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The Cost for Nothing

Market Structure for Nothing

It may be difficult at first glance to tell what type of market structure our company, Nothing, Ltd. fits into, and so we need to take a closer look.  There are four basic classifications for market competition: perfect competition, monopoly, oligopoly and   monopolistic competition.  As we examine these market structures closely, we will verify our place in the market, and learn to understand our cost schedule more clearly.

In the imperfect world of economics, perfect competition is the unattainable ideal that all business should strive for.  In perfect competition, there are many buyers and many sellers, each selling an identical item.  The consumer, who often believes that “a car is a car,” defines an identical item.  In perfect competition, each company operates at maximum efficiency, and each company produces at the lowest point of its Average Total Cost curve.  In perfect competition, each company is a price taker who takes the price that the consumer is willing to pay.  The perfect competitor operates at the break-even point, charging the lowest possible price while still staying in business, and maintaining peak efficiency.  Nothing, Ltd cannot be classified as a perfect competitor, so let us move on to the other possibilities.  (Slavin, 506-07)

Monopoly is defined as a single firm producing a product for which there is no substitution.  Other characteristics of monopolies are the barriers to entry.  A monopoly must control a large number of natural resources.  A monopoly must be able to afford the high start-up costs.  A monopoly also faces legal barriers, and the problem of challenging other, already established businesses.  These barriers to entry make it hard, if not impossible to break into the market. Because there is no competition, a monopoly is defined as a price maker rather than a price taker.  This means that a monopoly is able to charge the price they want rather than accepting the market equilibrium price.  This has created problems in the past, and has led to the government intervening with controls on monopolistic practices.  Nothing, LTD could not be described as a monopoly, so we will continue to examine our options. (Slavin, 427-36)

Oligopoly is described as an industry that has just a few sellers selling a similar product.  An oligopoly has so few sellers that not one of them can influence the price.  Similar to a monopoly, characteristics of an oligopoly are the barriers to entry.  High start-up costs, legal barriers, and competition with well-established firms are the characteristics that form these barriers. In an oligopoly, the firms are often interdependent.   This means that an oligopoly will rarely change their prices unless all the firms also change their prices.  Because the products are similar, if a firm in an oligopoly raises its prices, the consumer will go to the next firm to purchase the product at the lower price.  When the leading firm in an oligopoly changes prices, the other firms will follow-the-leader, and change their prices as well.   Because there are so many firms creating Nothing, Nothing, Ltd. cannot be described as an oligopoly.  (Slavin, 567) (Margetts)

What we are left with is a monopolistic competition.  In a monopolistic competition, there are many companies selling a differentiated product.  As with perfect competition, a monopolistic competitive market has so many sellers that no single firm can influence the price.  Unlike perfect competition, the companies in a monopolistic competition do not sell identical products.  Monopolistic competition is characterized by selling a differentiated product.  Once again, the consumer makes the decision as to what constitutes a differentiated product.   Our Nothing may look similar to the Nothing created by another firm, but the consumer often discovers that our Nothing is different because it is a stronger, better crafted, and more satisfying Nothing.  Nothing, Ltd. is most certainly a monopolistic competitor.

Once we have identified our place in the market, we can do a quick cost schedule analysis.  Every company has fixed costs, and Nothing, Ltd is no exception.  Our fixed costs are relatively small, and consist of rent, wages, taxes, and interest payments.  Along with the fixed costs, Nothing, Ltd. also has variable costs.  These variable costs include the cost of the raw materials we use to produce Nothing.  These variable costs increase as our production of Nothing increases because for each unit of Nothing, we are using more resources. When we add the fixed costs to the variable costs, we find our total costs.  To find our average fixed costs, we divide our fixed cost by output, and to find our average variable costs, we divide our variable costs by output.  Likewise, to find our average total costs, we divide our total costs by output.  Our marginal cost is the cost of producing one more unit of Nothing.  This can be seen quite clearly in the table below.

Output Fixed Cost Variable Cost Total Cost AFC AVC ATC MC
1  $ 100.00  $       5.00  $   105.00  $ 100.00  $     5.00  $ 105.00  $     5.00
2  $ 100.00  $     10.00  $   110.00  $   50.00  $     5.00  $   55.00  $     5.00
3  $ 100.00  $     20.00  $   120.00  $   33.33  $     6.67  $   40.00  $   10.00
4  $ 100.00  $     35.00  $   135.00  $   25.00  $     8.75  $   33.75  $   15.00
5  $ 100.00  $     55.00  $   155.00  $   20.00  $   11.00  $   31.00  $   20.00
6  $ 100.00  $     80.00  $   180.00  $   16.67  $   13.33  $   30.00  $   25.00
7  $ 100.00  $   125.00  $   225.00  $   14.29  $   17.86  $   32.14  $   45.00

 

The chart shows the AVC, ATC, and MC curves for the output of different amount of Nothing. We can see from this chart that our ATC curve crosses our MC curve at approximately $31 with an output of 6.3.  If Nothing, Ltd, was a perfect competitor, this is where we would operate for peak efficiency, and this is the price we would charge to break even.  Because Nothing, Ltd. is a monopolistic competitor with hopes of making a profit in the short run; we will operate on a different schedule.  Stay tuned next week as we examine the revenue schedule for the monopolistic competitor in the long run and the short run.

Sources

Margetts, Steve Oligopoly http://www.revisionguru.co.uk/economics/oligopoly.htm

Slavin, Stephen L. Economics 7th Edition 427-36, 506-07, 567