CHAPTER FIVE
MARKET STRUCTURE
Introduction
How a particular firm makes a decision to achieve its profit
maximization
Four major types of markets:
A. perfectly competitive market,
A. monopolistically competitive market,
A. oligopolistic market, and
A. pure monopoly market.
5.1 The Concept of Market in Physical
and Digital Space
A market describes place or digital space by which goods,
services and ideas are exchanged to satisfy consumer need.
The means can be categorized as:
A. Digital marketing is the marketing of products or services
using digital technologies, mainly on the internet but also
including mobile phones, display advertising, and any other
digital media, using digital networks.
A. Physical market is a set up where buyers can physically meet
their sellers and purchase the desired merchandise from them
in exchange of money.
5.2. Perfectly Competitive Market
Perfect competition is a market structure characterized by a
complete absence of rivalry among the individual firms.
A market is said to be pure competition (perfectly competitive
market) if the following assumptions are satisfied.
I. Large number of sellers and buyers:
II. Homogeneous product:
III. Perfect mobility of factors of production:
IV. Free entry and exit:
V. Perfect knowledge about market conditions:
VI. No government interference.
Cont…
Large number of sellers and buyers:
The share of each seller in the total supply of a product is
very small.
No single seller can influence the market price by changing the quantity
supply.
The number of buyers is so large.
the share of each buyer in the total demand is very small.
no single buyer can influence the market price
o by changing their individual for a product.
Sellers and buyers are not price makers but price takers.
The price is determined by market supply and demand
forces.
Cont…
Homogeneous product:
Implies that buyers do not distinguish between products supplied by the
various firms of an industry.
Product of each firm is regarded as a perfect substitute for the products of
other firms.
Therefore, no firm can gain any competitive advantage over the other firm.
Perfect mobility of factors of production:
Factors of production are free to move from one firm to another throughout
the economy.
Labour can move from one job to another and from one region to another.
Capital, raw materials, and other factors are not monopolized.
Cont…
Free entry and exit:
There is no restriction or market barrier on entry of new firms
to the industry, and
No restriction on exit of firms from the industry.
A firm may enter the industry or quit it on its accord.
Perfect knowledge about market conditions:
All the buyers and sellers have full information regarding;
o the prevailing and future prices and
o availability of the commodity.
Cont…
No government interference:
Government does not interfere in any way with the
functioning of the market.
There are;
o no discriminator taxes or subsidies,
o no allocation of inputs by the procurement, or
o any kind of direct or indirect control.
The government follows the free enterprise policy.
Where there is intervention by the government, it is
intended to correct the market imperfection.
Cont…
A single producer is a price-taker.
At the market price, the firm can supply whatever quantity it would like
to sell.
Once the price of the product is determined in the market, the producer
takes the price.
The demand curve (Df) that the firm faces in this market situation is a
horizontal line drawn at the equilibrium price, Pm.
Short run equilibrium of the firm
The main objective of a firm is profit maximization.
If the firm has to incur a loss, it aims to minimize the loss.
Profit is the difference between total revenue and total cost.
Total Revenue (TR): it is the total amount of money a firm
receives from a given quantity of its product sold.
Cont…
Marginal Revenue: it is the additional amount of money/
revenue the firm receives by selling one more unit of the
product.
It is the change in total revenue resulting from the sale of an
extra unit of the product.
Cont…
A competitive firm will maximize its economic profit only by
adjusting its output.
only through changes in the amount of variable resources.
It adjusts its variable resources to achieve the output level that
maximizes its profit.
There are two ways to determine the level of output at which a
competitive firm will realize maximum profit or minimum loss.
I. Total approach (TR-TC approach)
II. Marginal approach (MR-MC approach)
a) Total Approach (TR-TC approach)
Note: The profit maximizing output level is Qe because it is at this output level
that the vertical distance between the TR and TC curves (or profit) is
maximized.
b) Marginal Approach (MR-MC)
In the short run, the firm will maximize profit or minimize loss
by producing the output at which marginal revenue equals
marginal cost.
More specifically, the perfectly competitive firm maximizes its
short-run total profits at the output when;
I. MR = MC
I. The slope of MC is greater than slope of MR;
or MC is rising) (that is, slope of MC is greater than zero).
