Market Structure

What is a Market?
• In Economics, Market means an arrangement that establishes an
effective relationship between buyers and sellers of a commodity.
• Market structure explains the way in which goods and services are
supplied by firms in a particular market.
Forms of Market

Perfect Monopolistic
Oligopoly Monopoly
Competition Competition

Imperfect Competition
Characteristics of each Market
Characteristics Perfect Competition Monopolistic Oligopoly Monopoly
Competition
Number of Firms Large Large Few One
Barriers to entry None Low High Very high
Nature of Product Homogeneous Differentiated Differentiated or Unique
Identical
Control over price Price taker Limited Limited Price maker
Availability of Perfect Limited Limited Less
information
Possible consumer Elastic Elastic Inelastic Inelastic
demand
Barriers to entry & exit

Market Physical
Legal Barriers Cost Barriers
Barriers Barriers
• Market is • Consumer • The access to • Monopoly
state owned loyalty capital will access to raw
or produced towards be limited to materials,
under licence established few large components
from the brand firms. or raw
Government materials
Perfect competition
Characteristics
• There is a large number of firms.
• All firms produce identical, or homogeneous products.
• There is free entry and exit.
• There is perfect (complete) information.
• There is perfect resource mobility
• The firm is a price taker
Short-run
Determine Determine per Determine total
output unit profit/loss Profit/total loss

• Compare MR • Compare • Multiply the per

with MC to average revenue unit profit/loss by
determine profit (or price) and the quantity to
maximizing level average total get the total
of output cost to profit/ loss.
determine the
amount of profit
(or loss) per unit
of output
Super-normal Profit, Normal Profit and Sub-normal
Profit in the Short-run

Supernormal Profit Normal Profit

Subnormal Profit
 Shut down in the Short run

The price P = minimum AVC is called the shutdown If the price falls below the shut-down price, or below minimum
price, and is P4 in the above diagram. At this price, AVC, the firm should shut down. In the above diagram, if the
the firm’s loss per unit of output is exactly equal to firm were to produce, it would produce Q5 units of output,
AFC, or ATC – AVC (the vertical difference between where MC = MR. But at Q5 the loss per unit is equal to the
points e and f). distance between points g and h, which is greater than AFC.
Therefore, the firm is better off not producing at all, and its loss
will equal its fixed costs.
Summary of the perfectly competitive firm’s
short-run decisions, and the firm’s short-run
supply curve
Summary
In perfect competition in the short run:
• When P > ATC, the firm makes supernormal profit.
• When P = minimum ATC, the firm makes normal profit. This P is a break-even price of
the firm (at the break-even point).
• When ATC > P > AVC, the firm produces at a loss, but its loss is less than fixed costs;
therefore, it continues to produce.
• When P = minimum AVC, the firm’s loss = fixed costs; this P is the firm’s short-run
shut-down price.
• When P < AVC, i.e. when price falls below the shut-down price, the firm shuts down
(stops producing); its loss will then be more than its fixed costs.
• The MC curve represent the various quantities that a firm is willing and able to supply in
a market at different possible prices. Therefore the firm’s short-run supply curve is the
segment of the MC curve which begins at P = minimum AVC.
Monopoly
Features
• There is a single seller or dominant firm in the market
• There are no close substitutes
• There are significant barriers to entry
• The monopolist is a price maker

Note that: Monopoly power arises whenever a firm faces a demand curve
that is downward-sloping. Firms in all market structures except perfect
competition face a downward-sloping demand curve and therefore have
varying degrees of monopoly power, or the ability to influence the price at
which they sell their output.
Demand & Revenue Curves
• Since the pure monopolist is the entire industry, the demand curve it faces
is the industry or market demand curve, which is downward-sloping.
• Under monopoly, As price (P) falls, output (Q) increases because of the
downward-sloping demand curve. Total revenue (TR), obtained by Q×P, at
first increases, reaches a maximum, and then begins to fall.
• Marginal revenue, showing the change in total revenue resulting from a
change in output, falls continuously; MR is equal to zero when total
revenue is at its maximum and becomes negative when total revenue falls.
• Average Revenue is equal to price. The AR and P curves represent the
demand curve facing the firm.
• The MR curve lies below the demand curve.
Profit maximisation by the monopolist

