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FourMarketStructures

Thefocusofthislectureisthefourmarketstructures.Studentswilllearnthecharacteristicsofpure
competition,puremonopoly,monopolisticcompetition,andoligopoly.Usingthecostschedulefromthe
previouslecture,theideaofprofitmaximizationisexplored.
OBJECTIVES
1.Identifyvariousmarketstructuresandtheircharacteristics.
2.Beabletocategoryfirmsintofourmarketstructures.
3.Describetheeffectsofimperfectcompetitionuponthemarketandthefirm.
4.Understandthepricingstructureofthefourstructures.
TOPICS
Pleasereadallthefollowingtopics.
PERFECTCOMPETITION
PERFECTCOMPETITIONCONT.
PERFECTCOMPETITIONEXAMPLE
PUREMONOPOLY
MONOPOLYEXAMPLE
PRICEDISCRIMINATION
MONOPOLISTICCOMPETITION
OLIGOPOLY
TECHNOLOGICALDEVELOPMENT
ECONOMICEFFICIENCY

PerfectCompetition
Pureorperfectcompetitionisrareintherealworld,butthemodelisimportantbecauseithelps
analyzeindustrieswithcharacteristicssimilartopurecompetition.Thismodelprovidesacontextin
whichtoapplyrevenueandcostconceptsdevelopedinthepreviouslecture.Examplesofthismodel
arestockmarketandagriculturalindustries.
Characteristics
1.Manysellers:thereareenoughsothatasinglesellersdecisionhasnoimpactonmarketprice.
2.Homogenousorstandardizedproducts:eachsellersproductisidenticaltoitscompetitors.
3.Firmsarepricetakers:individualfirmsmustacceptthemarketpriceandcanexertnoinfluenceon
price.
4.Freeentryandexit:nosignificantbarrierspreventfirmsfromenteringorleavingtheindustry.
Demand
Theindividualfirmwillviewitsdemandasperfectlyelastic.Aperfectlyelasticdemandcurveisa
horizontallineattheprice.Thedemandcurvefortheindustryisnotperfectlyelastic,itonlyappears
thatwaytotheindividualfirms,sincetheymusttakethemarketpricenomatterwhatquantitythey
produce.Therefore,thefirmsdemandcurveisahorizontallineatthemarketprice.
Marginalrevenue(MR)istheincreaseintotalrevenueresultingfromaoneunitincreaseinoutput.
Sincethepriceisconstantintheperfectcompetition.Theincreaseintotalrevenuefromproducing1
extraunitwillequaltotheprice.Therefore,P=MRinperfectcompetition.

