Market Structures

Dr. Aruna Kumar Dash

IBS Hyderabad
 Market
•Any arena/place where buyers and
sellers voluntarily come together to
exchange a product or service.

•Buyers and sellers are free to do what is

in their own best interest.
 Market Structures
• There are thousands of individual Companies
or firms in the Indian economy.
• Companies or Firms can be grouped into
industries.
• Industries are groups of firms producing the
same or similar products, e.g., the auto
industry, telecom industry, the steel industry,
etc.
Market Structures
• Market structures are classified according to:
 Power of firm over price;
number of producers
 Product standardization
 Barriers to entry
 Extent of nonprice competition
 Market Structures
Market structure refers to the competitive environment in which the buyers
and sellers of the product operate.
Four types of market structure are usually identified. These are : perfect
compaction at one extreme, pure monopoly at the opposite extreme, and
monopolistic competition and oligopoly in between.

These type of market structure are defined in terms of the number and size
of the buyers and sellers of the product, the type of product bought and
sold(Standardized or homogeneous product compared with differentiated
products), the degree of mobility of resources (i.e. the ease with which
firms and input owners can enter or exit the market), and the degree of
knowledge that economic agents (i.e. firms, suppliers of inputs, and
consumers), have of price and cost, demand and supply conditions.
 Market Structure
Perfect Competition is the form of market organization in which (a) there are many
buyers and sellers of a product, each one too small to affect the price of the
product(b) the product is homogeneous( c ) there is perfect mobility of resources(d)
economic agents have perfect knowledge of market conditions.

Monopoly is the form of market organization in which a single firm sells a product
for which there are no close substitutes. Entry into the industry is very difficult or
impossible (as evidenced by the fact that there is a single firm in the industry)

Monopolistic competition is the form of market organization where there are many
sellers of a differentiated products and entry into or exit from the industry is rather
easy in the long run.

Oligopoly is the form of market organization where there are few sellers of
homogeneous or differentiated product. Although entry into the industry is possible,
it is not easy (as evidenced by the small number of firms in the industry)

Monopoly, Monopolistic competition and oligopoly are referred to as imperfect

competition to distinguish them from perfect competition.
 Market Structure

Perfect Competition Monopoly Monopolistic Oligopoly

Eg. Stock price/Parts of Eg. Public utilities Eg. Retail trade Eg. Computers, oil,
agriculture No. of Buyers: Many No. of Buyers: Many steel
No. of Buyers: Many No. of Sellers: One No. of Sellers: Many No. of Buyers: Many
No. of Sellers: Many Type of Product: Type of Product: No. of Sellers: Few
Type of Product: unique product(No differentiated Product:
Homogeneous/identical substitutes are Barriers to entry and Homogeneous/
Barriers to entry and available) exit- low entry differentiated
exit-No Barriers to entry and barriers. Barriers to entry and
Power of the firm over exit-Yes/very high Power of the firm over exit- with high entry
price –None Power of the firm price –Some barriers.
Firms acts as a price over price – eFirms acts as a price Power of the firm
taker Considerable maker over price –Some
Non-Price competition: Firms acts as a price Non-Price Firms acts as a price
None maker competition: Yes maker
Non-Price Non-Price
competition: Yes competition: Yes
Perfect Competition
Perfect Competition

• There are large number of buyers and sellers in the market

• Each seller and buyer is too small in relation to the market and not able to
affect the price of the product by his/her action. Hence a change in the
output of a single firm will not affect the market price of the product .
• Each firm produces identical /homogeneous product. An example of this
might be A grade wheat produced by many farmers. As a result , buyers
can not distinguish between the output of the one firm and the output of
the other firms. Hence, buyers will be indifferent
• Under perfect competition, there is perfect mobility of resources. That is
workers and other inputs can easily move geographically from one place
to another
• In the long run, firm can enter or leave the industry without much
difficulty
Perfect Competition
Under perfect competition , consumer , resource owner, firm
in the market have perfect knowledge as to present and future
prices, cost and economic opportunities. Thus, the consumer
will not pay a higher price and producer exactly how much to
produce

