Learning Module 1
The firm and market structures

Perfect Competition — Firm is a price taker; demand curve is horizontal (perfectly elastic). Price = Marginal Revenue (MR) = Average Revenue (AR).

Imperfect Competition — Firm faces downward-sloping demand; MR < Price. To sell more, price must be reduced.

Profit Maximization — Produce where MR = MC and MC is rising. Economic profit = TR − TC.

Breakeven Point — TR = TC, or Price = Average Total Cost (ATC). Economic profit is zero (normal profit).

Shutdown Point — In the short run, firm should shut down if Price < Minimum Average Variable Cost (AVC). By shutting down, it only loses fixed costs.

Short-run vs Long-run — In the long run, all costs are variable; if price cannot cover ATC, firm exits the market.

Economies of Scale — Long-run average cost (LRAC) decreases as output increases. Sources: specialization, bulk purchasing, more efficient technology.

Diseconomies of Scale — LRAC increases as output increases. Sources: management inefficiencies, bureaucracy, coordination problems.

Minimum Efficient Scale (MES) — The lowest output level at which LRAC is minimized. In perfect competition, firms operate at MES in the long run.

Short-run vs Long-run — Short-run costs have fixed factors; long-run all factors are variable. The LRAC curve is the envelope of short-run ATC curves.

Demand — Downward-sloping because product differentiation gives some pricing power.

Short-run equilibrium — MR = MC; price set on demand curve. Can earn positive economic profit in short run.

Long-run equilibrium — Entry of new firms drives economic profit to zero. Price = ATC, but not at minimum ATC (excess capacity).

No well-defined supply curve — Because price and output are determined by MR=MC and demand.

Interdependence — Each firm's pricing decisions affect others; strategic behavior is key.

Kinked Demand Curve — Competitors match price cuts but not price increases. Demand is more elastic for price increases, less elastic for cuts. MR has a discontinuity.

Cournot Model — Firms choose output assuming rivals' output is fixed. Equilibrium is where each firm maximizes profit given the other's output.

Nash Equilibrium — No firm can improve its outcome by unilaterally changing its strategy. Used in game theory to analyze oligopoly behavior.

Collusion and Cartels — Firms may cooperate to maximize joint profits, but incentive to cheat exists. Cartels are explicit agreements.

Price Leadership — Dominant firm sets price, others follow.

Concentration Ratio — Sum of market shares of the largest N firms (e.g., CR4). Simple but ignores distribution among top firms and barriers to entry.

Herfindahl-Hirschman Index (HHI) — Sum of squared market shares (expressed as fractions or percentages). More sensitive to mergers among large firms.

Limitations — Do not account for ease of entry, demand elasticity, or potential for collusion. High concentration does not always imply market power.