ProfitMaximizingOutput

ShortRunAnalysis
Intheshortrun,thefirmhasfixedresourcesandmaximizesprofitorminimizeslossbyadjustingoutput.Firmsshould
produceifthedifferencebetweentotalrevenueandtotalcostisprofitable(EP>0),orifthelossislessthanthefixedcost
(EP> FC).Thefirmshouldnotproduce,butshouldshutdownintheshortrunifitslossexceedsitsfixedcosts.Byshutting
down,itslosswilljustequalthosefixedcosts.Fixedcostinreallifewouldberentoftheoffice,businesslicensefees,
equipmentlease,etc.Thesecostwouldhavetobepaidwithorwithoutanyoutput.Therefore,fixedcostwouldbetheloss
ofshutdownatanytime.Ifbyproducingoneunitofoutput,thislosscouldbelowered,thenthisunitshouldbeproduced
tominimizetheloss.However,ifbyproducingoneunitofoutput,thislosswouldbehigher,thenthisunitshouldnotbe
produced.Thefirmshouldshutdown,justpayforthefixedcost.
IfEP< FC firmshouldshutdown.ThenitslostwillbetheFixedcost.EP= FC.InorderforEP< FC,marketprice,P,must
belowerthantheminimumAVC.
IfEP> FC,firmshouldproduce.ThatiswhenmarketpriceisgreaterthanminimumAVC.
Marginalrevenueandmarginalcost(MC)arecomparedtodecidetheprofitmaximizingoutput.
IfMR>MC,thenthefirmshouldcontinuetoproduce.
IfMR=MC,thenthefirmshouldstopproducingtheadditionalunit.AstheadditionalunitsMCwouldbehigheraccording
tolawofdiminishingreturns,MRwouldbelessthanMC;thatis,thefirmwouldlossprofitbyproducingadditionalunits.
Therefore,thisistheprofitmaximizingoutputlevel.
IfMR<MC,thenthefirmshouldloweritsoutput.
Inconclusion:
Theshutdownpointisthelevelofoutputandpriceatwhichthefirmjustcoversitstotalvariablecost.IftheMRofthe
productislessthantheminimumaveragevariablecost(minAVC),thefirmwillshutdownbecausethisactionminimizes
thefirmsloss.Inthiscase,thefirmseconomiclossequalsitstotalfixedcosts.IfMR<minAVC,theneachadditionalunit
producedwouldincreasetheloss.Forpurecompetition,MRisequaltopriceasthefirmisfacingaperfectlyelastic
demand.Therefore,forshortrun,ifPrice<minAVC,thenthefirmshouldshutdown.IfPrice>minAVC,thenthefirm
shouldproduce.PriceandMCarecomparedtofindtheprofitmaximizingorlossminimizingoutputlevel.Thesupplycurve
ofthepurecompetitionfirmswouldbetheportionoftheMCcurveabovetheminAVC.
1.IfEP< FCorMarketP<MinAVC,firmshouldshutdown.Output=0,andEP=FC
2.IfEP> FCorMarketP>MinAVC,firmshouldproduce.Firm'soutputlevelshouldbeatwhereMR=MCorP=MC.
UseEP=TR TCtogeteconomicprofitofthefirm.

PerfectCompetitionCont.
Followingtherulesdiscussedintheprevioussection.Hereisanexample.
Firmsfixedcostis$100,itsminAVCis$55.
Ifmarketpriceis50whichislessthanminAVC,thefirmwouldloss$5morebyproducingeachunit.Ifthefirmproduces
oneunit,itstotallosswouldbe$5plus$100fixedcost.Ifthefirmdecidestoshutdown,itslosswouldbeonly$100asthe
firmdoesnotneedtopayforthevariablecost.Shutdownwouldbethelossminimizationstrategy.
Ifthemarketpriceis60,thefirmwouldlose$5lessbyproducingeachunit.Ifthefirmproducesoneunit,itstotalcost
wouldbefixedcostless$5,whichis$95.Thefirmisbetteroffbyproducing,notshuttingdown.Whenthemarketpriceis
higherthantheminimumAVC,MRandMCshouldbecomparedtofindouttheoptimallevelofoutput.

LongRunAnalysis
Obviously,thefirmcannotbeinlossforlong.Threeassumptionsaremadeforthelongrunanalysis:
1.Entryandexitaretheonlylongrunadjustments.
2.Firmsintheindustryhaveidenticalcostcurves.
3.Theindustryisinconstantreturntoscale.
Inlongrun,ifeconomicprofitsareearned,firmsentertheindustry,whichincreasesthemarketsupply,causingtheproduct
pricetogodown.Untilzeroeconomicprofitsareearned,thenthesupplywillbesteady.Iflossesareincurredintheshort
run,firmswillleavetheindustrywhichdecreasesthemarketsupply,causingtheproductpricetoriseuntillossesdisappear.
Thismodelisoneofzeroeconomicprofitsinlongrun.Thelongrunequilibriumisachieved,theproductpricewillbeexactly
equalto,andproductionwilloccurat,eachfirmspointofminimumaveragetotalcost.

