Market Structure

Team Teaching Economic

The Meaning of Competition
Competitive market is a market with many buyers and sellers
trading identical products so that each buyer and seller is a
price taker.
A competitive market, sometimes called a perfectly competitive
market, has two characteristics:
• There are many buyers and many sellers in the market.
• The goods offered by the various sellers are largely the same.
Firms can freely enter or exit the market.
Fakultas Ekonomi dan Bisnis
School Economics and Business Total, Average, and Marginal Revenue for a Competitive Firm

average revenue is
total revenue divided by the quantity sold.

marginal revenue is
the change in total revenue from an
additional unit sold

3 Creating the great business leaders

Fakultas Ekonomi dan Bisnis
School Economics and Business Profit Maximization: A Numerical Example

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Fakultas Ekonomi dan Bisnis
School Economics and Business
Profit Maximization for a Competitive Firm
This figure shows the marginal-cost
curve (MC), the average-total-cost curve
(ATC), and the average-variable-cost
curve (AVC).
It also shows the market price (P), which
for a competitive firm equals both
marginal revenue (MR) and average
revenue (AR).
At the quantity Q1, marginal revenue
MR1 exceeds marginal cost MC1, so
raising production increases profit.
At the quantity Q2, marginal cost MC2 is
above marginal revenue MR2, so
reducing production increases profit.
The profit-maximizing quantity Qmax is
found where the horizontal line
representing the price intersects the
marginal-cost curve.
5 Creating the great business leaders
Fakultas Ekonomi dan Bisnis
School Economics and Business
Marginal Cost as the Competitive Firm’s Supply Curve
An increase in the price from P1 to P2 leads to
an increase in the firm’s profit-maximizing
quantity from Q1 to Q2.
Because the marginal-cost curve shows the
quantity supplied by the firm at any given price,
it is the firm’s supply curve.
6 Creating the great business leaders
 Fakultas Ekonomi dan Bisnis
School Economics and Business The Firm’s Short-Run Decision to Shut Down

• A shutdown refers to a short-run decision not to produce anything

during a specific period of time because of current market conditions.
Exit refers to a long-run decision to leave the market.
• The short-run and long-run decisions differ because most firms cannot
avoid their fixed costs in the short run but can do so in the long run.
• That is, a firm that shuts down temporarily still has to pay its fixed
costs, whereas a firm that exits the market does not have to pay any
costs at all, fixed or variable

7 Creating the great business leaders

 Fakultas Ekonomi dan Bisnis
School Economics and Business

the firm shuts down if

the revenue that it would earn from producing is less than its variable
costs of production

Shutdown if
TR < VC
TR/Q < VC/Q
P < AVC

8 Creating the great business leaders

 Fakultas Ekonomi dan Bisnis
School Economics and Business The Competitive Firm’s Short-Run Supply Curve
In the short run,
the competitive firm’s supply curve is the
portion of its marginal-cost curve (MC) that lies
above its average-variable cost curve (AVC).

If the price falls below average variable cost, the

firm is better off shutting down temporarily.

The competitive firm’s short-run supply curve is

the portion of its marginal-cost curve that lies
above the average-variable-cost curve.

sunk cost
a cost that has already been committed
and cannot be recovered

9 Creating the great business leaders

The Firm’s Long-Run Decision to Exit or Enter a
Market
 Fakultas Ekonomi dan Bisnis
School Economics and Business The Competitive Firm’s Long-Run Supply Curve
In the long run,
the competitive firm’s supply curve is
the portion of its marginal-cost curve
(MC) that lies above its average total-
cost curve (ATC).

If the price falls below average total

cost, the firm is better off exiting the
market.

Exit if :
TR < TC
TR/Q < TC/Q
P < ATC

11 Creating the great business leaders

 Fakultas Ekonomi dan Bisnis Measuring Profit in Our Graph for the Competitive
School Economics and Business
Firm
Profit = TR - TC
= (TR - TC) x Q
Q Profit as the Area
= (TR/Q - TC/Q) x Q between Price and
= (P – ATC) x Q Average Total Cost
The area of the shaded box between price and
average total cost represents the firm’s profit.

The height of this box is price minus average total

cost (P – ATC), and the width of the box is the
quantity of output (Q).