Cont…
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Whether the firm in the short- run gets positive or zero or
negative profit depends on the level of ATC at equilibrium.
Thus, depending on the relationship between price and ATC, the
firm in the short-run may;
A. earn economic profit,
B. normal profit or
C. incur loss and
decide to shut-down business.
Cont…
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iv) Shutdown point - The firm will not stop production simply
because AC exceeds price in the short-run.
The firm will continue to produce irrespective of the existing loss
as far as the price is sufficient to cover the average variable costs.
This means, if P is larger than AVC but smaller than AC, the
firm minimizes total losses.
But if P is smaller than AVC, the firm minimizes total losses by
shutting down.
Thus, P = AVC is the shutdown point for the firm.
Cont…
Short run equilibrium of the industry
The perfectly competitive firm always produces where;
P =MR=MC (as long as P exceeds AVC).
The firm‘s short-run supply curve is given by;
the rising portion of its MC curve above its AVC, or
shutdown point.
The industry/market supply curve is;
a horizontal summation of the supply curves of the
individual firms. Or
can be obtained by multiplying the individual supply at
various prices by the number of firms, if firms have
identical supply curve.
5.3. Monopoly Market
Definition and Characteristics:
This is at the opposite end of the spectrum of market
structures.
Pure monopoly exists when a single firm is the only
producer of a product for which there are no close
substitutes.
Cont…
Main characteristics:
A. Single seller:
A pure or absolute monopoly is a one firm industry.
A single firm is the only producer of a specific product or the sole
supplier of the product;
The firm and the industry are synonymous.
B. No close substitutes:
The monopolist‘s product is unique in that there are no good or close
substitutes.
From the buyer‘s view point, there are no reasonable alternatives.
Cont…
C. Price maker:
The individual firm exercises a considerable control over price.
The firm confronted a down ward sloping demand curve for its product,
The monopolist can change product price by changing the quantity of the
product supplied.
D. Blocked entry:
A pure monopolist has no immediate competitors because of barriers.
Potential competitors never enters in to the industry.
These barriers may be economic, legal, technological etc.
Under conditions of pure monopoly, entry is totally blocked.
Cont…
Sources of Monopoly
There are many factors which prevent the entry of other
firms in to the industry.
The barriers to entry are therefore the sources of
monopoly power.
The major sources of barriers to entry are:
A. Legal restriction:
B. Control over key raw materials:
C. Efficiency:
D. Patent rights:
Cont…
Legal restriction: some monopolies are created by law
in public interest.
Control over key raw materials: Some firms acquire monopoly
power from their traditional control over certain scarce and key
raw materials that are essential for the production of certain other
goods.
Efficiency: a primary and technical reason for growth of
monopolies is economies of scale.
Monopolies created through efficiency are known as
natural monopolies.
Cont…
Patent rights: are granted by the government to a firm;
to produce commodity of specified quality and
character or
to use specified rights to produce the specified
commodity or
to use the specified technique of production.
Such monopolies are called to patent monopolies.
5.4 Monopolistically Competitive Market
In this market, there are relatively many firms selling
differentiated products.
It is the blend of competition and monopoly.
The competitive element arises from the existence of large
number of firms and no barrier to entry or exit.
The monopoly element results from differentiated products, i.e.
similar but not identical products.
Cont…
A seller of a differentiated product has limited monopoly power
over customers who prefer his product to others.
His monopoly is limited because the difference between his
product and others are small enough that they are close substitutes
for one another.
This market is characterized by:
A. Differentiated product:
B. Many sellers and buyers:
C. Easy entry and exit:
D. Existence of non-price competition:
Cont…
NOTE:
The product produced and supplied by many sellers in the market
is similar but not identical.
The difference could be in style, brand name, in quality, or others. in the
eyes of the buyers.
Hence, the differentiation of the product could be real (eg. quality) or
fancied (e.g. difference in packing).
The number is not as large as that of the perfectly competitive
market.
Economic rivals take the form of non-price competition in terms
of product quality, advertisement, brand name, service to
customers, etc.
5.5. Oligopoly Market
This is a market structure characterized by:
Cont…
Chapter summary