EfficiencyAnalysis
1. Productiveefficiency:occurswhereP=minATC.Perfectcompetitivefirmswill
achieveproductiveefficiencyasfirmsmustusetheleastcosttechnologyorthey
won'tsurvive.
2.Allocative efficiency: occurswhereP=MC.Pricerepresentthebenefitthatsociety
getsfromadditionalunitsofaproduct,MCrepresentsthecosttosocietyofother
goodsgivenuptoproducethisproduct.Dynamicadjustmentswilloccurinthis
marketstructurewhenchangesindemand,supplyortechnologyoccurs.Perfect
competitivefirmswillachievethisefficiency.Sincenoexplicitordersaregivento
theindustry,"theInvisibleHand"worksinthissystem.
Eventhoughbothefficienciesareachievedinthissystem,theconsumersarefacing
standardproducts,makingshoppingtobenofunatall.Ontheotherhand,the
consumerswillreceivethehighestconsumersurplusinthisstructureasthelongrun
marketpricewillbeattheminATC.Producerswillreceivethelowestproducersurplus
asconsumerscaneasilyfindsubstitutes.

AnExample
Thefollowingdatarepresentsacostfunctionofaperfect
competitivefirm:
TP or Q

AFC

AVC

ATC

MC

0
1

60

45

105

45

30

42.5

72.5

40

20

40

60

35

15

37.5

52.5

30

12

37

49

35

10

37.5

47.5

40

8.57

38.57

47.14

45

7.5

40.63

48.13

55

6.67

43.33

50

65

10

46.5

52.5

75

Ifthemarketprice,P<37;thisfirm'soutput Q=0;firm's
economicprofit,EP=60
Ifthemarketprice,P>37,thisfirm'soutput Q>0;firms'
economicprofit,EP=TR TC.
Forexample,whenP=65,Q=9,EP=$65x9 50X9=135

AnExampleCont.
Bygiventhemarketdemandatvariouspricelevel,amarketequilibriumpricecouldbefound.
TP or Q

AFC

AVC

ATC

MC

0
1

60

45

105

45

30

42.5

72.5

40

20

40

60

35

15

37.5

52.5

30

12

37

49

35

10

37.5

47.5

40

8.57

38.57

47.14

45

7.5

40.63

48.13

55

6.67

43.33

50

65

10

46.5

52.5

75

Onefirm'soutputlevel(column2intheabovetable)is
obtainedbycomparing PandMC.Sinceallfirmsarehaving
thesamecostfunction,themarketoutputlevelisthesumof
individualfirms'output(column4intheabovetable).
Bycomparingthemarketsupplyandmarketdemand,wecan
findthemarketequilibriumat:
P=46and Q=10500
Atthislevel,eachfirmislosing8dollars,indicatinga
contractioninthisindustry.Somefirmsmayleaveinthelong
run,causingthemarketsupplytodecreaseandequilibrium
pricewillincreasetothebreakevenlevel.

PRICE Qs (1 firm's output) PROFIT Qs(1500 firms in the market) / market supply

Qd / market demand

26

-60

17000

32

-60

15000

38

-55

7500

13500

41

-39

9000

12000

46

-8

10500

10500

56

63

12000

9500

66

144

13500

8000

(assuming identical cost function for all firms)