In panel (a), price is greater than average total

cost, so the firm has positive profit. In panel (b),
price is less than average total cost, so the firm
incurs a loss.

12 Creating the great business leaders

 Fakultas Ekonomi dan Bisnis Measuring Profit in Our Graph for the Competitive
School Economics and Business
Firm
Profit = TR - TC
= (TR - TC) x Q
Q Profit as the Area
= (TR/Q - TC/Q) x Q between Price and
= (P – ATC) x Q Average Total Cost
The area of the shaded box between price and
average total cost represents the firm’s profit.

The height of this box is price minus average total

cost (P – ATC), and the width of the box is the
quantity of output (Q).

In panel (a), price is greater than average total

cost, so the firm has positive profit. In panel (b),
price is less than average total cost, so the firm
incurs a loss.

13 Creating the great business leaders

Fakultas Ekonomi dan Bisnis
School Economics and Business

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Fakultas Ekonomi dan Bisnis
School Economics and Business

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 Fakultas Ekonomi dan Bisnis
School Economics and Business

• Panel (a) shows a market in a long-run equilibrium at point A.

• In this equilibrium, each firm makes zero profit, and the price equals the minimum average
total cost.

16 Creating the great business leaders

 Fakultas Ekonomi dan Bisnis
School Economics and Business

• Panel (b) shows what happens in the short run when demand rises from D1 to D2.
• The equilibrium goes from point A to point B, price rises from P1 to P2, and the quantity sold in the market rises
from Q1 to Q2.
• Because price now exceeds average total cost, each firm now makes a profit, which over time encourages new
firms to enter the market.

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 Fakultas Ekonomi dan Bisnis
School Economics and Business

• Panel (c) shows how this entry shifts the short-run supply curve to the right from S1 to S2.
• In the new long-run equilibrium, point C, price has returned to P1 but the quantity sold has increased to Q3.
• Profits are again zero, and price is back to the minimum of average total cost, but the market has more firms to
satisfy the greater demand.

18 Creating the great business leaders

Fakultas Ekonomi dan Bisnis
School Economics and Business Monopolistic Competition

The Four Types of Market Structure

Economists who study industrial
organization divide markets into
four types: monopoly, oligopoly,
monopolistic competition, and
perfect competition.

19 Creating the great business leaders

Market Structures
• Type of market structure influences how a firm behaves:
• Pricing
• Supply
• Barriers to Entry (halangan masuk)
• Efficiency
• Competition
Market Structures
• Degree of competition in the industry
• High levels of competition – Perfect competition
• Limited competition – Monopoly
• Degrees of competition in between
Market Structure
• Determinants of market structure
• Freedom of entry and exit
• Nature of the product – homogenous (identical), differentiated?
• Control over supply/output
• Control over price
• Barriers to entry
Market Structure
• Perfect Competition:
• Free entry and exit to industry
• Homogenous product – identical so no consumer preference
• Large number of buyers and sellers – no individual seller can influence price
• Sellers are price takers – have to accept the market price
• Perfect information available to buyers and sellers
Market Structure
• Examples of perfect competition:
• Financial markets – stock exchange, currency markets,
bond markets?
• Agriculture?
• To what extent?
Market Structure
Advantages of Perfect Competition:
• High degree of competition helps allocate resources to most efficient
use
• Price = marginal costs
• Normal profit made in the long run
• Firms operate at maximum efficiency
• Consumers benefit
Market Structure
• What happens in a competitive environment?
• New idea? – firm makes short term abnormal profit
• Other firms enter the industry to take advantage of abnormal profit
• Supply increases – price falls
• Long run – normal profit made
• Choice for consumer
• Price sufficient for normal profit to be made but no more!
Market Structure
• Imperfect or Monopolistic Competition
• Many buyers and sellers
• Products differentiated
• Relatively free entry and exit
• Each firm may have a tiny ‘monopoly’ because of the differentiation of their
product
• Firm has some control over price
• Examples – restaurants, professions – solicitors, etc., building firms –
plasterers, plumbers, etc.
Market Structure
• Oligopoly – Competition amongst the few
• Industry dominated by small number of large firms
• Many firms may make up the industry
• High barriers to entry
• Products could be highly differentiated –
• Non–price competition
• Price stability within the market - kinked demand curve?
• Potential for collusion?
• Abnormal profits
• High degree of interdependence between firms
Market Structure
• Examples of oligopolistic structures:
• Supermarkets
• Banking industry
• Chemicals
• Oil
• Medicinal drugs
• Broadcasting
Market Structure
• Measuring Oligopoly:
• Concentration ratio – the proportion of market share accounted for
by top X number of firms:
• E.g. 5 firm concentration ratio of 80% - means top 5 five firms account for 80%
of market share
• 3 firm CR of 72% - top 3 firms account for 72% of market share
Market Structure
• Duopoly:
• Industry dominated by two large firms
• Possibility of price leader emerging – rival will follow price leaders
pricing decisions
• High barriers to entry
• Abnormal profits likely
Market Structure
Monopoly:
• Pure monopoly – industry is the firm!
• Actual monopoly – where firm has >25% market share
• Natural Monopoly – high fixed costs – gas, electricity, water,
telecommunications, rail
Market Structure
• Monopoly:
• High barriers to entry
• Firm controls price
• Abnormal profits in long run
• Possibility of price discrimination
• Consumer choice limited
• Prices in excess of MC
Market Structure
• Advantages and disadvantages of monopoly:
• Advantages:
• May be appropriate if natural monopoly
• Encourages R&D
• Encourages innovation
• Development of some products not likely without some guarantee of
monopoly in production
• Economies of scale can be gained – consumer may benefit
Market Structure
• Disadvantages:
• Exploitation of consumer – higher prices
• Potential for supply to be limited - less choice
• Potential for inefficiency –
X-inefficiency – complacency over controls on costs
Jumlah Harga Pendapatan Pendapatan Pendapatan
Total Rata-rata Marginal

