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1. Market Structure
1

2. MARKET STRUCTURE
• Market structure consists of four
main market characteristics:
(2) the number of sellers,
(3) the nature of the product,
(4) the ability of individual firms to
influence the market price,
(5) the ease of entry into or exit from
the market.
2

3. PERFECT COMPETITION
• Definition - PC is a market structure in
which there are many small firms selling
homogeneous product.
• Characteristics:
1. many small firms
2. homogeneous product
3. Price taker
4. Very easy entry and exit
3

4. The meaning of price taker
• A price-taker firm has no power to
influence the market price.
• It faces a perfectly elastic demand
curve - It can sell all it wishes at the
market-determined price, but it will sell
nothing above the given market price.
4

5. P Market Supply and Demand
13
12 S
10
8
6
4
2 DQ
5 10 15 20 25 30 35 40 45
5

6. P
14
12 Individual firm’s demand
10 D
8
6
4
2
5 10 15 20 25 30 35 40 45
Q
6

7. The individual firm’s
Demand Curve
A horizontal line at the
market price – firm will
offer all of its output at
this price (price taker)
7

8. Profit maximising condition:
(1) TR-TC approach
The total revenue-total cost method
is one way the firm determines the
level of output that maximizes
profit.
Profit reaches a maximum when
the vertical difference between the
total revenue and the total cost
curves is at a maximum. 8

9. TR/TC/Π
500
TR
Maximize Profit
400 TC
300
200
100
1 2 3 4 5 Q
9

10. (2) MR=MC approach
• The MR = MC rule states that the firm
maximizes profit or minimizes loss by
producing the output where marginal
revenue equals marginal cost.
• If the price (average revenue) is below
the minimum point on the average
variable cost curve, the MR = MC rule
does not apply, and the firm shuts down
to minimize its losses.
10

11. P Equilibrium MC
14
12
10
8 MR=AR=D
6
4
2
0 1 2 3 4 5 6 Q
11

12. Short Run Equilibrium
• Supernormal Profit : when TR>TC
AR>AC
• Subnormal Profit: when TR<TC
AR<AC
•Normal Profit: when TR=TC
AR=AC
12

13. What is a Normal Profit?
The minimum profit
necessary to keep a
firm in operation
13

14. P ATC
MC
70
P=MR=AR
60
50 Profit
40
30
20
10
1 2 3 4 5 6 7 8 Q
14

15. P
70 MC
ATC
60
50
40 Loss P=MR=AR
30
20
10
1 2 3 4 5 6 7 8 9 Q
15

16. P NORMAL PROFIT
MC
70
60 ATC
50
40
30 MR
20
10
1 2 3 4 5 6 7 8 9 Q
16

17. Firm will shut down
Price (MR) is below
minimum average
variable cost
SHORT RUN SHUT DOWN DECISION 17

18. PC firm’s short run supply curve
• The perfectly competitive firm’s short-run
supply curve is a curve showing the relationship
between the price of a product and the quantity
supplied in the short run.
• The individual firm always produces along its
marginal cost curve above its intersection with the
average variable cost curve.
• The perfectly competitive industry’s short-run
supply curve is the horizontal summation of the
short-run supply curves of all firms in the
industry.
18

19. P Industry Supply
130 S =∑ MC
120
100
80
60
40
20
5 10 15 20 25 30 35 40 45 Q
19

20. Long run equilibrium
• Long-run perfectly competitive
equilibrium occurs when the firm
earns a normal profit by producing
where price equals minimum long-
run average cost equals minimum
short-run average total cost equals
short-run marginal cost.
20

21. Long-Run Competitive Equilibrium
P LRMC
70
60
50 LRAC
40
30 MR
20
10
1 2 3 4 5 6 7 8 9 Q
21

22. In the long-run, if existing firms
make Supernormal Profits:
New firms enter the industry
Market supply increases
A downward pressure is put
on prices
Until all firms only able to
make normal profit
22

23. In the long-run, if existing
firms make losses:
 Some firms leave the industry
(those whose losses are larger than
TVC)
Market supply decrease
An upward pressure is put on prices
Until remaining firms make normal
profit
23

24. Short-Run Shutdown (P=min AVC)
P
70 MC
60 ATC
50 AVC
40
30
P=MR=AR
20
10
1 2 3 4 5 6 7 8 9 Q
24

25. Monopoly
• Monopoly is a single seller facing
the entire industry demand curve
because the firm is the industry.
• Characteristics:
(3)Single seller
(4)Unique product
(5)Price maker
(6)Impossible entry into the market
25