PureMonopoly
Puremonopolyexistswhenasinglefirmisthesoleproducerofaproductforwhichtherearenoclosesubstitutes.Examples
arepublicutilitiesandprofessionalsportsleagues.
Characteristics
1.Asingleseller:thefirmandindustryaresynonymous.
2.Uniqueproduct:noclosesubstitutesforthefirmsproduct.
3.Thefirmisthepricemaker:thefirmhasconsiderablecontroloverthepricebecauseitcancontrolthequantitysupplied.
4.Entryorexitisblocked.
BarrierstoEntry
Economiesofscaleisthemajorbarrier.Thisoccurswherethelowestunitcostand,therefore,lowunitpricesforconsumers
dependontheexistenceofasmallnumberoflargefirms,orinthecaseofmonopoly,onlyonefirm.Becauseaverylarge
firmwithalargemarketshareismostefficient,newfirmscannotaffordtostartupinindustrieswitheconomiesofscale.
Publicutilitiesareknownasnaturalmonopoliesbecausetheyhaveeconomiesofscaleintheextremecase.Morethanone
firmwouldbeinefficientbecausethemazeofpipesorwiresthatwouldresultiftherewerecompetitionamongwater
companiesorcablecompanies.Legalbarriersalsoexistintheformofpatentsandlicenses,suchasradioandTVstations.
Ownershiporcontrolofessentialresourcesisanotherbarriertoentry,suchastheprofessionalsportsleaguesthatcontrol
playercontractsandleasesonmajorcitystadiums.Ithastobenotedthatbarrierisrarelycomplete.Thinkaboutthe
telephonecompaniesacoupledecadesago;therewasnosubstituteforthetelephone.Nowadays,cellularphonesarevery
popular.Itcreatesasubstituteforyourhousephone,causingthetraditionaltelephonecompaniestolosetheirmonopoly
position.
DemandCurve
Monopolydemandistheindustryormarketdemandandisthereforedownwardsloping.Pricewillexceedmarginal
revenuebecausethemonopolistmustlowerpricetoboostsalesandcannotpricediscriminateinmostcases.Theadded
revenuewillbethepriceofthelastunitlessthesumofthepricecutswhichmustbetakenonallpriorunitsofoutput.The
marginalrevenuecurveisbelowthedemandcurve.

ProfitMaximizingOutput&Efficiency
ProfitMaximizingOutput:
TheMR=MCrulewillstilltellthemonopolisttheprofit maximizingoutput.Themonopolistcannotchargethehighest
pricepossible,itwillmaximizeprofitwhereTRminusTCisthegreatest.Thisdependsonquantitysoldaswellasonprice.
Themonopolistcanchargethepricethatconsumerswillpayforthatoutputlevel.Therefore,thepriceisonthedemand
curve.Lossescanoccurinmonopoly,althoughthemonopolistwillnotpersistentlyoperateatlossinthelongrun.
Monopolieswillsellatasmalleroutputandchargeahigherpricethanwouldpurecompetitiveproducerssellinginthe
samemarket.
Incomedistributionismoreunequalthanitwouldbeunderamorecompetitivesituation,unlessthegovernmentregulates
themonopolyandpreventsmonopolyprofits.Ifamonopolycreatessubstantialeconomicinefficiencyandappearstobe
longlasting,antitrustlawscouldbeusedtobreakupthemonopoly.

Efficiency:
1. Productiveefficiency:occurswhereP=minATC.Monopolyfirmswillnot achieveproductiveefficiencyasfirmswill
produceatanoutputwhichislessthantheoutputofminATC.Xinefficiencymayoccursincethereisnocompetitive
pressuretoproduceattheminimumpossiblecosts.
2.Allocative efficiency: occurswhereP=MC.Thisefficiencyisnotachievedbecauseprice(whatproductisworthto
consumers)isaboveMC(opportunitycostofproduct).
Itispossiblethatmonopolyismoreefficientthanmanysmallfirms.Economiesofscale(naturalmonopoly)maymake
monopolythemostefficientmarketmodelinsomeindustries.However,Xinefficiencyandrentseekingcost(lobbying,legal
fees,etc.)canentailsubstantialcosts,causinginefficiency.
Producersurplusissignificantduetolackofcompetition,consumersurplusmaybeminimized.Thismarketstructurewill
notcontributetoafairincomedistributionofoursociety.

AnExample

Inthisexample,thecostfunctionisthesameastheoneusedin the
perfectcompetitionexample.Youcanseefromthefollowinganalysis
thattheoutputlevelandmarketpricearedifferentinmonopoly.
Theoutputlevelislowerthanoutputoftheperfectcompetitive
firm;andpriceishigherthanthepriceofperfectcompetitivefirm.

