Managerial Economics (E501) Lecture: 7 Date: August 14, 2018

Name: Anindya Mustafa Roll: ZR-1801016

Market is a mechanism that facilitates transaction.

Market structure is a classification system for the key traits of a market, including the number of firms, the
similarity of the products they sell, availability of information, and the ease of entry into and exit from the
market.

In the two extremes of these key traits, we have monopoly and perfect competition. The table below shows us
the two extremes.
Key traits Monopoly Perfect Competition
Number of firms One Huge
Degree of product differentiation Unique Homogenous
Availability of information Very restricted Widely available
Easy of entry and exit Extremely difficult Very easy

In reality, however, most markets are structured somewhere in between. Examples of these are shown in the
table below:
Key traits Oligopoly Monopolistic Competition
Number of firms A few Many
Degree of product differentiation Differentiated Near identical
Availability of information Somewhat restricted Available
Easy of entry and exit Somewhat difficult Easy

Perfect Competition in the Short Run

We would look into how market demand and supply affect a firm in perfect competition. In perfect
competition, a single firm is so tiny, that it can’t have any power over market. I can’t, therefore, set the price in
the market; rather it takes the market price.

First, we see the whole picture in the short run. The complete representation of a perfect competition market
has two side-by-side graphs, market on the left and a typical firm on the right.

In this short run equilibrium, we have the firm making a profit. We could also have drawn it
with the firm making a loss. We can see that the optimum quantity is where MC intersects MR. Beyond that
point, further production will decrease profit. Therefore, the decision rule is, we should produce until:
MR = MC and MC is rising.

Perfect Competition in the Long Run

In the long run, entry and exit become possible because potential firms can buy fixed inputs and become
actual firms. And existing firms can sell off or stop renting their fixed inputs and go out of business.
Firms will choose to enter the industry if the existing firms in the industry are making economic profits. The
profits are an incentive to enter. Now, as that the market supply curve is just the summation of all the
individual firms’ supply curves. If more firms come into the business, the market supply curve must shift to the
right. The rightward shift of supply curve drives down the price on the market, thereby reducing the profits of
each firm. As shown in the graphs below.

Now the firms are making profits, but smaller profits than before. But if there are still economic profits being
made, more firms will enter. This must continue until there are no economic profits. When profits equal zero,

TR = TC
p*×q = q×ATC
p* = ATC

So entry finally stops when firms are producing at their lowest average total cost, that is, when MR is tangent
to ATC. Here is a diagram of the final, long-run equilibrium under perfect competition:

We see that the supply curve is rather far to the right in the picture above, because there were a lot of profits
that had to be eliminated. However, most important is that in the end there are zero economic profits.

It is important to mention that when there is zero economic profit, there will still be some accounting profit or
normal profit.

In the whole situation, we have assumed that a typical firm is making profit; but what if typical firm is making
losses? Then the reverse process will take place. Firms will exit the market, causing a leftward shift of market
supply, causing a rise in market price, causing a reduction of losses. This continues until losses are zero.