CH 8 MARKET STRUCTURE
AND OUTPUTPRICING
DECISIONS
Firms output and pricing decisions
depend on the current market structure
in which the firm is operating i.e.
“How much control over price we have.”
whether the firm is competing in perfect
competition, monopoly, monopolistic
competition or oligopoly situation
1Competition vs. Monopoly
One useful way in which issues of
competition and monopoly can be
investigated is called the Structure,
Conduct and Performance Model
2Competition vs. Monopoly continued
Market
Conduct PerformanceStructure
e.g. number of e.g. firm's goals, e.g. efficiency,
buyers and sellers pricing and output, profitability and
(the size of firms) their investments growth
3Þ
MC
AC
P* D=MR=AR
OutputPerfect Competition q*
Firms are price takers
they face a perfectly elastic
demand curve
market price changes only if
demand or supply changes
Given the market price, what is the
appropriate level of production?
Since market price will settle at the
point where only normal profits are
earned output will settle where
p = MC = AC = MR
4Industry Demand Increase and the
LongRun Industry Supply Curve
P S1
S2
b
a c Longrun S
DD 21
Q
a) Constant industry costs
5Industry Demand Increase and The Long
Run Industry Supply Curve continued
P S1 S2
b Longrun S
ca
DD 21
Q
b) Increasing industry costs: external
6diseconomies of scale Industry Demand Increase and The Long
Run Industry Supply Curve continued
P S1 S2
b
a c
Longrun S
D1 D2
Q
c) Decreasing industry costs: external
7economies of scaleWhy is perfect competition so rare in
the real world if it even exists at all?
One important reason for this has to do with
economies of scale:
Perfect competition requires there to be many
firms (non having a large market share). Firms
must therefore be small under perfect
competition too small for economies of scale.
LAC2
LAC3
LAC1 D
8
OutputÞ
BUT
once a firm expands sufficiently to
achieve economies of scale, it will
usually gain market power
it will be able to undercut the prices of
smaller firms and so drive them out of
business perfect competition will be
destroyed
therefore, perfect competition could
only exist in an industry, if there were
no (or virtually no) economies of scale
9Perfect Competition and Public Interest
Possible pluses:
the fact that p = mc leads to efficient resource
allocation
competition between firms will spur to efficiency
will encourage the development of new
technology
there is no point in advertising!?
in longrun equilibrium: LRAC at its minimum,
so company producing at the leastcost output
consumers gain from low prices
quick response to changed consumer tastes
10