TP or Q

AFC

Itispossibleforthisfirmtocontinueearningthisprofitinthelong
runastherearenocompetitioninthemarket.

ATC

MC

0
1

60

45

105

45

30

42.5

72.5

40

20

40

60

35

15

37.5

52.5

30

12

37

49

35

10

37.5

47.5

40

8.57

38.57

47.14

45

7.5

40.63

48.13

55

6.67

43.33

50

65

10

46.5

52.5

75

Pd

BycomparingtheMRandMCunitbyunit,wecanfindthisfirm's
outputat:
Q=4,and P=63.Thisistheprofitmaximizationoutputlevel,with
EP=42.

AVC

Qd

TR

MR

EP

115

100

100

100

-5

83

166

66

21

71

213

47

33

63

252

39

42

55

275

23

30

48

288

13

42

294

-35.98

37

296

-89.04

33

297

-153

29

10

290

-7

-235

PriceDiscrimination
Pricediscriminationissellingagoodorserviceatanumberofdifferentprices,andthe
pricedifferencesisnotjustifiedbythecostdifferences.Inordertopricediscriminate,
amonopolymustbeableto
1. beabletosegregatethemarket
2. makesurethatbuyerscannotreselltheoriginalproductorservices.
Perfectpricediscriminationisapricediscriminationthatextractstheentireconsumer
surplusbychargingthehighestpricethatconsumerarewillingtopayforeachunit.
Asaresult,thedemandcurvebecomestheMRcurveforaperfectpricediscriminator.
Firms capturetheentireconsumersurplusandmaximizeeconomicprofit.

MonopolisticCompetition
Monopolisticcompetitionreferstoamarketsituationwitharelativelylargenumberof
sellersofferingsimilarbutnotidenticalproducts.Examplesarefastfoodrestaurants
andclothingstores.
Characteristics
1.Alotoffirms:eachhasasmallpercentageofthetotalmarket.
2.Differentiatedproducts:varietyoftheproductmakesthismodeldifferentfrom
purecompetitionmodel.Productdifferentiatedinstyle,brandname,location,
advertisement,packaging,pricingstrategies,etc.
3.Easyentryorexit.
DemandCurve
Thefirmsdemandcurveishighlyelastic,butnotperfectlyelastic.Itismoreelastic
thanthemonopolysdemandcurvebecausethesellerhasmanyrivalsproducingclose
substitutes;itislesselasticthanpurecompetition,becausethesellersproductis
differentiatedfromitsrivals.

Profit MaximizingOutput
TheMR=MCrulewillgivethefirmstheprofit maximizingoutput.Thepricetheychargewouldbeon
thedemandcurve.
Inthelongrun,thesituationwilltendtobebreakingevenforfirms.Firmscanentertheindustryeasily
andwilliftheexistingfirmsaremakinganeconomicprofit.Asfirmsentertheindustry,thedemandcurve
facingbyanindividualfirmshiftdown,asbuyersshiftsomedemandtonewfirmsuntilthefirmjust
breakseven.Ifthedemandshiftsbelowthebreakevenpoint,somefirmswillleavetheindustryinthe
longrun.
Therefore,mostmonopolisticcompetitivefirmsshouldexperiencebreakeveninthelongrun
theoretically.Inreality,somefirmsexperienceprofitastheyabletodistinguishthemselvesfromthe
othersandbuildaloyalcustomerbase;suchassomenamebrandapparelcompanies.Somefirms
experiencelostinlongrunbutmaycontinuethebusinessastheyarestillearningnormalprofit.These
firmownersusuallyliketheflexiblelifestyleandwillingtoearnanormalprofitthatislowerthantheir
opportunitycost.
Priceexceedsmarginalcostinthelongrun,suggestingthatsocietyvaluesadditionalunitswhicharenot
beingproduced.Averagecostsmayalsobehigherthanunderpurecompetition,duetoadvertisingcost
involvedtoattractcustomersfromcompetitors.Thevarioustypes,styles,brandsandqualityofproducts
offersconsumerschoices.However,economicinefficiencyistheresult.Theexcesscapacity(producingat
thequantitythatafirmproducesislessthanthequantityatwhichATCisaminimum)existsinthis
industry.