26. BARRIERS TO ENTRY
Barriers to entry that prevent new
firms from entering an industry are:
(1) ownership of an essential
resource,
(2) legal barriers, and
(3) economies of scale.
26

27. NATURAL MONOPOLY
A natural monopoly arises because of economies
of scale in which the LRAC curve falls as
production increases.
Without government restrictions, EOS allow a
single firm to produce at a lower cost than any
firm producing a smaller output.
Thus, smaller firms leave the industry, new firms
fear competing with the monopolist, and the
result is that a monopoly emerges naturally.
27

28. P Minimizing Costs in a
40 Natural Monopoly
35
30 5 firms
25
20
15
10
5 2 firms 1 firm
Q
20 40 60 80 100
28

29. MONOPOLY AS A
PRICE MAKER
•A price-maker firm faces a
downward-sloping demand curve. It
therefore searches its demand curve
to find the price-output combination
that maximizes its profit or
minimizes its loss.
29

30. MR, AR and TR
• The MR and AR (demand) curves are
downward-sloping for a monopolist.
• The MR curve for a monopolist is
always below the AR (demand) curve.
• The TR curve reaches its maximum
where MR equals zero.
30

31. P
AR=D
MR
Q
31

32. Price elasticity of demand and
MR curve.
• When MR is positive, demand is
elastic, Ed > 1 (P↓ TR↑)
• When MR is equal to zero, demand is
unit elastic, Ed = 1 (TR max)
• When MR is negative, demand is
inelastic, Ed < 1 (P ↑ TR ↓)
• Q: where would a monopolist normally
choose to produce? 32

33. P
Ed > 1
Ed =1
Ed < 1
Q
AR=D
MR 33

34. EQUILIBRIUM MONOPOLY
• The profit-maximizing monopolist, like the
perfectly competitive firm, locates the profit-
maximizing output level where the MR and the
MC curves intersect and charges the price
corresponds to that MR (refer diagram on next
slide) :
 MR=MC determines eqm output level
 P = AR, and is always higher than MR
 Remember P>MR!!!
34

35. P MR=MC
35 MC
30
25
20
15
10
5 MR
D
1 2 3 4 5 6 7 8 9 Q
35

36. SHORT RUN EQUILIBRIUM
• SR-profit-maximizing Q=MR=MC and
price is the AR above that point of
intersection between MR and MC.
• 3 types of profits:
 Supernormal profit: TR>TC, AR>AC
 Normal profit: TR=TC, AR=AC
 Subnormal profit: TR<TC, AR<AC
36

37. P
200
175 MC
150
125
100 ATC
75 Profit
50
25 MR D
1 2 3 4 5 6 7 8 9 Q
37

38. P
40
35 MC
30
25
20 ATC
15
10
5 MR
D
1 2 3 4 5 6 7 8 9 Q
38

39. P
200 MC ATC
175
150
125 Loss
100
75
50
25
MR
D
1 2 3 4 5 6 7 8 9 Q
39

40. LONG RUN EQUILIBRIUM
• The long-run-profit-maximizing
monopolist earns a positive profit
because of perfect barriers to entry.
• If demand and cost conditions prevent
the monopolist from earning a profit, it
will leave the industry.
40

41. Price discrimination
• Price discrimination is the practice of
a seller charging different prices for the
same good not justifies by cost
differences.
• Price discrimination allows the
monopolist to increase profits by
charging buyers different prices, rather
than a single price.
41

42. Conditions necessary for Price
Discrimination
Three conditions:
(2)the demand curve must be downward-
sloping (firm must be a monopoly)
(3)buyers in different markets must have
different price elasticities of demand (high
elasticity low price, vice versa), and
(4)buyers must be prevented from reselling the
product at a higher price than the purchase
price.
42

43. P Price Discrimination
Market for inelastic demand
MR=MC
T1
MC
MR D
Q1 Q
43

44. P Monopolist
Price Discrimination
Market for elastic demand
MR=MC
T2 MC
MR D
Q2 Q
44

45. Disadvantages of monopoly
(1)A monopolist charges a higher price and
produces less output than a perfectly
competitive firm,
(2)Resource allocation is inefficient because the
monopolist produces less than if competition
existed (P>min AC, P>MC),
(3)monopoly produces higher long-run profits
than if competition existed, and
(4)monopoly transfers income from consumers
to producers to a greater degree than under
perfect competition. 45

