CHAPTER V: MARKET STRUCTURE

 A firm‘s decision to achieve this goal is dependent on

the type of market in which it operates.
 So market describes place or digital space by which
goods, services and ideas are exchanged to satisfy
consumer need. American Marketing Association (1985)
 Digital marketing is the marketing of products or
services using digital technologies, mainly on the
internet but also including mobile phones, display
advertising, and any other digital media.
 In physical marketing, marketers will effortlessly reach
their target local customers and thus they have more
personal approach to show about their brands.
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 Classifying Markets by the Degree of
Competition
• We Classify markets Based on:
– 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
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 6.1 Perfect Competition
Perfect competition : Mkt characterized by complete
absence of rivalry among individual firms
• Assumptions
– Large number of buyers and sellers
– firms are price takers
– freedom of entry and exit
– Identical/homogenous products
– perfect knowledge about market conditions
– No government interference
– Perfect mobility of factors of production

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• From these assumptions, a single producer under
perfectly competitive market is a price-taker.
• Once the price of the product is determined in the
market, the producer takes the price (Pm in the figure
below) as given. Hence, the demand curve (Df) that the
firm faces in this market situation is a horizontal line
drawn at the equilibrium price, Pm.

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 5.2.2 Short run equilibrium of the firm
• The main objective of a firm is profit maximization.
• If the firm has to incur a loss, it aims to minimize the loss.
• Profit is the difference between total revenue and total
cost.
1.Total Revenue (TR):is the total amount of money a firm
receives from a given quantity of its product sold.
TR=P X Q, where P = price of the product
Q = quantity of the product sold
2.Average revenue (AR):-it is the revenue per unit of item
sold
AR =TR/Q = P.Q/Q =>AR = P
Therefore, the firm‘s demand curve is also the average 5
 Marginal Revenue
• It is the additional amount of money/ revenue the firm
receives by selling one more unit of the product.
MR = (∆TR/∆Q) = ∆(P*Q)/∆Q = P∆Q/∆Q = P
Price is constant and firm is price taker
 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
• In the short run, the firm has a fixed plant. Thus, it can
adjust its output only through changes in the amount of
variable resources.
• There are two ways to determine the level of output at
which a competitive firm will realize maximum profit or
minimum loss 6
 Profit Maximization: General Frame
• Disregarding the level of competition, firms are supposed to
be rational and optimize their profit;

• Two methods to identify the optimum level of profit.

• NB: when profit has negative value, we say the firm is

minimizing its loss.

1) Total Approach: - this method tries to look at the maximum

positive difference or the minimum negative difference (if
the firm is running at loss) between total revenue & total
cost.

On the other hand, graphically we seek for the point at which

the vertical distance b/n the total revenue curve & the TC
curve is maximum (minimum when it is a loss). 7
• E.g. for the cost table that you have taken, assume that
price of the product is Br. 100.

Q TR=P.Q TC Profit (∏) =TR-TC

0 0 100 -100 loss
1 100 190 -90 loss
2 200 270 -70 loss
3 300 340 -40 loss
4 400 400 0 breakeven output
5 500 470 30 profit
6 600 550 50 profit
7 700 640 60 profit
8 800 750 50 profit
9 900 880 20 profit
10 1000 1030 -30 loss
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This can be shown graphically as follows: -
TR, TC
TC Loss
900 TR

Max. Profit

400

Loss

0 4 7 9.5 Output

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2) Marginal Approach: - We use the marginal revenue (MR)
and marginal cost (MC) curves to determine the optimum
output level, where
A.MR= MC and ,,,,,,,,,,,,,,,,,,,,, 1st order condition

B.MC is rising (The slope of MC is greater than slope of MR)

҉ slope of MC is greater than zero,,,,,2nd Order condition

 In the figure below, the profit maximizing output is Q*,

where MC=MR and MC curve is increasing.

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 Output decision of competitive firm
at q1: MR  MC

MC at q2 : MC  MR
Revenue
Price
at qo : MR  MC but MC is failling

at q * : MR  MC and MC cuts from below

MC
Loss  for q1  q *
Loss  for q 2  q *
P = MR = AR

qo q1 q * q 2 Output/Sales

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 Profit Maxn: A competitive firm making positive profit
*
At q : MR  MC and P  ATC

  ( P  AC )  q*
MC
Revenue
Price  area of ABCD

MC
ATC
A
D AR = MR = P
B
C AVC

o
qo q* Output/Sales

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 A competitive firm incurring losses
*
At q : MR  MC and P  ATC

Loss  ( P  AC )  q*

MC
Revenue
 area of ABCD
Price
ATC
MC
A
D
C AR = MR = P
B
AVC
F E

o
qo q* Output/Sales

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 A competitive firm at zero profits, break even
point
*
At q : MR  MC and P  ATC

Zero 
MC
Revenue
Price

ATC
MC

AR = MR = P
AVC

o
q* Output/Sales

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 A competitive firm incurring losses, shut down
point At q : MR  MC and P  ATC
*

Loss  ABCD  fixed cos ts  AEFD

Lossless money at zero output

MC var iable cos t not cov ered

Revenue
Price MC
ATC

A
D AVC
F E
C AR = MR = P
B

o
qo q* Output/Sales
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 Choosing output In the short run
Summary of production decisions

