Understanding Market Structures in Economics

Lecturer: Dr. (Mrs.) Nkechi S. Owoo, Department of Economics Contact Information: nowoo@ug.edu.gh College of Education School of Continuing and Distance Education 2014/2015 2016/2017

Session Overview This session is the first of two that analyze different market structures. Market structure is a way of describing those characteristics of a market that influence the behavior of buyers and sellers when they come together to trade. To determine market structure, we must ask how many buyers and sellers are in the market, whether the product is standardized, and whether there are barriers to entry. The answers to these questions help to classify a market into one of four basic types: perfect competition, monopoly, monopolistic competition, or oligopoly. This session concludes the discussion on perfectly competitive markets. Slide 2

Session Outline The key topics to be covered in the session are as follows: Perfect Competitive Firms in the long run Slide 3

Reading List Hall and Lieberman Chapter 8, pp: 231- 250 Slide 4

Topic One PERFECTLY COMPETITIVE FIRMS IN THE LONG RUN Slide 5

6 Long-Run Competitive Equilibrium Profits and losses are inconsistent with long-run equilibrium. Profits create incentives for new firms to enter, output will increase, and the price will fall until zero profits are made. Only zero profit will stop entry.

7 Competitive Markets in the Long Run New firms can enter the market Existing firms can exit the market Profit and loss in the long run When Economic profits exist, outsiders enter the market When Economic losses exist, existing firms exit the market

8 Long-Run Competitive Equilibrium The existence of losses will cause firms to leave the industry. Zero profit condition is the requirement that in the long run zero profits exist. The zero profit condition defines the long-run equilibrium of a competitive industry.

9 Illustration: From SR Profit to LR Equilibrium See the illustration on the next slide on long run equilibrium when firms begin with some profits in the short run Economic profit attracts new entrants Market supply curve - shift rightward Market price - falls Demand curve facing each firm - shifts downward Each firm - decrease output Positive economic profit - attracts new entrants until economic profit = 0

10 Illustration: Long-Run Equilibrium Market Firm S1 Price per bagl Ghcs so each firm earns an economic profit. MC With initial supply curve S1, market price is $4.50 A A 4.50 4.50 d1 ATC D Bags of maize Bags of maize 900,000 9,000

11 Illustration: Long-Run Equilibrium From Short-Run Profit to Long-Run Equilibrium Market Firm S1 S2 Price per Bushel Dollars MC A A $4.50 $4.50 d1 ATC E E d2 2.50 2.50 D 900,000 5,000 9,000 1,200,000 Bushels per Year Bushels per Year until market price falls to $2.50 and each firm earns zero economic profit. Profit attracts entry, shifting the supply curve rightward

12 From SR Loss to LR Equilibrium What happens to long run equilibrium when firms begin with some losses in the short run Economic losses - firms exit the market Market supply curve - shift leftward Market price - rises Demand curve facing each firm - shifts upward Economic loses firms exit until economic loss = 0 In the LR, firms earn normal profit - zero economic profit Show with a Graphical Illustration

13 Why Do Competitive Firms Stay in Business If They make Zero Profit? Explanation?

14 Why Do Competitive Firms Stay in Business If They make Zero Profit? Zero economic profits not the same as zero accounting profits When firm makes zero economic profits, still makes positive accounting profits Accounting profit just enough to cover all farmer s opportunity/implicit costs Illustration Suppose a farmer paid Ghc100,000 for a maize farm and works 40 hours a week Suppose that Ghc100,000 could have been invested to earn Ghc6,000 per year Farmer could have also worked somewhere else and earned Ghc50,000 a year Then farmer s implicit costs is Ghc56,000 Therefore, zero economic profits= farmer earning Ghc56,000 in accounting profits each year! Competitive firms stay in business because they can do no better elsewhere!!

15 Is Perfect Competition Realistic? What do you think?

16 Realistic? Most products have some degree of differentiation Therefore, the assumption of standardized products can be problematic Significant barriers to entry Start-up costs, govt regulations (utilities), etc Therefore, the assumption of easy entry and exit can be problematic Buyers not fully aware of all aspects of products This violates the assumption of perfect knowledge that the model of perfect competition assumes Can you think of any more limitations of the perfectly competitive market?

17 Is Perfect Competition Realistic? Many markets - while not strictly perfectly competitive - come reasonably close Perfect competition can approximate conditions and yield accurate-enough predictions in a wide variety of markets Therefore, this model remains useful in modeling firm behaviour, despite some unrealistic elements

References Economics: Principles and Applications: Hall R.E. and Lieberman M. (2008), Thomson/ South Western (4th Edition) Slide 18