46. P
200
P>min AC, P>MC
175 MC
150
125
100 ATC
75 Profit
50
25 MR D
1 2 3 4 5 6 7 8 9 Q 46

47. P P=min AC, P=MC
MC
70 ATC
60
50
40
30 MR
20
10
1 2 3 4 5 6 7 8 9 Q
47

48. IMPERFECT COMPETITION
• Imperfect competition is the
market structure between the
extremes of perfect competition and
monopoly.
• Monopolistic Competition and
Oligopoly belong to the imperfect
competition category.
48

49. MONOPOLISTIC COMPETITION
Monopolistic competition is a market
structure characterized by
(2)many small sellers
(3)differentiated product
(4)Some ability to influence market price
(firm’s demand curve is downward
sloping)
(5)easy market entry and exit.
49

50. PRODUCT DIFFERENTIATION
• Product differentiation is a key
characteristic of monopolistic
competition. It is the process of
creating real or apparent differences
between products.
• Each firm’s output is a close
substitute of another’s
50

51. NONPRICE COMPETITION
• Under imperfect competition,
firms may compete using non-price
competition, rather than price
competition.
• Non-price competition includes
advertising, packaging, free gift,
rebate, product development, better
quality, and better service.
51

52. SHORT RUN and LONG RUN
EQUILIBRIUM
• Short-run equilibrium for a
monopolistic competitor can yield
supernormal profit (TR>TC),
subnormal profit (TR<TC), or normal
profit (TR=TC).
• In the long run, monopolistic
competitors make normal profits only
due to easy market entry and exit.
52

53. Short Run Eqm: Supernormal Profit
P
50
40 MC
30
25
ATC
20
15 Profit
10
5 MR AR=D
1 2 3 4 5 6 7 8 9 Q
53

54. P
200
Short Run Eqm: Subnormal Profit
ATC
175 MC
150
125 Loss
100
75
50
25 MR AR=D
1 2 3 4 5 6 7 8 9 Q 54

55. P
40
NORMAL PROFIT
35 MC
30
25
20 ATC
15
10
5 AR=D
MR
1 2 3 4 5 6 7 8 9 Q
55

56. Comparison:
Monopolistic Comp & Perfect Comp
• Differences: Monopolistic competitive
firm charges a higher price, restricts
output, and does not achieve productive
efficiency (P>min AC) and allocative
efficiency (P>MC).
• Similarities: Both earn normal profits in
the long run. Why?
56

57. P
40
Normal Profits
35 Minimum MC
LRAC
30
25
20 ATC
15
10
5 MR
D
1 2 3 4 5 6 7 8 9 Q
57

58. P Perfect Competition
$40
Minimum MC
$35 LRAC LRAC
$30
$25 MR
$20
$15
$10
$5
1 2 3 4 5 6 7 8 9 Q
58

59. OLIGOPOLY
Oligopoly is a market structure characterized by
(2)few sellers,
(3)a homogeneous or differentiated product,
(4)considerable power to influence market price
but prefer to engage in non-price competition
(5)difficult market entry.
**Oligopolies are mutually interdependent
because an action by one firm may cause a
reaction on the part of other firms.
59

60. NONPRICE COMPETITION
• The nonprice competition model is a
theory that might explain oligopolistic
behavior.
• Under this theory, firms use advertising
and product differentiation, rather than
price reductions, to compete.
60

61. MODELS TO EXPLAIN PRICE
STABILITY IN OLIGOPOLY
• Paul Sweezy’s Kinked Demand
Curve
• Price Leadership
• Cartel
61

62. Paul Sweezy’ Model of Kinked
Demand Curve
• The model explains why prices may be
rigid (stable) in an oligopoly market.
• The kink is established because an
oligopolist assumes that rivals will match a
price decrease, but ignore a price increase.
62

63. 400
P Oligopolist’s Kinked Demand Curve
350 MC
300
250
200
150
100
50 AR=D
5 10 15 20 25 30 35 40 45 Q
MR 63

64. PRICE LEADERSHIP
• Price leadership is another theory of
pricing behavior under oligopoly.
• When a dominant firm in an industry
raises or lowers price, other firms
follow suit.
• Reason: To avoid “price war”
64

65. CARTEL
• A cartel is a formal agreement
among firms to set prices and output
quotas.
• The goal is to maximize profits,
but firms have an incentive to cheat,
which is a constant threat to a cartel.
65

66. Comparison between Oligopoly
Perfect Competition
• Oligopolist charges a higher price,
restricts output so that price may exceed
average cost and allocates resources
inefficiently.
• Oligopolist are able to maintain
supernormal profit in the long run due to
effective market entry barriers.
66