Market Structure
Preface
• Market structure refers to the environment within which
buyers and sellers interact.
• One of the most important decisions made by a manager is
how to price the firm’s product. If the firm is a profit
maximizer, the price charged must be consistent with the
realities of the market and economic environment within
which the firm operates.
• One important element in the firm’s ability to influence the
economic environment within which it operates is the nature
and degree of competition.
Preface
• A firm operating in an industry with many competitors may
have little control over the selling price of its product because
its ability to influence overall industry output is limited. In this
case, the manager will attempt to maximize the firm’s profit
by minimizing the cost of production by employing the most
efficient mix of productive resources.
• On the other hand, if the firm has the ability to significantly
influence overall industry output, or if the firm faces a
downward-sloping demand curve for its product, the manager
will attempt to maximize profit by employing an efficient
input mix and by selecting an optimal selling price.
Market Structure
• There are many ways to classify a firm’s competitive environment,
or market structure. It is possible to categorize markets in terms of
certain basic characteristics. These characteristics of market
structure include:
1. The number and size distribution of sellers:
The ability of a firm to set its output price will largely depend on the
number of firms in the same industry producing and selling that
particular product. If there are a large number of equivalently sized
firms, the ability of any single firm to independently set the selling
price of its product will be severely limited. on the other hand, the
firm is the only producer in the industry (monopoly) or one of a few
large producers (oligopoly) satisfying the demand of the entire
market, the manager’s flexibility in pricing could be quite
considerable.
Market Structure
2. The number and size distribution of buyers:
Markets may also be categorized by the number and size distribution
of buyers. When there are many small buyers of a particular good or
service, each buyer will likely pay the same price. On the other hand,
a buyer of a significant proportion of an industry’s output will likely
be in a position to extract price concessions from producers. Such
situations refer to monopsonies (a single buyer) and oligopsonies (a
few large buyers).
3. Product Differentiation:
Product differentiation is the degree that the output of one firm
differs from that of other firms in the industry. Firms that produce
goods having unique characteristics may be in a position to exert
considerable control over the price of their product. When products
are undifferentiated, consumers will decide which product to buy
based primarily on price.
Market Structure
4. The conditions of entry into and exit from the industry:
The ease with which firms are able to enter and exit a
particular industry is also crucial in determining the nature of a
market. When it is difficult for firms to enter into an industry,
existing firms will have much greater influence in their output
and pricing decisions. Managers can make pricing decisions
without worrying about losing market share to new entrants.
Exit conditions from the industry also affect managerial
decisions.
Four Basic Market Structures
Perfect Competition
• Perfect competition refers to the market structure in which
there are many utility-maximizing buyers and profit-
maximizing sellers of a homogeneous good or service in which
there is perfect mobility of factors of production and buyers,
sellers have perfect information about market conditions, and
entry into and exit from the industry is very easy.
Perfect Competition: Characteristics
• The characteristics of perfect competition in terms of market
structure characteristics are:
1. Large number of sellers or firms:
Perfectly competitive industries are characterized by a large number
of more or less equally sized firms. Because the contribution of
each firm to the total output of the industry is small, the output
decisions of any individual firm will not significantly affect the
market price. Thus, firms in perfectly competitive markets may be
described as price takers.
2. Large number of buyers:
A second requirement of a perfectly competitive market is that
there also be a large number of buyers. Since no buyer purchases a
significant proportion of the total output of the industry, the
actions of any single buyer will not significantly affect the
equilibrium price of the product.
Perfect Competition: Characteristics
3. Homogenous or undifferentiated product:
A third important characteristic of perfectly competitive
markets is that the output of one firm cannot be distinguished
from that of another firm in the same industry. The
purchasing decisions of buyers, therefore, are based entirely
on the selling price.
4. Easy entry and exit:
A final characteristic of perfectly competitive markets is that
firms may easily enter or exit the industry. The purchasing
decisions of buyers, therefore, are based entirely on the
selling price.
Total, Average, and Marginal
Revenue for a Competitive Firm
Profit Maximization: A Numerical Example
Exercise
Exercise
Short-run Equilibrium
• The market-determined price of a good or service is accepted
by the firm in a perfectly competitive industry. Moreover, the
equilibrium price and quantity of that good or service are
determined through the interaction of supply and demand.