Oligopoly
Oligopolyexitswherefewlargefirmsproducingahomogeneousordifferentiated
productdominateamarket.Examplesareautomobileandgasolineindustries.
Characteristics
1.Fewlargefirms:eachmustconsideritsrivalsreactionsinresponsetoitsdecisions
aboutprices,output,andadvertising.
2.Standardizedordifferentiatedproducts.
3.Entryishard:economiesofscale,hugecapitalinvestmentmaybethebarriersto
enter.
DemandCurve
Facingcompetitionorintacitcollusion,oligopoliesbelievethatrivalswillmatchany
pricecutsandnotfollowtheirpricerise.Firmsviewtheirdemandsasinelasticfor
pricecuts,andelasticforpricerise.Firmsfacekinkeddemandcurves.Thisanalysis
explainsthefactthatpricestendtobeinflexibleinsomeoligopolisticindustries.

Efficiency&Advertisement
1. Productiveefficiency:occurswhereP=minATC.
Monopolisticcompetitivefirmswillnot achieveproductiveefficiencyasfirmswill
produceatanoutputwhichislessthantheoutputofminATC.Productdifferentiationis
themajorcauseofexcesscapacity.
2.Allocative efficiency: occurswhereP=MC.
Thisefficiencyisnotachievedbecauseprice(whatproductisworthtoconsumers)is
aboveMC(opportunitycostofproduct).

Advertisementisverycrucialforeachfirminthismarketstructureasfirmsneed
exposuretogetconsumer'sattention.However,toomuchspendingwillresultinhigher
cost,andlowerprofit.Price,productattributes,andadvertisementarethreemain
factorsthatproducershavetoconsider.Theperfectcombinationcannotbeforecasted
easily.

GameTheory&Cartel
Gametheorysuggeststhatcollusionisbeneficialtotheparticipatingfirms.Collusionreducesuncertainty,increasesprofits,
andmayprohibitentryofnewrivals.
Considerthefollowingpayoffmatrixinwhichthenumbersindicatetheprofitinmillionsofdollarsforaduopoly(GMand
Ford)basedoneitherahighpriceoralowpricestrategy. ThisexampleillustratedthatGMorFordwillearnthehighest
individualprofitwheneachadoptslowpricestrategywhileotherfirmcontinueswiththehigherpricestrategy(inBorC).
Butfirmswillearnthehighesttotalprofitwhenbothadoptthehighpricestrategy(A).Whenfirmsformacartel,theyare
actingasoneentity(A).Theywillperformastheyarealargemonopoly,earningthehighesttotalprofitpossible.However,
membersdohaveanincentivetocheatasindividualscanincreasetheirownprofitsbycheatinginshortrun(BorC).When
othermembersareawareofthecheating,theymaycarryoutthesamepractice,sometimesitmayresultinapricewarand
allmembersloss(D).
Duopoly
GM

Ford

High-price
Low-price

Profit Analysis

High-price
A: GM=$50M Ford=$50M
C: GM=$20M Ford=$60M

Low-price
B: GM=$60M Ford=$20M
D: GM=$30M Ford=$30M

GM Profit
Earns $50M

Ford Profit
Earns $50M

Total profit in the industry


$50 + $50 =$100M

B: GM lowers price and Ford continues with


high price strategy

Increased to $60 M

Dropped to $20M

$60 + $20 =$80M

C: Ford lowers price and GM continues with


high price strategy

Dropped to $20 M

Increased to $60M

$20 + $60 =$80M

D: Both firms adopt low price strategy

Earns $30M

Earns $30M

$30 + $30 =$60M

A: Both firms adopt high price strategy

TheOrganizationofPetroleumExportingCountries(OPEC)isacartel.Theelevencountriesagreedontheoutputamount
andworkingtogethertocontroltheworldscrudeoilsupply.InUS,antitrustlawhassetupguidelinesforcorporationsto
followtoavoidcollusionoflargefirmsinthesameindustryandprotectconsumerrights.