1.  is max when MR  MC

2. If P  ATC the firm making positive 

3. If AVC  P  ATC the firm produces at loss

4. If P  AVC  ATC the firm should shut down

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 Firm’s Profit maximization
• The firm's problem is to maximise profit

π = TR – TC = P0.Q - TC

– First-order condition:
d dTC
 P0 
dQ dQ

 P0  MC

– Second-order condition:
d 2 d 2TC dMC
2
 0   2
  0
dQ dQ dQ
dMC
 0
dQ
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Example: Suppose that the firm operates in a perfectly
competitive market. The market price of its product is
$10. 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

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A.Q=0 AND Q=8/3
MC =dmc/Dq = -8 + 6q,,,equl,,,,8/3
B. = TR – TC
= 26.67 – 19.18 = $ 7.48
C.AVC=10-4q+Q2
-4+2Q= Q=2 ,,,,,AVC is minimum when
Q=2
AVC=10-4(2)+(2)2=6
AVC=Minimum of $6 needed from the
market to stay. 19
 Cont..
e.g. If the total cost function of a firm under
perfectly competitive market is given by TC =
2Q2 – 28Q + 100. Find the optimum level of
output & the corresponding profit when price
of the product is Br. 20.
Solution: MC = 4Q - 28
P= MR = 20 Br.
At equilibrium: MC = MR = P => 4Q-28 =
20
Q* = 12 units
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 Benefits of perfect competition:
• Output produced at minimum feasible cost;

• optimal allocation of resources;

• consumer pay minimum possible price:

P = MC, P = MU thus MU = MC

• Plants are used at full capacity in long run:

- No waste of resource.
- Firms only earn normal profit.

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 Short run equilibrium of the industry
• 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(Break even point graph).
• Industry supply curve can be obtained by multiplying
the individual supply at various prices by the number of
firms, if firms have identical supply curve.
• When an industry reaches at its equilibrium, there is no
tendency to expand or to contract the output.

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 6.2 Pure Monopoly
• Defining monopoly
A) Exists when one seller or one firm industry
B) No substitute products,product is unique
C)Price maker the monopolist can change product price
by changing the quantity of the product supplied.
D) Barrier to entry barriers,which keep potential
competitors from entering in to the industry.
Bases of monopoly/barrier to entry
– economies of scale
– product differentiation and brand loyalty
– lower costs for an established firm
– ownership/control of key factors
– legal protection/patent/trademark/licence 23
 Sources of monopoly
The barriers to entry are the sources of monopoly power.
The major sources of barriers to entry are:-
1. Legal restriction:-created by law in public interest
including postal service, telegraph, telephone services,
radio and TV.
2. Control over key raw materials:-
3.Efficiency:-The most efficient plant (probably large size firm,)
which produces at minimum cost, can eliminate the competitors
by curbing down its price for a short period and can acquire
monopoly power. Monopolies created through efficiency are
known as natural monopolies
4. Patent rights (patent monopolies):-
• Patent rights are granted by the government to a firm to produce commodity of
specified quality and character or to use specified rights to produce the
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specified commodity or to use the specified technique of production
 Monopoly ... Cont’d
• Disadvantages of monopoly
– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
– Rent seeking
– X-inefficiency

• Advantages of monopoly
– economies of scale
– profits can be used for investment
– high profits encourage risk taking
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 6.3 Monopolistic competitive market
Monopolistic competition (MpC)
 defined as the market organization in which there are
relatively many firms selling differentiated products
 blend of competition and monopoly
is a market with the following characteristics:
i) Differentiated product
• the product produced and supplied by many sellers in
the market is similar but not identical in the eyes of
the buyers.
• the differentiation of the product could be real (eg.
quality) or fancied (e.g. difference in packing).
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 Characteristics … cont’d
ii) Many sellers and buyers

• there are many sellers and buyers of the product, but

their number is not as large as that of the perfectly
competitive market.
iii) Easy entry and exit
iv)Existence of non-price competition
• Economic rivals take the form of non-price competition
in terms of product quality, advertisement, brand
name, service to customers,etc.
• Many retail trade activities such as clothing, shoes,
soap, etc are in this type of market structure
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6.4 Oligopolistic Market
Definition:
 Oligopoly is a mkt structure where there are a few
sellers of a particular product or service;

 Firms recognize their rivalry & interdependence;

 Aware that any action on their part is likely to induce

counter-actions by the rivals (strategies & Counter-
Strategies b/n mkt participants);

 It is one of mkt in b/n the two extreme cases: in b/n

PC & PM like the MpC mkt structure.
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 Oligopoly … Cont’d

Characteristics of the market:

1. Few sellers but large producers in the mkt;
2. Entry is difficult (obstacles to entry);
3. Mutual interdependence of firms (b/c firms have
substantial power over price);
4. Sticky or rigid price: – prices tend to be sticky while it is
flexible in the other mkt structures such as MpC.
 Based on this chtx, there are 2 types of oligopoly: Non-
collusive and Collusive oligopoly

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5.Products may be homogenous or differentiated.
 If the product is homogeneous, we have a pure
oligopoly.
 If the product is differentiated, it will be a differentiated
Oligopoly
7.Lack of uniformity in the size of firms
8.Non-price competition: firms try to avoid price
competition due to the fear of price wars and hence
depend on non-price methods like advertising, after
sales services, warranties,etc. This ensures that firms
can influence demand and build brand recognition.
• A special type of oligopoly in which there are only two
firms in the market is known as duopoly.
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Thank You!

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