(Q) (P) (TR = P x Q) (AR = TR / Q) (MR = ∆TR / ∆Q)

1 gallon $6 6 6

2 6 12 6 =(12-6)/(2-1) =6

3 6 18 6 6

4 6 24 6 6

5 6 30 6 6

6 6 36 6 6

7 6 42 6 6

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Introduction
• A monopoly is a firm that is the sole seller of a product without close
substitutes.
• In this chapter, we study monopoly and contrast it with perfect
competition.
• The key difference:
A monopoly firm has market power, the ability to influence the
market price of the product it sells. A competitive firm has no market
power.

CHAPTER 15 MONOPOLY
Why Monopolies Arise

The main cause of monopolies is barriers

to entry – other firms cannot enter the market.
Three sources of barriers to entry:
1. A single firm owns a key resource.
E.g., DeBeers owns most of the world’s
diamond mines
2. The govt gives a single firm the exclusive right to produce the good.
E.g., patents, copyright laws

CHAPTER 15 MONOPOLY
Why Monopolies Arise
3. Natural monopoly: a single firm can produce the entire
market Q at lower ATC than could several firms.

Example: 1000 homes

need electricity. Cost Electricity
Economies of
ATC is lower if scale due to
one firm services huge FC
all 1000 homes $80
than if two firms $50 ATC
each service
Q
500 homes. 500 1000
CHAPTER 15 MONOPOLY
Monopoly vs. Competition: Demand Curves
In a competitive market, the
market demand curve slopes
downward.
but the demand curve A competitive firm’s
for any individual firm’s demand curve
P
product is horizontal
at the market price.
The firm can increase Q
without lowering P, D
so MR = P for the
competitive firm.

Q
CHAPTER 15 MONOPOLY
Monopoly vs. Competition: Demand Curves
A monopolist is the only
seller, so it faces the market
demand curve.
A monopolist’s
To sell a larger Q,
the firm must reduce P. demand curve
P
Thus, MR ≠ P.

