Question

Explain the significance that the average total cost (ATC) curve has on profit and loss based on each type of market structure. Explore how the ATC curve affects all four market structures and identify whether firms will earn a profit or loss based on the placement of the ATC curve and price.

Market Structures are as followed: perfectly competitive, monopolistic competitive, oligopolistic, and monopoly market structures

Answer 1

Four markets are perfect competition, monopolistic competition, monopoly competition, and oligopoly.

let us understand the difference between these four markets in the short run and long run with the help of diagrams.

1. Perfect competition: This type of market has large numbers of buyers and sellers. All the products in the market are identical or homogeneous. Therefore the consumers have the perfect knowledge about the market and the product. There is perfect mobility of labors with no government interventions. there is free exit and entry of firms thus when profit, new firms enter the market and vice versa. In the short run, perfect competition makes supernormal, normal and loss as per the firm's marginal cost and marginal revenue. Firms try to minimize the average cost. In the long run, the firm incurs nornmal profit with the minimum average cost. In this case, the MR=MC and the slope of MC are greater than the slope of MR. This can be shown through the below diagram:

2. Monopoly competition: In this type of market there is only one seller and there are a large number of buyers. Since they are the only producer thus they are price maker. They can set either price level or output level in the market. In order to gain more profit, they practice price discrimination which means they charge a different price to different consumers. Their product do not have any close substitute. In this market, the supply curve is absent as the product is sold at different prices to different consumers. In the short run, Marginal cost is equal to marginal revenue. The average revenue curve depicts the demand curve and is downward sloping due to which the MR curve is also downward sloping. The slope of MC is greater than the slope of MR. In the short run, the monopolist makes a supernormal profit and normal profit. They do not incur loss generally. In the long run, the factors of production are variable, therefore the size of the plants are also variable. The threats to other firms to enter the market increases which are not there is short run.

This can be further seen in the diagram below:



3. Monopolistic competition: As the perfect competition, there are large numbers of buyers and sellers in this market but the products are not identical. This is known as product differentiation which means the product differs in size, shape, color, packaging, etc. The products are a close substitute of each other and therefore there is strong competition between the firms in the market. The factors of production and technology are fixed. The final goal is to maximize profit. The MR, MC, AR curves are the same as monopoly market but the difference is that the demand curve (AR) and MR curve are flatter than that of the monopoly market. The firms and industries show different revenues and cost whereas in the monopoly market the firm and the industry is the same. Toothpaste, shampoo industry are examples of monopolistic competition. In the long run, when firms are making profit, new firms try to enter the market which decreases in market share and therefore the demand curve tends to shift leftwards. Thus making normal profits in the long run, which results in excess capacity. Excess capacity is the situation in which the firm decreases the output to its minimum efficient level underutilising the resources. Excess capacity leads to social cost. This is shown in the diagram below:



4. Oligopoly market: This market has only a few sellers and large numbers of buyers. OPEC is a good example of an oligopoly market. The sellers share the market and choose one as a leader, who is more powerful which is decided by the market share and the rest of the sellers follow the price. This is known as price leadership. therefore, they form cartel and work. The demand curve of oligopoly market is kinked demand curve which means that at first, the AR curve is flat and then after kink, the AR curve becomes steeper than before due to change is elasticity of demand. In long run, the market earns supernormal profit as the price is controlled by the cartel or group of oligopoly. It can capture excess capacity and restrict the entry of the firms in long run. This can be shown with the help of the diagram below:



Thus these are the difference between the four markets. Also, these diagrams show how ATC affects profit and loss. Coming to the next part of the question which is the significance of average total cost (ATC) in profit and loss in each market and ATC affecting these markets through its position.  ATC plays an important role as a deciding whether the firm will incur loss or earn the profit.

There are two conditions common in each market which are necessary condition in which MR=MC, and sufficient condition in which the slope of marginal revenue should be less than the slope of marginal cost. These are the two conditions for equilibrium in all four markets. Here, the slope of MC is taken out by the derivative of the average total cost curve.

In perfect competition, there are three conditions: a) normal profit b) supernormal profit and c) loss. These conditions depend on the average total cost position. In the above diagram under perfect competition, it shows that when the firm earn average revenue more than average cost then there is supernormal profit. When the average revenue is equal to the average total cost then the firm earns a normal profit. It is also known as the break-even point. When the average total cost is more than the average revenue then the firm incurs losses. Thus, average total cost decides the profit and loss of the firm in perfect competition. Therefore, the firm tries to minimize its average total cost.

In a monopoly, there is only one seller and therefore they are price maker. They set high prices to earn high profit. In this case also the firm tries to minimize its cost and earn more. the ultimate objective of the firm is making a huge profit. The firm in monopoly if fixes the price, it will not have control over the output produced. Thus, in the long run, the monopoly firm fixes the amount of output and adopt price discrimination to earn supernormal profits. In this case, also, the average total cost should be less than average revenue. In the long run also, these firms earn the supernormal profit.

The monopolistic market has got the same kind of demand curve as average revenue curve which is downward sloping but the only difference is that the AR curve of the monopolistic market is flatter than that of the monopoly market. The average cost is tangent to the average revenue curve in this case. The level of price and out is determined by the position of the average total cost curve.

Oligopoly market controls the price forming a cartel so that they always earn the supernormal profit. The average total cost position is also important for this market in a similar manner as they were for the other three markets.

When the diagrams are closely observed, it explains how the revenue differs in each market by the position of the average total cost. Marginal cost curve cuts the average total cost curve from below which means at its minimum point. This is because the marginal cost curve becomes upward sloping once AC and MC are equal. This determines the price level and output level of the firm.

Therefore, ATC affects all forms of market and decide revenue if it is profit or loss through its position