The relation between the market-determined price and the
output decision of a firm is illustrated in Figure 8.2.
Short-run Equilibrium
Short-run Equilibrium
• The market demand for a good or service is the horizontal
summation of the demands of individual consumers, while
the market supply curve is the sum of individual firms’
marginal cost (above-average variable cost) curves. if the
prevailing price is above the equilibrium price (P*), a
condition of excess supply forces producers to lower the
selling price. Alternatively, if the selling price is below P* a
situation of excess demand arises. This adjustment dynamic
will continue until both excess demand and excess supply
have been eliminated at P*.
Short-run Equilibrium
Short-run Profit Maximizing Price and Output
• We assume that the perfectly competitive firm is a profit
maximizer. A firm earns economic (above-normal) profit when
total revenue is greater than total economic cost. The profit-
maximizing condition for this firm is:
P=MR = MC
• Assuming that the firm has U-shaped average total and
marginal cost curves, Figure 8.2 illustrates that the perfectly
competitive firm maximizes profits by producing 0Qf units of
output, that is, the output level at which P* = MC. The
economic profit earned is illustrated by the shaded area
AP*BC in the figure 8.2.
Short-run Profit Maximizing Price and Output
Short-run Supply Curve
Long-run Supply Curve
Short-run Equilibrium: Three Possibilities
Exercise
Exercise
Long-run Equilibrium
• In the long run all inputs are variable, and the increased
output by new and existing firms will result in a right-shift of
the market supply curve. In Figure 8.4, a right-shift of the
industry supply function has resulted in a fall of the
equilibrium price from P* to P΄ and an increase in the
equilibrium output from Q* to Q΄. The decline in the market
equilibrium price has reduced the economic profit to the firm
to the shaded area A ΄P ΄B ΄C ΄.
Long-run Equilibrium
Long-run Equilibrium
• The situation depicted in Figure 8.4 is not stable in the long
run, since the area A ΄P ΄B ΄C ΄ still represents a situation in
which the firm is earning economic profits. The continued
existence of economic profits will continue to attract
resources to the production of the particular good or service
in question. The situation of long-run competitive equilibrium
is illustrated in Figure 8.5.
Long-run Equilibrium
Long-run Equilibrium
• In Figure 8.5, P and Q represent the break-even price and
output level for the individual firm, respectively. In this
situation, the firm described in Figure 8.4 is no longer earning
an economic profit. Since there is no further incentive for
firms to enter this industry, it may be said that the firm is in a
position of long-run competitive equilibrium.
An Increase in Demand in the SR and LR
Exercise
Exercise
Exercise
Exercise
Monopoly
• The term “monopoly” is used to describe the market structure
in which there is only one producer of a good or service for
which there are no close substitutes and entry into and exit
from the industry is impossible.
• A monopolist is the only seller in an industry and therefore,
has no competitors.
Monopoly: Characteristics
1. Controlling scarce productive resources:
Monopolist is a firm that controls the entire supply of a vital
factor of production will control production for the entire
industry.
2. Patent rights:
A legal barrier to the entry of new firms into an industry is the
patent. A patent is the exclusive right granted to an inventor by
government to a product or a process.
3. Government franchise:
Perhaps the most common example of a monopoly in the
United States is the government franchise. Many firms are
monopolies because the government has granted them the
sole authority to supply a particular product within a given
region. Public utilities are the most recognizable of
government franchises.
Monopoly: Characteristics
4. Lawsuits:
Monopolists can attempt to protect exclusive market positions
by filing lawsuits against potential competitors claiming patent
or copyright infringement.
Demand Curves for Competitive and Monopoly Firms
Monopoly’s TR, AR and MR
Monopoly’s AR and MR
Elasticity and Pricing Decision
Profit maximization for a Monopoly
Short-run profit maximizing price and output
• The monopolist faces the downward-sloping market demand
curve, and the usual U-shaped marginal and average total cost
curves. the profit-maximizing monopolist will adjust its output
level up to the point at which the marginal cost of producing
an addition unit of the good is just equal to the marginal
revenue from its sale. This condition is satisfied at point E in
Figure, at output level Qm.