D
Q
CHAPTER 15 MONOPOLY
A C T I V E L E A R N I N G 1:
A monopoly’s revenue
Moonbucks is
the only seller of Q P TR AR MR
cappuccinos in town.
0 $4.50 n.a.
The table shows the
market demand for 1 4.00 4 4
cappuccinos. 2 3.50 7 3.5 3
Fill in the missing
spaces of the table. 3 3.00 9 3 2
What is the relation 4 2.50 10 2.5 1
between P and AR?
Between P and MR? 5 2.00 10 2 0
6 1.50 9 1.5 -1

42
A C T I V E L E A R N I N G 1:
Answers

Here, P = AR, Q P TR AR MR
same as for a 0 $4.50 $0 n.a.
competitive firm. $4
1 4.00 4 $4.00
Here, MR < P, 3
whereas MR = P 2 3.50 7 3.50
for a competitive firm. 2
3 3.00 9 3.00
1
4 2.50 10 2.50
0
5 2.00 10 2.00
–1
6 1.50 9 1.50

43
 Moonbuck’s D and MR Curves
P, MR
Q P TR AR MR $5
0 $4.50 $0 n.a. 4
$4 Demand curve (P)
1 4.00 4 $4.00 3
3 2
2 3.50 7 3.50
2 1
3 3.00 9 3.00
1 0
4 2.50 10 2.50 -1 MR
0
5 2.00 10 2.00 -2
–1 -3
6 1.50 9 1.50 Q
0 1 2 3 4 5 6 7
CHAPTER 15 MONOPOLY
Understanding the Monopolist’s MR
• Increasing Q has two effects on revenue:
• The output effect:
More output is sold, which raises revenue
• The price effect:
The price falls, which lowers revenue
• To sell a larger Q, the monopolist must reduce the price
on all the units it sells.
• Hence, MR < P
• MR could even be negative if the price effect exceeds
the output effect
(e.g., when Moonbucks increases Q from 5 to 6).
CHAPTER 15 MONOPOLY
Profit-Maximization
• Like a competitive firm, a monopolist maximizes profit by producing
the quantity where MR = MC.
• Once the monopolist identifies this quantity,
it sets the highest price consumers are willing to pay for that quantity.
• It finds this price from the D curve.

CHAPTER 15 MONOPOLY
Profit-Maximization
Costs and
1. The profit- Revenue MC
maximizing Q
is where P
MR = MC.
2. Find P from
the demand curve
at this Q. D
MR

Q Quantity

Profit-maximizing output
CHAPTER 15 MONOPOLY
The Monopolist’s Profit
Costs and
Revenue MC

As with a P
competitive firm, ATC
ATC
the monopolist’s
profit equals
D
(P – ATC) x Q
MR

Q Quantity

CHAPTER 15 MONOPOLY
A Monopoly Does Not Have an S Curve
A competitive firm
 takes P as given
 has a supply curve that shows how its Q depends on P
A monopoly firm
 is a “price-maker,” not a “price-taker”
 Q does not depend on P;
rather, Q and P are jointly determined by
MC, MR, and the demand curve.
So there is no supply curve for monopoly.

CHAPTER 15 MONOPOLY
Case Study: Monopoly vs. Generic Drugs
Patents on new drugs give The market for
a temporary monopoly to Price a typical drug
the seller.
When the PM
patent expires,
the market
becomes competitive, PC = MC
generics appear. D
MR

QM Quantity
QC

CHAPTER 15 MONOPOLY
The Welfare Cost of Monopoly
• Recall: In a competitive market equilibrium,
P = MC and total surplus is maximized.
• In the monopoly eq’m, P > MR = MC
• The value to buyers of an additional unit (P)
exceeds the cost of the resources needed to produce that
unit (MC).
• The monopoly Q is too low –
could increase total surplus with a larger Q.
• Thus, monopoly results in a deadweight loss.

CHAPTER 15 MONOPOLY
The Welfare Cost of Monopoly
Competitive eq’m:
Price Deadweight
quantity = QE loss MC
P = MC
total surplus is P
P = MC
maximized
Monopoly eq’m: MC
quantity = QM D
P > MC MR
deadweight loss
QM QE Quantity

CHAPTER 15 MONOPOLY
Public Policy Toward Monopolies
• Increasing competition with antitrust laws
• Examples: Sherman Antitrust Act (1890), Clayton Act
(1914)
• Antitrust laws ban certain anticompetitive practices, allow
govt to break up monopolies.
• Regulation
• Govt agencies set the monopolist’s price
• For natural monopolies, MC < ATC at all Q,
so marginal cost pricing would result in losses.
• If so, regulators might subsidize the monopolist or set P =
ATC for zero economic profit.

