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
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