Page 586 - Microeconomics, Fourth Edition

c13marketstructureandcompetition.qxd 7/30/10 10:44 AM Page 560

560 CHAPTER 13 MARKET STRUCTURE AND COMPETITION

curve D is tangent to its average cost curve AC. Put another way, the margin between
a firm’s price and its variable costs is just sufficient to cover its fixed costs of operation
and the up-front costs of entering the business. Given that this is so, entrants have no
incentive to come into the market.

PRICE ELASTICITY OF DEMAND, MARGINS,
AND NUMBER OF FIRMS IN THE MARKET

In monopolistically competitive markets, free entry and exit of firms determines how
many firms ultimately compete in the market. Figure 13.15 illustrates two possible
long-run equilibria.
In Market A, consumers are sensitive to price differences when they choose among
existing sellers. A seller in this market has a demand curve that is highly price elastic.
In a long-run equilibrium (where the demand curve D is tangent to the average cost
curve AC ), the margin (P* MC) between price and marginal cost is small, and firms
produce a large volume of output. By contrast, in Market B, consumers are not espe-
cially sensitive to price differences among competing sellers, so a firm’s demand is not
as sensitive to price as in Market A. In a long-run equilibrium, the margin between
price and marginal cost is large and each firm produces a small volume of output. If the
total number of units purchased in equilibrium is about the same in Markets A and B,
Market B would have more firms than Market A because each firm in market B sells a
smaller quantity than each firm in market A.

DO PRICES FALL WHEN MORE FIRMS ENTER?

When we studied the Cournot model earlier in this chapter, we saw that the equilib-
rium price went down as more firms competed in the market. Figure 13.14 portrays a
similar phenomenon in a monopolistically competitive market. In that figure, the
entry of more firms resulted in a reduction in the market price.

Price (dollars per unit) P* AC Price (dollars per unit) P* AC

MR D MC MR D MC
Quantity (units per month) Quantity (units per month)
(a) Market A firms face relatively elastic (b) Market B firms face relatively inelastic
demand demand

FIGURE 13.15 Price Elasticity of Demand and Long-Run Equilibrium
In Market A, firms face relatively elastic demand. At a long-run equilibrium, the margin P* MC
between price and marginal cost is small, and each firm produces a large volume of output. In
Market B, firms face relatively less elastic demand. At a long-run equilibrium, the margin between
price and marginal cost is large, and each firm produces a small volume of output.