CHAPTER 15 MONOPOLY
Public Policy Toward Monopolies
• Public ownership
• Example: U.S. Postal Service
• Problem: Public ownership is usually less efficient since no
profit motive to minimize costs
• Doing nothing
• The foregoing policies all have drawbacks,
so the best policy may be no policy.

CHAPTER 15 MONOPOLY
Price Discrimination
• Discrimination is the practice of treating people differently based on
some characteristic, such as race or gender.
• Price discrimination is the business practice of selling the same good
at different prices to different buyers.
• The characteristic used in price discrimination
is willingness to pay (WTP):
• A firm can increase profit by charging a higher price to buyers with higher
WTP.

CHAPTER 15 MONOPOLY
Perfect Price Discrimination vs.
Single Price Monopoly

Consumer
Here, the monopolist Price
surplus
charges the same price
(PM) to all buyers. Deadweight
PM loss
A deadweight loss
results.
MC
Monopoly
profit D
MR

QM Quantity

CHAPTER 15 MONOPOLY
Perfect Price Discrimination vs.
Single Price Monopoly

Here, the monopolist

Price
produces the Monopoly
competitive quantity, but profit
charges each buyer his or
her WTP.
This is called perfect
price discrimination. MC
The monopolist captures D
all CS
as profit. MR
But there’s no DWL. Quantity
Q
CHAPTER 15 MONOPOLY
Price Discrimination in the Real World

• In the real world, perfect price discrimination is not possible:

• no firm knows every buyer’s WTP
• buyers do not announce it to sellers
• So, firms divide customers into groups
based on some observable trait
that is likely related to WTP, such as age.

CHAPTER 15 MONOPOLY
Examples of Price Discrimination
Movie tickets
Discounts for seniors, students, and people
who can attend during weekday afternoons.
They are all more likely to have lower WTP
than people who pay full price on Friday night.
Airline prices
Discounts for Saturday-night stayovers help distinguish business
travelers, who usually have higher WTP, from more price-sensitive
leisure travelers.

CHAPTER 15 MONOPOLY
Examples of Price Discrimination
Discount coupons
People who have time to clip and organize coupons are more likely to
have lower income and lower WTP than others.
Need-based financial aid
Low income families have lower WTP for
their children’s college education.
Schools price-discriminate by offering
need-based aid to low income families.

CHAPTER 15 MONOPOLY
Examples of Price Discrimination
Quantity discounts
A buyer’s WTP often declines with additional units, so firms charge
less per unit for large quantities than small ones.
Example: A movie theater charges $4 for
a small popcorn and $5 for a large one that’s twice as big.

CHAPTER 15 MONOPOLY
 CONCLUSION: The Prevalence of Monopoly

• In the real world, pure monopoly is rare.

• Yet, many firms have market power, due to
• selling a unique variety of a product
• having a large market share and few significant competitors
• In many such cases, most of the results from this chapter apply,
including
• markup of price over marginal cost
• deadweight loss

CHAPTER 15 MONOPOLY
CHAPTER SUMMARY
• A monopoly firm is the sole seller in its market.
Monopolies arise due to barriers to entry, including:
government-granted monopolies, the control of a key
resource, or economies of scale over the entire range of
output.
• A monopoly firm faces a downward-sloping demand
curve for its product. As a result, it must reduce price
to sell a larger quantity, which causes marginal revenue
to fall below price.

CHAPTER 15 MONOPOLY
CHAPTER SUMMARY
• Monopoly firms maximize profits by producing the
quantity where marginal revenue equals marginal cost.
But since marginal revenue is less than price, the
monopoly price will be greater than marginal cost,
leading to a deadweight loss.
• Policymakers may respond by regulating monopolies,
using antitrust laws to promote competition, or by
taking over the monopoly and running it. Due to
problems with each of these options, the best option
may be to take no action.

CHAPTER 15 MONOPOLY
CHAPTER SUMMARY
• Monopoly firms (and others with market power) try to
raise their profits by charging higher prices to
consumers with higher willingness to pay. This practice
is called price discrimination.

CHAPTER 15 MONOPOLY
Monopoly
məˈnäpəlē
The company is the only seller of an item without substitute goods

66
 Monopoly on Resources
Barriers to
entering the
Monopoly
Government regulations
market
Production process

67
Business practices by selling the same goods to
different consumers at different prices
Price Discrimination