Supernormal Profit Subnormal Profit

Natural Monopoly
If the market demand for a product is within the range of falling
LRATC, this means that a single large firm can produce for the
entire market at a lower average total cost than two or more
smaller firms. When this occurs, the firm is called a natural
monopoly.
The demand curve intersects the ATC curve before ATC reaches
its minimum, indicating that economies of scale have not
been full exhausted.
Using the MC = MR rule, we find the unregulated monopoly
produces Qm output and sells it at price Pm, with supernormal
profit per unit given by a – b.
Marginal Cost Pricing:
Marginal cost pricing forces an efficient allocation of
resources, and quantity of the good produced increases
to the socially desirable level. It is set where P = MC (allocative
efficiency.
The intersection of the demand (or AR) and MC curves give rise
to price Pmc and to quantity Qmc.
Natural Monopoly
Average Cost Pricing:
This price is determined by the intersection of the demand curve
with the ATC curve, occurring at point e and giving rise to price
Pac and quantity Qac.
Average cost pricing results in a higher price than marginal cost
pricing (Pac > Pmc) and a lower quantity (Qac < Qmc), indicating
that it is not as efficient as marginal cost pricing.
Average cost pricing results in a higher price than marginal cost
pricing (Pac > Pmc) and a lower quantity (Qac < Qmc), indicating
that it is not as efficient as marginal cost pricing.
Monopoly Vs Perfect Competition
 Monopoly price is higher than the Perfectly competitive price
 Monopoly output is lower than the perfectly competitive
output
 The monopoly is making short and long run profit whereas a
perfectly competitive firm make profit only in the short run
but not in the long run
 A firm in PC is productively and allocatively efficient whereas a
monopolist is neither productively efficient nor allocatively
efficient (P>MC)
 Consumer surplus in monopoly is less than in perfect
competition due to the higher price that is charged by a
monopolist.
 Producer surplus in monopoly is greater than in perfect
competition because the monopolist’s higher price and lower
output has taken away some of the consumer surplus.
 The deadweight loss is the sum of the loss of the total
consumer surplus and producer surplus.
Monopolistic Competition
Features
• There is a large number of buyers and sellers.
• There are few barriers to entry into the market.
• Consumers face a wide choice of differentiated products.
• Each firm has a slight degree of monopoly power in that it controls its
own brand through quality and physical differences.
• Firms have some influence on the market price and are therefore
price makers.
Monopolistic Competition – Short -run
Monopolistic Competition – Long -run
 At the profit maximising level of output, Qe,
price is higher than MC, indicating that there is
an under allocation of resources to the
production of the good.
 production occurs at greater than minimum
average total cost, and therefore average cost
is higher than what is optimal from society’s
point of view.
 Qc is the capacity output or optimum output,
where ATC is the minimum.
 the long-run equilibrium of the firm in
monopolistic competition, indicates that
neither allocative nor productive efficiency is
achieved.
Oligopoly
Features
• There are few large firms
• High barriers to entry
• The products may be differentiated or undifferentiated
• There is mutual interdependence
• Price rigidity
Non-collusive Oligopoly - Kinked Demand
Curve
 The kinked demand curve is a model that has been
developed to explain price rigidities of oligopolistic
firms that do not collude.
 Suppose a firm increases its price. This will not be
followed by all firms as they have little to gain since
their revenue is likely to fall.
 If price is reduced, there will be the same reaction from
all firms. Again, revenue will fall.
 Any change in costs, for example from MC1 to MC2,
will not lead to a price increase. Prices will tend to
stay the same and to change little over time.
Game Theory
 The characteristics of mutual
Firm A interdependence, strategic behaviour, and
conflicting incentives are illustrated very
Payoff figures are in Rs ‘000 effectively by game theory.
High Price Low Price  The Nash equilibrium shows that there is
(100) (60) sometimes a conflict between the pursuit
of individual self-interest and the collective
40/40 10/50 firm interest.
High Price  This conflict is the prisoner’s dilemma.
(100)  Although the firms could be better off by
Firm B

cooperating, each firm, trying to make itself

50/10 20/20 better off, ends up making both itself and
Low Price its rival worse off
(60)
Contestable Market
• A market where entry is free and exit is costless.
• A market is perfectly contestable where:
there is a pool of potential entrants seeking to enter the market
entry and exit are costless
 all firms are subject to the same regulations and state of technology
mechanisms are in place to prohibit limit pricing, as existing firms have lower
costs than potential entrants
firms already in the market are vulnerable to ‘hit and run’ competition