TechnologicalDevelopment
Technologicaladvanceisathreestepprocessthatshiftstheeconomysproductionpossibilitiescurve
outwardenablingmoreproductionofgoodsandservices.
1.Invention:isthediscoveryofaproductorprocessandtheproofthatitwillwork.
2. Innovation:isthefirstsuccessfulcommercialintroductionofanewproduct,thefirstuseofanew
method,orthecreationofanewformofbusinessenterprise.
3. Diffusion:isthespreadofinnovationthroughimitationorcopying.
Expendituresonresearchanddevelopment(R&D)includedirecteffortsbybusinesstowardinvention,
innovation,anddiffusion.GovernmentalsoengagesinR&D,particularlyfornationaldefense.Finding
theoptimalamountofR&Disanapplicationofbasiceconomics:marginalbenefitandmarginalcost
analysis.OptimalR&Dexpendituresoccurwhentheinterestratecostoffundsisequaltotheexpected
rateofreturn.
Manyprojectsmaybeaffordablebutnotworthwhilebecausethemarginalbenefitislessthanmarginal
cost.OftentheR&Dspendingdecisioniscomplexbecausetheestimationoffuturebenefitsishighly
uncertainwhilecostsareimmediateandmoreclearcut.

TheRoleofMarketStructure
1.Purecompetition:thesmallsizeofcompetitivefirmsandthefacthattheyearnzero
economicprofitinthelongrunleadstoseriousquestionsastowhethersuchproducerscan
financesubstantialR&Dprograms. Thefirmsinthismarketstructurewouldspendno
significantamount. However,firmsofthesameindustrymaygathertheirresourcesand
developR&Dprograms.
2.Monopolisticcompetition:thereisastrongprofitincentivetoengageinproduct
developmentinthismarketstructureasthefirmsdependonproductdifferentiationtostand
outfromalargenumberofrivals.However,mostfirmsremainsmallwhichlimitstheirability
tosecureinexpensivefinancingforR&Dandanyeconomicprofitsareusuallytemporary.
Therefore,spendingonR&Dislimitedinthismarketstructure.
3.Oligopoly:manyofthecharacteristicsofoligopolyareconducivetotechnicaladvances
including:theirlargesize,ongoingeconomicprofits,theexistenceofbarrierstoentryanda
largevolumeofsales.FirmsinoligopolyspentthehighestamountonR&Damongthefour
differentmarketstructures.
4.Puremonopoly:monopolyhaslittleincentivetoengageinR&Dastheprofitisprotectedby
absolutebarrierstoentry,theonlyreasonforR&Dwouldbedefensive toreducetheriskofa
newproductorprocesswhichwoulddestroythemonopoly.