Price differences are quickly eliminated and a single price will

prevail through out the market for the product.
Price taker markets: Perfect
competition
• Examples: Parts of agriculture
• Number of producers: Many
• Power of firm over price: None
• Type of product: Standardized
• Barriers to entry: No barriers
• Non-Price competition: None
When we say “identical”
Market Structures:
that is exactly what we
mean. The consumer does Perfect Competition
not perceive any
How large is “large?” There is
difference, real or
no set cutoff. There needs to be
imagined, between the
enough companies so that each
product that is produced
one is so small that it has no
by this large number of
“power” to determine its own
different suppliers.
price. Company in the industry
Products are perfect
is the price taker(Industry is
substitutes
price maker and firm/company
is price taker)
The equilibrium Price and Demand level Faced by a
Perfectly Competitive firm
The companies are “price
takers.” They “take” the
P P price determined by the
industry.
INDUSTRY S
55 FIRM

45
E
45 D=P=MR
Pls note AR is price
35
D

400 0 1 2 3 4 5 Q
0
Quantity of commodity(Q) Why doesn’t a company try
to undercut the competition
and sell at a lower price?
 Explanation Continues
Under perfect competition, the price of a product is determined at the
intersection of the market demand and market supply curve of the
product. The market demand curve is simply the horizontal summation
of the demand curves of all the consumers in the market. The market
supply curve of a product is simply the horizontal summation of supply
curve of the individual producers of the product. D is the market demand
curve for the product and S is the market supply curve of the product.
The interaction between market demand and market supply will give
equilibrium price and equilibrium quantity. The equilibrium price of a
product is Rs. 45 and it is determined at point E at the interaction of D
and S. At a higher price than the equilibrium price, say P=Rs 55, the
quantity supplied of the product exceeds the quantity demanded of the
product. As a result price of the product will fall. As P falls, the quantity
demanded of the product increases and the quantity supplied declines
until the equilibrium price of P=Rs. 45 is established, at which quantity
demand is equal to quantity supplied. By contrast, at price below the
equilibrium price QD>QS and P rises to the equilibrium P=Rs. 45
• Can one Perfectly competitive firm charge higher price above the
market price?
Since the products of all the firms are homogeneous, a firm can not sell
at a price higher than the market price of the product. If the firm will
do , it will loose all the customers.
Can one Perfectly competitive firm charge below the market price?
There is no reason for the firms to sell at a price below the market
price, since it can sell any quantity of the product at the given market
price.

As a result, the firm faces a horizontal or infinitely elastic demand

curve for the product . For example, a small wheat farmer can sell any
amount of wheat at the given market price of wheat.
The perfectly competitive firm is a price taker and faces infinitely
elastic demand curve d, at P=Rs.45. Since the firm can sell any
quantity of the product at P=45, the change in total revenue per unit
change in output or marginal revenue (MR) is equal to 45.
 Profit Maximization with price taker
firms
• individual firms cannot affect market price, i.e., they are
“price takers”
• only decision is what quantity to produce
• result is perfectly elastic demand curve
• Market price Is determined by the market supply and demand
curves.
• The firm’s demand curve is perfectly elastic,  = 
• As a consequence, MR = P.
Equilibrium or Profit Maximizing
Conditions:
1. Fist Order or Necessary Condition
MR= MC
Second Order or Sufficient Condition
MC cuts MR from below. MC curve must
be Rising at the point of Equilibrium.
That is slope of MC > Slope of MR
Since P = MR, the profit max condition for a price taker is P = MC
 Equilibrium in the Short-run

Price SMC

F E
45
D= P=MR

0 Q Q1
Quantity
Perfect Competition: Short Run

•Equilibrium or Profit Maximization is

ok.
•The problem is to see how much profit
the company is gaining at equilibrium
or profit maximized output or making
any loss.
•That will be known once we introduce
SAC and SAVC curves.
 The price and output determination of a
perfectly competitive firm in the short run
The profit maximizing
quantity is where
MC=MR.
Price Supernormal SMC
Profit SATC
E
45 c
Profit (TR-TC) D=P=MR
B
35 Total A
At what price
can you sell 4
Revenue
Total Cost units? Always
(Q*
(Q* x AR)
x ATC) get the price
off of the
Demand
0
4 Q
Curve.
The price and output determination of a perfectly competitive
firm in the short run continued…