• The selling price of the monopolist output is determined
along the market demand function at Pm. At this price–
quantity combination, the economic profit earned by the firm
is illustrated by the shaded area APmBC.
Short-run profit maximizing price and output
Long-run profit maximizing price and output
Exercise
Exercise
Exercise
Exercise
Exercise
Evaluating Perfect competition and Monopoly
• In the case of a perfectly competitive output market, the
equilibrium price and quantity are determined through the
interaction of supply and demand forces. In Figure 8.11, the
equilibrium price and quantity are determined at point E. At
that point the equilibrium price and quantity in a perfectly
competitive market are Ppc and Qpc, respectively.
• In the case of monopoly, the equilibrium price and quantity
are determined where MC = MR. In Figure 8.11 the
equilibrium price and quantity are Pm and Qm, respectively.
• From society’s perspective, perfect competition is clearly
preferable to monopoly because it results, in the short run, in
greater output and lower prices.
Evaluating Perfect competition and Monopoly
Dead-weight Loss
• In the case of perfect competition, equilibrium price and
quantity are determined by the intersection of the supply
(marginal cost) and demand (marginal benefit) curves. In
Figure 8.14 this occurs at point E. The equilibrium price and
quantity are P* and Q*, respectively.
• consumer surplus is the area P*AE and
• producer surplus is the area BP*E.
• The sum of consumer and producer surplus is the area BAE.
Dead-weight Loss
Dead-weight Loss
• Suppose that the industry depicted in Figure 8.14 is
transformed into a monopoly. A monopolist will maximize
profits by producing at the output level at which MR = MC. The
monopolist in Figure 8.14 will produce Qm units of output and
charge a price of Pm.
• Consumer surplus has been reduced from P*AE to PmAC.
• Producer surplus has changed from the area BP*E to BPmCF.
Dead-weight Loss
• Before the monopolization of the industry:
The net benefits to society are given by the sum of consumer
and producer surplus, P*AE + BP*E = BAE.
• After monopolization of the industry :
The net benefits to society are given by the sum of consumer
and producer surplus PmAC + BPmCF = BACF.
• Since BACF < BAE, society has been made worse off as a result
of monopolization of the industry.
Dead-weight Loss
• The area GCE is referred to as consumer deadweight loss.
• The area FGE is referred to as producer deadweight loss.
• The portion of lost consumer and producer surplus is the area
GCE + FGE = FCE.
• The area FCE is referred to as total deadweight loss.
The Inefficiency of Monopoly
Price Discrimination
Welfare with and without Price Discrimination
A Summary Comparison
Monopolistic competition
• Monopolistic competition is a market structure in which
many firms sell products that are similar but not identical.
• Monopolistic competition describes a market with them
following attributes:
• Many sellers: There are many firms competing for the
same group of customers.
• Product differentiation: Each firm produces a product that
is at least slightly different from those of other firms. Thus,
rather than being a price taker, each firm faces a
downward-sloping demand curve.
• Free entry and exit: Firms can enter or exit the market
without restriction. Thus, the number of firms in the
market adjusts until economic profits are driven to zero.
Short-run Equilibrium
Long-run Equilibrium
Monopolistic Vs Perfect Competition
Monopolistic Competition: Between Perfect
Competition and Monopoly
Oligopoly
• Oligopoly is a market structure in which only a few sellers
offer similar or identical products.
• Oligopolistic firms may collude to avoid the uncertainties
arising from immense interdependence. This type is called
collusive oligopoly.
• In noncollusive oligopoly, firms do not collude, rather take
independent action which pushes them into a worse
position in terms of profit and market share.
• In collusive oligopoly, firms collude to enhance their profit
by avoiding uncertainty generated through independent
action of individual firm.
Warning!
• Never use these slides as a substitute of your text books.
• These slides should help to keep you on track, as a guiding
assistance of reading text books that has come to you along
with these slides.
• Please use the relevant sections of the following text books in
reading the slides.
• Microeconomics- N. Gregory Mankiw
• Managerial Economics- Christopher R. Thomas & S. Charles
Maurice.
• Managerial Economics - Thomas J. Webster
