JMJ Marist Brothers

COLLEGE OF BUSINESS ADMINISTRATION

Notre Dame of Marbel University
City of Koronadal

A MODULE IN BAC 101 (BASIC MICROECONOMICS)

MODULE 5
MARKET STRUCTURES
LEARNING OUTCOMES
At the end of the module, the students can be able to:

1. Explain are the essential features of a market.

2. Familiarize what is a market structure.
3. Identify determinants of a market structure.
4. Differentiate the forms of market structure.
5. Analyze how is profit determined under each form.

INTRODUCTION
The concept of market structure is central to both economics and marketing. Both disciplines are
concerned with strategic decision making. In decision-making analysis, market structure has an important
role through its impact on the decision-making environment. The extent and characteristics of competition
in the market affect choice behavior among the actors.

The problem for economists is that a meaningful operational definition of market structure is elusive.
Each discipline takes a different methodological approach toward solving this problem, and each has its
own strengths and limitations. Economics is concerned with broad socio-economic issues as well as
managerial, microeconomic problems.

The purpose of this module is to build an understanding of the importance of market structure. As
different market structures result in different sets of choices facing a firm’s decision makers, an
understanding of market structure is a powerful tool in analyzing issues such as pricing and potential to
increase profitability.

In the long run, a firm’s profitability will be determined by the forces associated with the market structure
within which it operates. In a highly competitive market, long run profits will be driven down by the
forces of competition. In less competitive markets, large profits are possible even in the long run. In the
short run, any outcome is possible. Therefore, understanding the forces behind the market structure will
aid the analyst in determining firm’s short- and long-term prospects.

ACTIVITY

Give examples of industry that belongs to the different market structures.

ACQUISITION OF NEW KNOWLEDGE
Contents:

1. Market Structure
2. Market
3. Essential Features of a Market
4. Determinants of the Market Structure
5. Market Structure Forms, Characteristics and Profit Determination

APPLICATION (Written task). In not more than 1,000 words, answer the questions assigned to you.
1) On Perfect Competition.
a) What are the main characteristics of a competitive market?
b) Explain the difference between a firm’s revenue and its profit. Which do firms maximize?
c) Under what conditions will a firm shut down temporarily? Explain.
d) Under what conditions will a firm exit a market? Explain.
e) Are market supply curves typically more elastic in the short run or in the long run? Explain.
2) On Monopoly.
a) Give an example of a government-created monopoly. Is creating this monopoly necessarily bad
public policy? Explain.
b) Define natural monopoly. What does the size of a market have to do with whether an industry is a
natural monopoly?
c) Why is a monopolist’s marginal revenue less than the price of its good? Can marginal revenue
ever be negative? Explain.
d) What gives the government the power to regulate mergers between firms? Give a good reason
and a bad reason (from the perspective of society’s welfare) that two firms might want to merge.
e) Describe the two problems that arise when regulators tell a natural monopoly that it must set a
price equal to marginal cost.
3) On Monopolistic Competition
a) Describe the three attributes of monopolistic competition. How is monopolistic competition like
monopoly? How is it like perfect competition?
b) Does a monopolistic competitor produce too much or too little output compared to the most
efficient level? What practical considerations make it difficult for policymakers to solve this
problem?
c) How might advertising reduce economic well-being? How might advertising increase economic
well-being?
d) How might advertising with no apparent informational content in fact convey information to
consumers?
e) Explain two benefits that might arise from the existence of brand names.
4) On Oligopoly
a) If a group of sellers could form a cartel, what quantity and price would they try to set?
b) Compare the quantity and price of an oligopoly to those of a monopoly.
c) Compare the quantity and price of an oligopoly to those of a competitive market.
d) Compare the quantity and price of an oligopoly to those of a competitive market.
e) How does the number of firms in an oligopoly affect the outcome in its market?

