Chapter Five

Market Structure
 The concept of market
• Market - place or digital space by which
goods, services and ideas are exchanged to
satisfy consumer need.

• It includes process of planning and executing

the conception, pricing, promotion, and
distribution of goods, services and ideas to
create exchanges that satisfy individual and
organizational objectives.
 The concept of market
• Physical market: is a set up where buyers can
physically meet their sellers and purchase the
desired merchandise from them in exchange of
money.
– E.g. Mercato

• Digital marketing: is the marketing of products or

services using digital technologies, mainly using
internet , mobile phones, display advertising, and
any other digital media.
– E.g. Amazon, eBay, Alibaba
 Types of market structure
• Perfectly competitive market

• Pure monopoly market

• Monopolistically competitive

• Oligopolistic market
Characteristics of market structures
 Perfectly competitive market
• A market structure where the market price is
independent of each firm’s level of output.
The firm is a price taker.

• Each firm only has to worry about how much

output it wants to produce.

• Whatever it produces can only be sold at one

price: the going market price.
Assumptions of perfectly competitive
market
• Large number of sellers and buyers - sellers and
buyers are price takers
• Homogeneous product- products are perfect
substitutes and no comparative advantage
• Perfect mobility of factors of production – factors can
move from one firm/industry to the other, and the are
not monopolized
• Perfect knowledge – buyers and sellers have full
information about market conditions
• Free entry and exit – no government interference
which prevent firms entering into the industry or
leaving it.
Demand curve facing a competitive
firm
 Revenue of a perfectly competitive firm
• Total Revenue (TR): it is the total amount of money a firm
receives from a given quantity of its product sold.
• 𝑻𝑹 = 𝑷 × 𝑸
• Where P = price of the product and Q = quantity of the
product sold.

• Average revenue (AR):- it is the revenue per unit of item

sold.
𝑻𝑹 𝑷.𝑸
• 𝑨𝑹 = = → 𝑨𝑹 = 𝑷
𝑸 𝑸
• Therefore, the firm‘s demand curve is also the average
revenue curve.
 Revenue of a perfectly competitive firm

• Marginal Revenue: it is the additional amount of

money/ revenue the firm receives by selling one
more unit of the product.
∆𝑻𝑹 ∆(𝑷×𝑸)
• 𝑴𝑹 = = = 𝑷 → 𝑴𝑹 = 𝑷
∆𝑸 ∆𝑸

• Thus, in a perfectly competitive market, a firm‘s

average revenue, marginal revenue and price of
the product are equal, i.e. AR = MR = P =Df
 Short run equilibrium of a
competitive firm
• The main objective of a firm is to maximize profit or
minimize loss.

Profit: the difference between total revenue and total cost.

𝝅 = 𝑻𝑹 − 𝑻𝑪

• There are two ways to determine the level of output at

which a competitive firm will realize maximum profit or
minimum loss.
– The total approach
– The marginal approach
 Total Approach (TR-TC approach)
• Firm maximizes total profits in the short run when the (positive) difference
between total revenue (TR) and total costs (TC) is greatest.

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.
 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.
– MR = MC, and
– MC is rising
Marginal Approach (MR-MC)
 Short run equilibrium of a
competitive firm
• Whether the firm in the short-run gets
positive or zero or negative profit depends on
the level of ATC at equilibrium.

• Depending on the relationship between price

and ATC, the firm in the short-run may earn
economic profit, normal profit or incur loss
and decide to shut-down the business.
 Economic/positive profit
• If the AC is below the market price at equilibrium, the firm earns a
positive profit equal to the area between the ATC curve and the price line
up to the profit maximizing output.
 Normal Profit (zero profit) or
break- even point
• If the AC is equal to the market price at equilibrium, the firm gets zero
profit or normal profit.
 Loss
• If the AC is above the market price at equilibrium, the firm earns a
negative profit (incurs a loss) equal to the area between the AC curve and
the price line.
 Shutdown point
• In the short run, the firm will not stop production simply because AC
exceeds price. 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 = min AVC is the shutdown point for the firm.
Perfect competition – three different cost situations
1. Describe each firm’s position relating to its profit.
2. If market demand increased and price rose to P1,
what would be the effect on each firm?
3. According to the theory of perfect competition, what
will happen following an increase of price to P1?
4. What output does a firm in perfect competition
choose?
5. How can an individual firm increase its profits?
 Short run equilibrium of a
competitive firm
Example 1: Suppose that the firm operates in a perfectly competitive market.
The market price of its product is 10birr.
The firm estimates its cost of production with the following cost
function: 𝑇𝐶 = 2 + 10𝑄 − 4𝑄2 + 𝑄3

A) What level of output should the firm produce to maximize its profit?
B) Determine the level of profit at equilibrium.
C) What minimum price is required by the firm to stay in the market?

Example 2: Given market price, P = 15birr and cost function,

TC =10 + 15𝑄 − 3𝑄 2 + 𝑄 3

A) Determine the profit maximizing level of output?

B) Determine the shutdown price of the firm?
The supply curve of a perfectly competitive
firm and industry
• Since 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.
 Short run equilibrium of the industry
• An industry is in equilibrium in the short-run when
market is cleared at a given price. i.e. when total supply
of the industry equals total demand for its product.
The prices at which market is cleared is equilibrium price.

• If at existing market price firms are making economic

profit or loss, the industry is only in the short run
equilibrium.
 Imperfect Market
• Markets with imperfect competition.

• A single firm has a certain degree of control over the

market price of its products.

• Occurs when one or more of the conditions for a perfectly

competitive market is/are violated.

• Three major types of imperfect markets:

o Pure monopoly
o Monopolistically competitive
o Oligopoly
 Monopoly market
• 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.
– Single seller
– No close substitutes
– Price maker
– Blocked entry
 Sources of monopoly
• Legal restriction – Public monopolies

• Patent rights – Patent monopolies

• Efficiency, economies of scale and high entry

costs – Natural monopolies

• Control over key raw materials

 Monopolistically competitive market
• This market model can be defined as the market
organization in which 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.
 Monopolistically competitive market
• Differentiated product – style, brand, quality etc.

• Many sellers and buyers – not as large as perfect

competition

• Easy entry and exit – no barrier on firms to entre or

leave the market

• Existence of non-price competition – product quality,

advertisement, brand name, service to customers, etc.
 Oligopoly market
• Few dominant firms – high rivalry among firms

• Interdependence – the decision one firm affects

the profitability of other firms

• Products may be homogenous or differentiated

– pure and differentiated oligopoly

• Entry barrier – economies of scale, legal, control

of strategic inputs, etc.
 Oligopoly market
• Lack of uniformity in the size of firms – firms
differ considerably in size.

• Non-price competition – avoid price

competition due to the fear of price wars.

• A special type of oligopoly in which there are

only two firms in the market is known as
duopoly.