had a surplus? Which "buyers" or "sellers" did not engage in transactions?
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