P SMC SATC
C E
45 D=P=MR
B A
35 per unit
profit

0
4 Q
The slide no 20 and 21 diagram is same
The best level of output of the firm in the short run is the one at which the
marginal revenue(MR) of the firm equal its short run marginal costs(MC).The
best level of output of the firm is given at point E where the MC curve
intersects the firm’s d or MR curve. At point E, the firm produces 4 unit of
output at P=MR=MC=Rs. 45. Since at point E, Price =Rs. 45 and ATC =Rs.
35. The firm earns a profit of EA=Rs. 10 per unit and EABC=Rs 40 in the total
area. This is the largest total profits that the firm can earn. This can be proved
as follows. Any output smaller than 4 units, where MR >MC, it pays for the
firm to expand output because by doing so the firm would add more to its total
revenue than to its total cost (so that its total profits would increase or its total
losses decrease). On the other hand, if MC > MR and price is Rs. 45, then it
pays for the firm to reduce output because by doing so the firm would reduce
its total costs more than its total revenue (so that its total profit increase or its
total losses decline). The best level of output is the one where MR=MC. Since
a perfectly competitive firm faces horizontal or infinitely elastic demand curve,
P=MR, so that the condition for the best level of output can be restricted as the
one which P=MR=MC. Thus the best level of output for the firm is Q=4, at
which MR=P=MC and the total profits of the firm are maximized.
The price and output determination
of a perfectly competitive firm in the
short run (Normal profit/breakeven)
Price SMC
SATC

E D= P=MR
40

Total Cost
Total
Revenue
5 Q
 Normal profit/breakeven
Continues……
Point E is the break even point(where AR=AC). It is a point
where there is no profit or no loss

Al long as MR>MC , the firm should expand the output

because by expanding the output the firm would add more
total revenue than its total cost

On the contrary , as long as MC exceeds MR, it is good for the

firm to reduce the output. By doing so the firm will reduce its
total cost more.
 Normal profit/breakeven
continues
•When the demand curve is just tangent
to ATC
• TR=TC
• normal profits
• profits maximized
•Break Even point is where AR=AC
The price and output determination of a perfectly
competitive firm in the short run (Losses)

Price SMC
SATC

B F
35 D=P=MR
Losses
25 E
C
Total
Total Cost
Revenue

0 3
Q
The price and output determination of a perfectly
competitive firm in the short run (Losses) Continues….
P SMC
SATC

C F
35
Loss
25 B E D=P=MR

0
3 Q
 The price and output determination in a
perfectly competitive firm in the short run
(Losses) Explanation continues….
 Important point to remember
A perfectly competitive firm can earn profits, break even or
incur losses in the short run. It all depends on the height of the
ATC at the best level of output.

If ATC =P, at the best level of output, the perfectly competitive

firm will be break even

If ATC >P, at the best level of output, the perfectly competitive

firm will incur loss

If ATC < P, at the best level of output, the perfectly competitive

firm will incur profit

If P < minimum point of AVC, then the PCM firm will be forceful
to shutdown their firm (out of business in the short run). Here
the firm is not able to cover fixed and variable cost.
Should a firm operate at a loss in the short-run?
Will it continue its operation or shut down

1. When the demand curve falls between the AVC and the ATC
 Yes the firm will continue its production as long as P > AVC.
 If P is less than ATC, but greater than AVC, all variable costs are covered plus
some of the fixed costs.

• variable costs are covered by revenue

• some, but not all, of your fixed costs are covered by revenue
• the remainder of the fixed costs need to be paid “out of pocket.”
2. When the demand curve is just tangent to the AVC
• variable costs are covered by revenue
• none of the fixed costs are covered by revenue
• all of the fixed costs need to be paid “out of pocket.”

•What should you do?

• Go out of business -No
Price

MC
AVC

D=P=MR

Q* Q
3. When the demand curve/Price falls below the AVC
•What should you do?
• Go out of business –Yes/NO. Lets have a look with one example.
Suppose fixed cost is Rs. 50
Your daily average variable cost is Rs. 10
Lets assume that you are selling the product at Rs. 11. By selling it Rs. 11 you
are covering your variable cost but not the fixed cost . Hence, you are making loss
as that loss is due to fixed cost. This situation is tolerable by a firm.

On the other hand, lets assume that you are selling the product at Rs. 9 and
average variable cost of producing that product is Rs. 10. Tell me whether you
are making profit or loss. You are making loss in both fixed as well as variable
cost. It is not at all tolerable for a company. All expenses are paid from the
pocket.
• not all variable costs are covered by revenue
• none of the fixed costs are covered by revenue
• the remainder of the variable costs and all of the fixed costs need to be paid
“out of pocket.”

The firm need to shutdown the business as the firm is unable to cover its fixed
and variable cost.
 Shut-Down Point
P SMC SATC

SAVC
B F
35

25
C E
D=P=MR
D A
15
H

0
3 Q
Shut-Down Point continues…..
 I asked you to
shut down your
operation

Give me some
money to pay
my laborers
Wake up! It is late in the morning

What
What II will
will do,
do, II have
have
shut
shut down
down mymy
operation.
operation. Let’s
Let’s sleep
sleep
for
for aa long
long time!
time!
 What kind of Company You would like to
be?