ASSESSMENT

Quiz
Market structure refers to the nature and degree of competition in the market for goods and services.
The structures of market both for goods market and service market are determined by the nature of
competition prevailing in a particular market.
Market refers to a particular place where goods are purchased and sold. In economics, it does not mean a
particular place but the whole area where the buyers and sellers of a product are spread as today the sale
and purchase of goods are through agents, samples, letters, telegrams, phones, internet, etc. The price of a
commodity is the same in the whole market. Chapman: “The term market refers not necessarily to a place
but always to a commodity and the buyers and sellers who are in direct competition with one another.”
Cournot: “Market is not any particular place in which things are bought and sold but the whole of any
region in which buyers and sellers are in free interaction with one another that the price of the same goods
tends to equality, easily and quickly.”
Essential Features of a Market
An Area. Modern modes of communication and transport have made the market area for a product very
wide.
One Commodity. A market is not a place but a product as there are separate markets for each commodity.
Buyers and Sellers. The presence of buyers and sellers is necessary for the sale and purchase of a product
in the market. Sometimes, the presence of buyers and sellers is not necessary in the market because they
can do transactions of goods through other means.
Free Competition. There should be free competition among buyers and sellers in the market in relation to
price determination of a product among buyers and sellers.
Market. The whole region where buyers and sellers of that product are spread and there is such free
competition that one price for the product prevails in the entire region – Mechanism whereby the desires
of buyers (demand) and sellers (supply) meet.

Determinants of the Market Structure

Number and Nature of Sellers. The market structures are influenced by the number and nature of sellers
in the market. They range from large number of sellers in perfect competition to a single seller in pure
monopoly, to two sellers in duopoly, to a few sellers in oligopoly, and to many sellers of differentiated
products. If there is a single buyer in the market, this is buyer’s monopoly and is called monopsony
market. Such markets exist for local labor employed by one large employer. There may be two buyers
who act jointly in the market called duopsony market. There may be a few organized buyers of a product
known as oligopsony. Duopsony and oligopsony markets are usually found for cash crops like rice,
sugarcane, etc. when local factories purchase the entire crops for processing.

Entry and Exit Conditions. Conditions for entry and exit of firms in a market depend upon profitability
or loss in a particular market. Profits in a market will attract the entry of new firms and losses lead to the
exit of weak firms from the market. Perfect competition market - freedom of entry or exit of firms.
Monopoly – barriers to entry of new firms like governments have a monopoly in public utility services
like postal, air and road transport, water and power supply services, etc - granting exclusive franchises,
entries of new supplies are barred. Oligopoly markets, there are barriers to entry of firms because of
collusion (cartels, mergers, conglomerates) and agreements. No restrictions in entry and exit in
monopolistic competition due to product differentiation.

Economies of Scale. Firms that achieve large economies of scale in production grow large in comparison
to others in an industry. Tend to weed out the other firms with the result that a few firms are left to
compete with each other leading to the emergency of oligopoly. If only one firm attains economies of
scale to such a large extent that it is able to meet the entire market demand, there is monopoly.

Forms of Market Structure

On the basis of competition, a market can be classified as:

1. Perfect Competition;
2. Monopoly;
3. Monopolistic Competition; and
4. Oligopoly.

Perfect Competition Market

The number of buyers and sellers is very large, all engaged in buying and selling a homogeneous product
without any artificial restrictions and possessing perfect knowledge of market at a time. Koutsoyiannis:
“Perfect competition is a market structure characterized by a complete absence of rivalry among the
individual firms.” Lipsey, “Perfect competition is a market structure in which all firms in an industry are
price-takers and in which there is freedom of entry into, and exit from, industry.”