EconomicEfficiency
Economicsisascienceofefficiencyintheuseofscarceresources.Efficiencyrequiresfullemploymentofavailable
resourcesandfullproduction.Fullemploymentmeansallavailableresourcesshouldbeemployed.Fullproduction
meansthatemployedresourcesareprovidingmaximumsatisfactionforourmaterialwants.Fullproductionimpliestwo
kindsofefficiency:
1.Allocativeefficiencymeansthatresourcesareusedforproducingthecombinationofgoodsandservicesmostwanted
bysociety.Forexample,producingcomputerswithwordprocessorsratherthanproducingmanualtypewriters.
2.Productiveefficiencymeansthatleastcostlyproductiontechniquesareusedtoproducewantedgoodsandservices.
Fullefficiencymeansproducingthe"right"(Allocativeefficiency)amountinthe"right"way(productiveefficiency).
Purecompetition:
Productiveefficiencyoccurswherepriceisequaltominimumaveragetotalcost(minATC);atthispointfirmsmustuse
theleasecosttechnologyortheywontsurvive.
Underpurecompetition,thisoutcomewillbeachieved,asthelongrunequilibriumpriceofpurecompetitivefirms
wouldbeattheminATC.
Allocativeefficiencyoccurswherepriceisequaltomarginalcost(P=MC),becausepriceissocietysmeasureofrelative
worthofaproductatthemarginoritsmarginalbenefit.AndthemarginalcostofproducingproductXmeasuresthe
relativeworthoftheothergoodsthattheresourcesusedinproducinganextraunitofXcouldotherwisehaveproduced.
Inshort,pricemeasuresthebenefitthatsocietygetsfromadditionalunitsofgoodX,andthemarginalcostofthisunit
ofXmeasuresthesacrificeorcosttosocietyofothergoodsgivenuptoproducemoreofX.
Underpurecompetition,thisoutcomewillbeachieved.Dynamicadjustmentswilloccurautomaticallyinpure
competitionwhenchangesindemandorinresourcessupply,orintechnologyoccur.Disequilibriumwillcauseexpansion
orcontractionoftheindustryuntilthenewequilibriumatP=MCoccurs.

EfficiencyCont.

Nonperfectcompetition:
Priceofnonperfectcompetitivefirmswillexceedmarginalcost,becausepriceexceedsmarginalrevenueandthefirms
producewheremarginalrevenue(MR)andmarginalcostareequal.Thenthefirmscanchargethepricethatconsumerswill
payforthatoutputlevel.Allocativeefficiencyisnotachievedbecauseprice(whatproductisworthtoconsumers)isabove
marginalcost(opportunitycostofproduct).Ideally,outputshouldexpandtoalevelwhereP=MC,butthiswilloccuronly
underpurecompetitiveconditionswhereP=MR.Productiveefficiencyisnotachievedbecausethefirmsoutputisless
thantheoutputatwhichaveragetotalcostisminimum.
Economiesofscale(naturalmonopoly)maymakemonopolythemostefficientmarketmodelinsomeindustries.X
inefficiency,theinefficiencythatoccursintheabsenceoffearofentryandrivalry,mayoccurinmonopolysincethereisno
competitivepressuretoproduceattheminimumpossiblecosts.Rentseekingbehavioroftenoccursasmonopoliesseekto
acquireormaintaingovernmentgrantedmonopolyprivileges.Suchrentseekingmayentailsubstantialcost(lobbying,
legalfees,publicrelationsadvertisingetc.)whichareinefficient.
Thereareseveralpolicyoptionsavailablewhenmonopolycreatessubstantialeconomicinefficiency:
1.Antitrustlawscouldbeusedtobreakupthemonopolyifthemonopolysinefficiencyappearstobelonglasting.
2.Societymaychoosetoregulateitspricesandoperationsifitisanaturalmonopoly.
3.Societymaysimplyignoreitifthemonopolyappearstobeshortlivedbecauseofchangingconditionsortechnology.
EfficiencyVstechnologicaladvances:
Allocativeefficiencyisimprovedwhentechnologicaladvanceinvolvesanewproductthatincreasestheutilityconsumers
canobtainfromtheirlimitedincome.Processinnovationcanlowerproductioncostandimproveproductiveefficiency.
Innovationcancreatemonopolypowerthroughpatentsortheadvantagesofbeingfirst,reducingthebenefittosociety
fromtheinnovation.Innovationcanalsoreduceorevendisintegrateexistingmonopolypowerbyprovidingcompetition
wheretherewasnone.Inthiscaseeconomicefficiencyisenhancedbecausethecompetitiondrivespricesdowncloserto
marginalcostandminimumaveragetotalcost.