Short-run
Short-run Short-run
equilibrium of
industry equilibrium of a
a firm (excess
equilibrium firm (losses)
profits)
Price and Output Determination of a perfectly competitive
market in the Long Run
In the long run all inputs are variable. Hence all the cost of production is variable. In long
run, firm can construct the optimum plant to produce the best level of output. The best level
of output is the one at which price is equal to long run marginal cost of the firm. The
optimum plant is the one with the short rum average cost tangent to the long run average
cost of the firm at the best level of output.
On one hand, if the existing firms earns profit, more firms enter the market in the long run.
This increases the market supply of the product and results in a lower product price until all
profits are squeezed out. On the other hand, if firms in the market incur losses, some firms
will leave the market in the long run. This reduces the market supply of the product until all
firms remaining in the market just breakeven. Thus, when a competitive market is long
run equilibrium, all firm produce at lowest point on their long run average cost curve and
break even. This is shown in point E*.
The best level of output of the perfectly competitive firm at P=25 is 4 units and is given by
point E*, at which P=MR=LMC=Lowest LAC. Because of free or easy entry into the market
, all profit and losses have been eliminated , and the firm produces at the lowest point on its
LAC curve.
When a perfectly competitive market is in long run equilibrium, firms break even, and earn
zero economic profit. Therefore, the owner of the firm receives only a normal return on
investment. Zero economic profit means total revenues of the firm just covers all
costs(explicit and implicit)
 Price and Output Determination of a perfectly competitive market
in the Long Run Continues….

Price LMC
SMC LAC
SAC

d E* d P = MR
25

0
4 Q
 Allocative Efficiency
Two concepts of efficiency are used to judge the performance of a
market. The first is called productive efficiency which refers to
producing the output at the least possible cost.
Productive efficiency occurs when the firm produces at the minimum
point on its long run average cost curve, so that market price equals
the minimum average cost. Perfectly competitive market produces
output at minimum average cost in the long run. The second one is
called allocative efficiency.
Allocative efficiency is the level of output where marginal cost is as
close as possible to the marginal benefits. Allocative efficiency is the
level of output where the price of a good or service is equal to the
marginal cost (MC) of production.
The marginal cost is the cost of producing one additional item. The
marginal benefit is extra benefit the consumer is getting by buying
one extra product.
 Allocative Efficiency
• Allocative efficiency occurs in highly efficient markets. It means there is
absence of asymmetric information. Same information is available to the
buyser and seller. In the presence of allocative efficiency the resources are
utilized properly and there is no wastage.
• The market will have allocative efficiency where the total surplus is maximum.
Whenever we are taking about total surplus is maximum that implies producer
surplus is more and consumer surplus is more. Consumer surplus is more and
producers profits is more. In the presence of allocative efficiency
demand=Supply or marginal benefit is equal to marginal cost. It will occus
when there is no government intervention.
Allocative Efficiency
• Allocative efficiency will occur when both consumers and
producers have free access to information (so no asymmetric
information), allowing them both to make the most efficient
possible decisions in purchasing and production. According
to this principle, it is also necessary that consumers have free
choice over the goods/services that maximize their individual
satisfaction. Allocative efficiency happens when resources
in the market are correctly allocated in response to
consumers’ desires as well as their needs.
Allocative Efficiency
Allocative Efficiency
When demand is equal to supply and prices are determined by the
market forces it implies there is no government intervention and total
surplus is maximum .
Pls note in the presence of allocative efficiency total welfare to the
society is maximum.

Consumer surplus is derived from the demand curve. It is area above

the market clearing price and below the demand curve. Consumer
surplus is the difference between what consumer is willing to pay and
what consumer actually pays. You are ready to Pay Rs 50,000 for air
ticket but actually you paid 20,000 due to discount. The difference of
20,000 is the consumer surplus.
Producer surplus is derived from the supply curve. It is the area below
the market clearing price and above the supply curve. Producer surplus
is the difference between the minimum price the producer is willing to
produce the product and the price actually the producer receives.
Allocative Efficiency
• But in reality allocative efficiency rarely occurs because buyers and
sellers don’t have same available information. Government
intervenes in the markets in the forms of taxes. As a result price
increases. With increase in price CS and PS decreases and allocative
inefficiency occurs.
Thank you