Characteristics of Perfect Competition Market

Large Number of Buyers and Sellers. The first condition is that the number of buyers and sellers must be
so large that none of them individually is in a position to influence the price and output of the industry as
a whole. The demand of individual buyer relative to the total demand is so small that he cannot influence
the price of the product by his individual action. Similarly, the supply of an individual seller is so small a
fraction of the total output that he cannot influence the price of the product by his action alone - the
individual seller is unable to influence the price of the product by increasing or decreasing its supply.
Adjusts supply to the price of the product - “output adjuster” - no buyer or seller can alter the price by his
individual action - accepts the price for the product as fixed for the whole industry - “price taker”.
Freedom of Entry or Exit of Firms. Firms are free to enter or leave the industry - implies that whenever
the industry is earning excess profits, attracted by these profits, some new firms enter the industry. Firms
leave the industry in case of losses.
Homogeneous Product. Each firm produces and sells homogeneous product – no buyer has any
preference for the product of any individual seller over others. Only possible if same product produced by
different sellers are perfect substitutes - cross elasticity is infinite. No seller has an independent price
policy - cannot raise the price of his product as customers would leave and buy from other sellers at ruling
low price. These conditions make the AR curve of the individual seller or firm perfectly elastic
(horizontal to the X-axis) – a firm can sell more or less at existing market price but cannot influence the
price due to homogeneous product and very large number of sellers.
Absence of Artificial Restrictions. Complete openness in buying and selling of goods. Sellers are free to
sell their goods to any buyers and the buyers are free to buy from any sellers - no discrimination on the
part of buyers or sellers. Prices are liable to change freely in response to demand-supply conditions. No
efforts on producers, government and other agencies to control the supply, demand or price of the
products - movement of prices is free.
Profit Maximization Goal. Every firm has only one goal – maximizing profits.
Perfect Mobility of Goods and Factors. Goods are free to move to those places where they can fetch the
highest price. Resources can move from a low-paid to a high-paid industry.
Perfect Knowledge of Market Conditions. Implies a close contact between buyers and sellers.
Knowledge about prices of goods bought and sold, and prices which others are prepared to buy and sell.
Knowledge of the place where the transactions are being carried on. Forces the sellers to sell their product
at the prevailing market price and the buyers to buy at that price.
Absence of Transport Costs. Essential for the existence of perfect competition which requires that a
commodity must have the same price everywhere at any time. If transport costs are added to the price of
the product, even a homogeneous commodity will have different prices depending upon transport costs
from the place of supply.
Absence of Selling Costs. Costs of advertising, sales-promotion, etc. do not arise because all firms
produce a homogeneous product.

Profit Maximization Condition. At MR=MC, P=AR>ATC>AVC.

Loss Minimization Condition. At MR=MC, ATC>P=AR>AVC

Equilibrium Condition. At MR=MC, P=AR=ATC>AVC

Shutdown Condition. At MR=MC, ATC>P=AR=AVC

Shutdown price is the price at which a firm should shut down even in the short run. Equal to a firm’s
minimum possible average variable cost (AVC) because the firm will never be able to achieve an AVC
lower than this. If the market price is less than even at the lowest-possible AVC, there is no output level at
which the firm will earn positive contribution margin. It does not make sense for a firm to keep producing
if the sales revenue (TR) will not cover even the total variable costs (TVC) at a firm’s optimal output.

Pure Monopoly Market

Market situation wherein there is only one seller of a product with barriers to entry of others. The product
has no close substitutes. No other firms produce a similar product.
Salvatore: “Monopoly is the form of market organization in which there is a single firm selling a
commodity for which there are no close substitutes.”
Firm is itself an industry and faces the industry demand curve. The demand curve for product is relatively
stable and slopes downward to the right, given the tastes, and incomes of customers – more products can
be sold at a lower price than at a higher price.
Price-maker/price setter - set the price to maximum advantage - can set either price and output.
Characteristics of a Pure Monopoly Market
There is one producer or seller of a particular product and there is no difference between a firm and an
industry - firm itself is an industry - may be individual proprietorship or partnership or joint-stock
company or a cooperative society or a government company - Has full control on the supply of a product.
There is no close substitute of a monopolist’s product in the market - cross elasticity of demand for a
product with some other good is very low.
There are restrictions on the entry of other firms in the area of monopoly product.
Demand curve slopes downwards to the right – can increase sales only by decreasing the price thereby
maximize profit.
The MR curve of a monopolist is below the AR curve and it falls faster than the AR curve - because a
monopolist has to cut down the price of his product to sell an additional unit.

