Topic 4.

1
Market Structure:
Perfect Competition,

Features of the four market structures

ForeignExchange

Doctors

Soft Drink

Railways

ALTERNATIVE MARKET STRUCTURES

Classifying markets by degree of
competition
number of firms
freedom of entry to industry
nature of product
nature of demand curve

The four market structures

perfect competition
monopoly
monopolistic competition
Oligopoly
Monopsony will add this year

Structure conduct performance

Perfect Competition
Monopolistic Competition
Oligopoly
Monopoly

Less Competitive

More Competitive

Market Structure

Market
Product
Perfect
Competitio
n
Homogenous
Monopolisti
c
Competitio
n
Differentiated
Oligopoly
Monopoly

Homogenous,
Differentiated
Homogenous

No. of
Firms

Many

Many
Few
One

Market will be served

Rule of Thumb:
Number of Firms
--------------------------Number of Firms + 1

Market - Optimality
Demand Curve downward
sloping in all markets

50

100

PERFECT COMPETITION
Assumptions
Many buyers and sellers
Firms (sellers) and buyers are price takers
freedom of entry
Product is homogeneous - identical products
perfect knowledge

Example: Stock Market, ForEx Market,

Bullion, Agricultural markets
Short-run equilibrium of the firm

P = MC

Short-run equilibrium of industry and firm under

perfect competition
P

Rs
S

Pe

D
O

O
Q (millions)

(a) Industry

Short-run equilibrium of industry and firm under

perfect competition
P

Rs
S

D = AR
P = MR

AR

Pe

D
O

O
Q (millions)

(a) Industry

Q (thousands)

(b) Firm

Short-run equilibrium of industry and firm under

perfect competition
P

Rs

MC

D = AR
= MR

AR

Pe

D
O

O
Q (millions)

(a) Industry

Qe
Q (thousands)

(b) Firm

PERFECT COMPETITION
Short-run equilibrium of the firm
P = MC
possible supernormal profits

Short-run equilibrium of industry and firm under

perfect competition
P

Rs

MC

D = AR
= MR

AR
AC

Pe

D
O

O
Q (millions)

(a) Industry

AC

Qe
Q (thousands)

(b) Firm

Short-run equilibrium of industry and firm under

perfect competition
P

Rs

MC

D = AR
= MR

AR
AC

Pe

D
O

O
Q (millions)

(a) Industry

AC

Qe
Q (thousands)

(b) Firm

Perfect Competition:
Short-Run Equilibrium
Firms Demand Curve = Market Price =
= Average Revenue = Marginal Revenue
Firms Supply Curve = Marginal Cost
where Marginal Cost > Average Variable Cost

PERFECT COMPETITION
Short-run equilibrium of the firm
P = MC
possible supernormal profits
short-run supply curve of firm

Deriving the short-run supply curve

Rs

MC
a

P1

D1 = MR1

D1

O
Q (millions)

(a) Industry

Q1
Q (thousands)

(b) Firm

Deriving the short-run supply curve

Rs

MC
a

P1

P2

D1 = MR1
D2 = MR2

D1
D2
O

O
Q (millions)

(a) Industry

Q2
Q (thousands)

(b) Firm

Deriving the short-run supply curve

Rs

MC
a

P1

P2

P3

D1 = MR1
D2 = MR2
D3 = MR3

D1
D3
O

D2
O

Q (millions)

(a) Industry

Q3
Q (thousands)

(b) Firm

Deriving the short-run supply curve

Rs

S
a

P1

P2

P3

D1 = MR1
D2 = MR2
D3 = MR3

D1
D3
O

D2
O

Q (millions)

(a) Industry

Q (thousands)

(b) Firm

PERFECT COMPETITION
Short-run supply curve of industry
Long-run equilibrium of the firm
all supernormal profits competed away

Perfect Competition:
Long-Run Equilibrium
Quantity is set by the firm so that short-run:
Price = Marginal Cost = Average Total Cost
Economic Profit < or > 0
At the same quantity, long-run:
Price = Marginal Cost = Average Cost
Economic Profit = 0

Long-run equilibrium under perfect competition

S1

Rs

LRAC
P1

AR1

D1

D
O

O
Q (millions)

(a) Industry

Q (thousands)

(b) Firm

Long-run equilibrium under perfect competition

The Dynamics
P

Rs

S1
Se

LRAC
P1

AR1

D1

PL

ARL

DL

D
O

O
Q (millions)

(a) Industry

QL
Q (thousands)

(b) Firm

Long-run equilibrium of the firm under perfect competition

(SR)MC

Price

(SR)AC

LRAC

DL
AR = MR = SRMC = LRMC = LRAC

Long-run equilibrium of the firm under perfect competition

Rs

(SR)MC
(SR)AC

LRAC

DL
AR = MR

LRAC = (SR)AC = (SR)MC = MR = AR

Perfect Competition
Price Determination

QD 625 5P
QS 175 5 P

QD QS

Perfect Competition:Price Determination

625 5 P 175 5 P
450 10P

P $45

QD 625 5P 625 5(45) 400

QS 175 5P 175 5(45) 400

Competition in the
Global Economy
t
es
m
o
D

u
S
c

l
pp

World Supply
Do
me
sti
c

De
ma
n

Ref: MIT Handout

Competition in the Global Economy

Foreign Exchange Rate
Price of a foreign currency in terms of the
domestic currency

Depreciation of the Domestic Currency

Increase in the price of a foreign currency
relative to the domestic currency

Appreciation of the Domestic Currency

Decrease in the price of a foreign
currency relative to the domestic currency

Competition in the Global Economy

R = Exchange Rate = Rupee Price of Dollar

R = Rs/$

Supply of Dollars

Demand for Dollars

Million $ per day

PERFECT COMPETITION
Short-run supply curve of industry
Long-run equilibrium of the firm
all supernormal profits competed away

Incompatibility of economies of scale with

perfect competition

PERFECT COMPETITION
Advantages of perfect competition
P = MC
production at minimum AC
only normal profits in long run
responsive to consumer wishes: consumer
sovereignty
competition efficiency
no point in advertising

PERFECT COMPETITION
Disadvantages of perfect competition
insufficient profits for investment
lack of product variety
lack of competition over product design and
specification