This module delves into the core principles of microeconomics, focusing on how firms make decisions regarding production and pricing, and how these decisions are influenced by the competitive landscape of different market structures. Understanding these concepts is crucial for analyzing industry dynamics and predicting firm profitability, a key skill for CFA candidates.

Firms operate under various constraints, primarily their production technology and market demand. The primary objective of a firm is typically profit maximization. However, other objectives like revenue maximization or market share growth can also influence decision-making, especially in the short run or under specific strategic considerations.

Understanding a firm's cost structure is fundamental to analyzing its behavior. Costs can be categorized in several ways, each offering a different perspective on the firm's financial landscape.

The competitive environment in which a firm operates significantly shapes its pricing power, output decisions, and profitability. Economists classify markets into four main structures based on the number of firms, product differentiation, and barriers to entry.

In perfect competition, numerous firms sell identical products, and there are no barriers to entry or exit. Firms are price takers, meaning they must accept the market price. In the short run, firms can earn economic profits, losses, or break even. In the long run, economic profits are competed away, and firms earn only normal profits (zero economic profit).

This structure features many firms selling differentiated products. Product differentiation can be through branding, quality, or features. Firms have some control over price due to differentiation but face competition from close substitutes. Like perfect competition, long-run economic profits are driven to zero due to low barriers to entry.

An oligopoly is characterized by a few dominant firms. These firms are interdependent, meaning the actions of one firm significantly affect the others. This interdependence can lead to strategic behavior, such as price wars or collusion. Barriers to entry are high, allowing firms to potentially earn positive economic profits in the long run.

A monopoly exists when a single firm is the sole producer of a unique product with no close substitutes. High barriers to entry, such as patents, control of resources, or economies of scale, protect the monopolist. The monopolist is a price maker and can earn significant economic profits in the long run.

A firm's supply curve shows the quantity of a good or service that a firm is willing and able to offer for sale at different prices. For perfectly competitive firms, the supply curve is the portion of the marginal cost curve that lies above the average variable cost curve. For firms in other market structures, the concept of a simple supply curve is more complex due to their price-making abilities and strategic considerations.

Market structures have implications for economic efficiency and consumer welfare. Perfectly competitive markets are generally considered the most efficient, achieving both allocative efficiency (price equals marginal cost) and productive efficiency (production at minimum average total cost) in the long run. Monopolies, on the other hand, tend to be less efficient, producing less output at a higher price, leading to a deadweight loss.