Profit Maximizing Condition. At MR=MC, P=AR>ATC>AVC

Loss Minimizing Condition. At MR=MC, ATC>P=AR>AVC

Equilibrium Condition. At MR=MC, ATC=P=AR>AVC

Shut-down Condition. At MR=MC, ATC>P=AR=AVC

Monopolistic Competition Market

Monopolistic competition is a market where there are many firms selling a differentiated product. There is
competition which is keen, though not perfect, among many firms making very similar products. No firm
can has any perceptible influence on the price-output policies of the other sellers nor can it be influenced
much by their actions. Thus monopolistic competition refers to competition among a large number of
sellers producing close but not perfect substitutes for each other.
Characteristics of Monopolistic Competition Market
Large Number of Sellers. The number of sellers is large - “many and small enough” but no one controls a
major portion of the total output. No seller by changing its price-output policy can have any perceptible
effect on the sales of others and in turn be influenced by them. No recognized interdependence of the
price-output policies of the sellers and each seller pursues an independent course of action.
Product Differentiation. Product differentiation exists which implies that products are different in some
ways from each other - heterogeneous rather than homogeneous so that each firm has an absolute
monopoly in the production and sale of a product. Slight difference between one product and other in the
same category. Products are close substitutes with a high cross-elasticity but not perfect substitutes.
“Differentiation may be based upon certain characteristics of the products itself, like exclusive patented
features; trademarks; trade names; peculiarities of package or container, if any; or singularity in quality,
design, color, or style - may also exist with respect to the conditions surrounding its sales.”

Freedom of Entry and Exit of Firms. As firms are of small size and are capable of producing close
substitutes, they can leave or enter the industry or group in the long run.
Nature of Demand Curve. No single firm controls more than a small portion of the total output of a
product. There is differentiation but products are close substitutes. Reduction in price will increase the
sales of the firm but it will have little effect on the price-output conditions of other firms, each will lose
only a few of its customers. Increase in its price will reduce its demand substantially but each of its rivals
will attract only a few of its customers. The demand curve or average revenue curve of a firm under
slopes downward to the right - elastic but not perfectly elastic within a relevant range of prices.
Independent Behavior. Every firm has independent policy. As the number of sellers is large, none
controls a major portion of the total output. No seller by changing its price-output policy can have any
effect on the sales of others and in turn be influenced by them.
Product Groups. There is no any industry but a group of firms producing similar products. Each firm
produces a distinct product and is itself an industry. Chamberlin: Lumps together firms producing very
closely related products and calls them product groups.
Selling Costs. Where the product is differentiated, selling costs are essential to push up the sales. Besides,
advertisement, it includes expenses on salesman, allowances to sellers for window displays, free service,
free sampling, premium coupons and gifts, etc.
Non-price Competition. A firm increases sales and profits without a cut in price – can change his
product by varying its quality, packing, etc. or by changing promotional programs.
NOTE: THE GRAPHICAL PRESENTATION UNDER MONOPOLISTIC COMPETITION IS SIMILAR
TO MONOPOLY.

Oligopoly Market
Market situation in which there are a few firms selling homogeneous or differentiated products –
“competition among the few”. Action of one firm is likely to affect the others. Produces either a
homogeneous product (pure or perfect oligopoly) or heterogeneous products (imperfect or differentiated
oligopoly). Pure oligopoly produces industrial products. Imperfect oligopoly produces consumer goods.
Characteristics of Oligopoly Market
Interdependence. Each firm knows that changes in its price, advertising, product characteristics, etc. may
lead to counter-moves by rivals. When the sellers are few, each produces a considerable fraction of the
total output of the industry and can have a noticeable effect on market conditions. Can change the price
for the whole market by selling more quantity or less affecting profits of other sellers – implies that each
seller is aware of the price moves of other sellers and their impact on profit and influence of price move
on actions of rivals - complete interdependence among the sellers with regard to price-output policies.
Advertisement. Decision making is dependent on the policies of other producers in the industry so spend
much on advertisement and customer services. Baumol: “In oligopoly, advertising can become a life-and-
death matter.” If all oligopolists continue to spend a lot on advertising and one seller does not match with
them, this seller will find his customers gradually going in for rival’s product. If one oligopolist advertises
his product, others will follow to keep up their sales.
Competition. A move by one seller immediately affects the rivals. Each seller is always on the alert and
keeps a close watch over the moves of its rivals in order to have a counter-move – true competition.
Barriers to Entry or Exit of Firms. Short-run: None. Long run: Economies of scale enjoyed by a few
large firms; control over essential and specialized inputs; high capital requirements due to plant costs,
advertising costs, etc; exclusive patents and licenses; and the existence of unused capacity which makes
the industry unattractive. When entry is restricted or blocked by such natural and artificial barriers, the
oligopolistic industry can earn long-run super normal profits. When entry is restricted or blocked by such
natural and artificial barriers, the oligopolistic industry can earn long-run super normal profits.
Lack of Uniformity in the size of Firms. Firms differ considerably in size - asymmetrical. A symmetrical
situation with firms of a uniform size is rare.
Demand Curve. How an individual seller’s demand curve look in oligopoly is uncertain because a seller’s
price or output moves lead to unpredictable reactions on price-output policies of his rivals that have
repercussions on his price and output. Complex system of crossed conjectures emerges as a result of the
interdependence among the rival oligopolists which is the main cause of the uncertain demand curve. As
the oligopolist does not have a definite demand curve for his product, sales depend upon his current price
and those of his rivals. In differentiated oligopoly where each seller fixes a separate price for product, a
reduction in price by one seller may lead to an equivalent, more, less or no price reduction by rival sellers.
A demand curve can be drawn by the seller within the range of competitive and monopoly demand
curves. Leaving aside retaliatory price movements, the individual seller’s demand curve under oligopoly
for both price cuts and increases is neither elastic than under perfect or monopolistic competition nor
inelastic than under monopoly. In the graph, where KD1 is elastic demand curve, MD is inelastic demand
curve, and oligopolist’s demand curve is the dotted kinked KPD.

