Four Market Structures
Perfect Competition: a market structure in which a very large number of firms produce a
Monopoly: A market structure in which one firm is the sole seller of a product or service.
Monopolistic Competition: A market structure in which a relatively large number of sellers produce
Oligopoly: A market structure in which a few large firms produce homogenous or differentiated
Imperfect Competition: The market models of monopoly, monopolistic competition, and oligopoly
considered as a group.
Characteristics of Perfect Competition and the Firm’s Demand Curve
Very Large Numbers- A basic feature of a perfectly competitive market is the presence of a large
number of independently acting sellers offering their products in large national or international
Standardized Product- firms in a perfectly competitive industry sell standardized products, they
make no attempt to differentiate their products and do not engage in other forms of nonprice
Price-Takers-the competitive firm is a price-taker: it cannot change market price, it can only adjust to
Price-Takers: A firm in a purely competitive market that cannot change market price, only adjust it.
Easy Entry and Exit- new firms can easily enter, and existing firms can easily leave perfectly
competitive industries in the long run.
Demand for a Firm in Perfect Competition
each firm in a perfectly competitive industry offers only a negligible fraction of total market supply,
so it must accept the price determined by the market; it is a price-taker, not a price-maker.
Average, Total, and Marginal Revenue
Average Revenue: total revenue from the sale of a product divided by the quantity of the product
Total Revenue: total number of dollars received by a firm from the sale of a product.
Marginal Revenue: the change in total revenue that results from selling one more unit of a firm’s
In perfect competition, marginal revenue and price are equal.
The marginal revenue curve coincides with the demand curve because the product price is constant.
The average revenue equals price and therefore also coincides with the demand curve.
Profit Maximization in the Short Run Since the firm in a perfectly competitive industry is a price-taker, it can maximize the economic profit
(or minimize its loss) only by adjusting its output.
Two methods exist to determine the level of output at which a competitive firm will obtain
maximum profit or minimum loss. One method is to compare total revenue and total cost; the other
is to compare marginal revenue and marginal cost.
Total-Revenue- Total-Cost Approach
Competitive producer will ask: (1) should we produce this product? (2) if so, in what amount? (3)
What economic profit (or loss) will we realize?
The total revenue for each output level is found by multiplying output (total cost) by price
Profit or loss at each output level by subtracting total cost, TC from total revenue, TR
Total cost increases with output because more production requires more factors of production, but
the rate of increase in total cost varies with the relative efficiency of the firm.
Total revenue covers all costs (including a normal profit, which is included I the cost curve) but there
is no economic profit
Break-eve point: an output at which a firm makes a normal profit but not an economic profit.
The firm compares the marginal revenue (MR) and the marginal cost (MC) of each successive unit of
The firm will produce any unit of output whose marginal revenue exceeds its marginal cost because
the firm would gain more in revenue from selling that unit than it would add to its cost by producing
If the marginal cost of a unit of output exceeds its marginal revenue, the firm will not produce that
unit. Producing it would add more to costs than to revenue, and profit would decline or loss would
In the initial stages of production, where output is relatively low, marginal revenue will usually (not
always) exceed marginal cost. But at later stages of production, where output is relatively high, rising
marginal costs will exceed marginal revenue.
In the short run, the firm will maximize profit or minimize loss by producing the output at which
marginal revenue equals marginal cost (as long as is preferable to shutting down); known as the
o For most sets of MR=MC data, MR and MC will be precisely equal at a fractional level of
o The rule applies only if producing is preferable to shutting down; if marginal revenue does
not equal or exceed average variable cost, the firm will shut down rather than produce the
o The rule is an accurate guide to profit maximization for all firms
o The rule can be restated as P=MC when applied to a firm in a perfectly competitive industry;
the demand schedule faced by a competitive seller is perfectly elastic at the going market
price, product price and marginal revenue are equal, under perfect competition we may
substitute P for MR in the rule; when producing is preferable to shutting down, the
competitive firm should produce at that point where price equals marginal cost (P=MC) Profit-Maximization Case
The economic profit can be calculated by subtracting total cost from total revenue; total revenue is
calculated by multiplying price by output
To calculate the economic profit:
Profit= (P-A) x Q
A is average total cost
By subtracting the average total cost from the product price we obtain a per-unit profit
There the per-unit economic profit is P-A, where P is the market price and A is the average total cost
for an output.
The shutdown case reminds us of the qualifier to our MR (=P) =MC rule. A competitive firm will
maximize profit or minimize loss in the short run by producing that output at which MR (=P) =MC,
provided that market price exceeds minimum average variable cost.
We can conclude that the portion of the firm‘s marginal-cost curve lying above its average-variable-
cost curve is its short-run supply curve.
Short-run supply curve: a curve that shows the quantities of the product a firm in a purely
competitive industry will offer to sell at various prices in the short run.
Diminishing Returns, Production Costs, and Product Supply
Because of the law of diminishing returns, marginal cost eve