If an oligopolist reduces price, rivals will also lower prices so that the oligopolist will not be able to
increase sales. So the demand curve for the individual seller’s product will be inelastic just below the
present price P (where KD1and MD curves are shown to intersect). When he raises its price, the other
sellers will not follow to earn larger profits at the old price. This individual seller will experience a sharp
fall in the demand for his product – demand curve above the price P in the segment KP will be highly
elastic. Demand curve of an oligopolist has a KINK at the current price P - much more elastic for price
increases than for price decreases.

The Kinked Demand Curve. The KINK is formed at the prevailing price level because the segment of
the demand curve above the prevailing price level is highly elastic and the segment of the demand curve
below the prevailing price level is highly inelastic.
Origin of the Kinked Demand Curve

The MR Curve of the Kinked Demand Curve

Profit Maximizing Oligopoly. At MR=MC, P=AR>ATC>AVC

No Unique Pattern of Pricing Behavior. The rivalry arising from interdependence among the
oligopolists leads to two conflicting motives. Each wants to remain independent and to get the maximum
possible profit – they act and react on the price-output movements of one another in a continuous element
of uncertainty. Motivated by profit maximization, each seller wishes to cooperate with his rivals to reduce
or eliminate the element of uncertainty - enter into a tacit or formal agreement with regard to price-output
changes - leading to a sort of monopoly within oligopoly - may even recognize one seller as a leader at
whose initiative all the other sellers raise or lower the price. The individual seller’s demand curve is a part
of the industry demand curve, having the elasticity of the latter. Not possible to predict any unique pattern
of pricing behavior in oligopoly markets.

SUMMARY OF THE FEATURES OF MARKET STRUCTURES

Market Number of Number of Barriers to Entry and Exit Homogeneous or Differentiated

Structure Sellers Buyers Entry Activity Product

PC Many Many None Yes Homogeneous

M One Unspecified Complete Blocked Entry Single, homogeneous, no close

substitutes

MC Many Many Very low Yes Differentiated but close

substitutes for consumers

O Few Unspecified High Difficult Differentiated or homogeneous

Market Short-run Long-run Profits Price Taker or Price Demand Curve

Structure Profits Setter

PC Available No Price Taker - Firm chooses Perfectly elastic

quantity but takes price
from the market.

M Available Available Price Setter Inelastic, to be an effective

monopoly

MC Available No Price Setter Very elastic but not

perfectly elastic because
close substitutes exist

O Available Available if entry is blocked and Price Setter Inelastic, to be an effective

the colluding cartel holds together oligopoly

REFERENCES

Mankiw, G. (2019). Principles of economics (7th ed.). Retrieved from http://blog.fezah.com/cgi-

bin/content/view.php?q=principles+of+economics+7th+edition+n+gregory+mankiw+pdf+pdf&id=62
58c26d65e8d89ce0e8fb2760fd3f77

Principles of economics (n.d.). Retreived January 12, 2021 from https://opentextbc.ca/principlesof

economics