Presented By:
Parakramesh Jaroli
MBA (Dual) II - Semester

Market structures
Perfect competition

Market Structures
 Market structure refers to the number and
size of buyers and sellers in the market for
a good or service.
 A market can be defined as a group of
firms willing and able to sell a similar
product or service to the same potential
buyers.

Classification of market
structures
 4 broad categories –
1. Perfect competition
2. Monopoly
3. Monopolistic competition
4. Oligopoly

Major features that determine
market structure
 Number of sellers
 Product differentiation
 Entry and exit conditions

What we analyze in all Market
Structures…
 AR, MR
 AC, MC
 The point where MR = MC ( Profit
maximum )
 Q* ( Equilibrium Output )
 P* ( Equilibrium Price )

Profit
 Normal Profit : That part of the cost that is
paid to the entrepreneur as a part of his
compensation.
 Super-normal Profit : The profit that the
entrepreneur may get over and above the
compensation he gets from the firm, for his
contribution.

Perfect competition
 Features –
1. Large number of buyers and sellers
2. Products are perfect substitutes of each other;
homogeneous products
3. Free entry and exit from the market
4. Perfect knowledge of the market to both buyers
and sellers
5. No govt. intervention
6. Transport cost are negligible hence don’t affect
pricing.

The Meaning of Competition
As a result of its characteristics, the
perfectly competitive market has the
following outcomes:
The actions of any single buyer or seller in
the market have a negligible impact on the
market price.
Each buyer and seller takes the market
price as given.

The Meaning of Competition
Buyers and sellers in competitive
markets are said to be price takers.
Buyers and sellers must accept the
price determined by the market.

Revenue of a Competitive Firm
Total revenue for a firm is the selling
price times the quantity sold.
TR = (P X Q)

Revenue of a Competitive Firm
Average revenue tells us how much
revenue a firm receives for the typical
unit sold.

Revenue of a Competitive Firm
In perfect competition, average
revenue equals the price of the
good.
Average revenue =
Total revenue
Quantity
=
(Price Quantity)
Quantity
= Price


Revenue of a Competitive Firm
Marginal revenue is the change in total
revenue from an additional unit sold.
MR =TR/ Q

Revenue of a Competitive Firm
For competitive firms, marginal
revenue equals the price of the good.

Total, Average, and Marginal Revenue
for a Competitive Firm
Quantity
(Q)
Price
(P)
Total Revenue
(TR=PxQ)
Average Revenue
(AR=TR/Q)
Marginal Revenue
(MR= )
1 $6.00 $6.00 $6.00
2 $6.00 $12.00 $6.00 $6.00
3 $6.00 $18.00 $6.00 $6.00
4 $6.00 $24.00 $6.00 $6.00
5 $6.00 $30.00 $6.00 $6.00
6 $6.00 $36.00 $6.00 $6.00
7 $6.00 $42.00 $6.00 $6.00
8 $6.00 $48.00 $6.00 $6.00
QTR  /

Profit Maximization for the
Competitive Firm
The goal of a competitive firm is to
maximize profit.
This means that the firm will want to
produce the quantity that maximizes
the difference between total revenue
and total cost.

Short run price and output
determination
 In SR a firm has to decide about the output it
should produce at the market price so that profit
is maximum.
 Some inputs are fixed=> fixed costs
 A firm may stay in business to cover these costs
even if it incurs losses in SR
 Cost functions of firms are different as factors of
production are not homogeneous
 Hence each firm has different profit levels.

Conditions for Profit Maximization
 MR = MC ( Necessary condition )
 MCC should intersect MRC from below or
MCC should be rising

Price and output determination
for a perfectly competitive firm
D
S
Q Q
PP
Industry Firm
P* P*
ACMC
Q* Q*
E
C B
A AR = MR

• Firm has to take the price as given by the market
•At the ruling price firm can sell any amount of
its product
•Demand is perfectly elastic
•AR is parallel to X axis
•Equilibrium is at pt. E where demand is equal to
supply
• This determines the price P*
• This price is taken by the individual firm

 Equilibrium for the firm is where MR =MC
and MC curve cuts MR curve from below.
I.e. at point A
 Profit in the short run is the P*ABC
 The firm may incur short run losses also. If
the AC curve lies above the AR=MR curve
the firm in the short run will incur losses.

Profit
Q
Measuring Profit in the Graph for the
Competitive Firm...
Quantity0
Price
P = AR = MR
ATCMC
P
ATC
Profit-maximizing quantity
A Firm with Profits

Loss
Measuring Profit in the Graph for the
Competitive Firm...
Quantity0
Price
P = AR = MR
ATCMC
P
Q
Loss-minimizing quantity
ATC
A Firm with Losses

Long run equilibrium of the firm and
industry
 All factors are variable in the long run
 Hence all costs are variable
 Firm can change the plant and adjust the
capacity according to the requirements of
production
 If profits are supernormal, more firms enter
the market and vice versa.
 Entry and exit of firms is possible

Long run equilibrium of the firm and
industry
 If the number of firms increase, ( because they
might be attracted towards the supernormal
profits ), or the same firms increase their
production, the supply curve moves to the right.
At the same demand, this results in a decrease in
price.
 If the number of firms decrease, ( because of
losses ), or the same firms decrease production,
the supply curve shifts to the left. At the same
demand, this results in an increase in price.

Long run equilibrium of the firm and
industry
 Hence, in the long run, supernormal profit is not
possible and all firms have to survive at a Normal
profit.
 This means that all the firms will stop production
at the point where AC is lowest. This is also the
price they will sell the goods at.
 Hence in the long run, firms have no incentive to
expand or contract their production capacity or
leave the industry and new firms have no
incentive to enter the industry.

 MR = MC in long run as well
 Under perfect competition, since MR =AR, in
equilibrium also MC is equal to AR
 Price must also equal AC.
 P > AC => supernormal profits
 New firms enter the market
 If there are losses, firms will leave the market.
 Thus in the long run equality of P and AC
becomes a necessary condition.
 Thus,
P(AR) =MR =AC = MC in the long run

Long run

 Economic Efficiency
 The fundamental economic problem is a
scarcity of resources.
 Definition of Efficiency
 Efficiency is concerned with the optimal
production and distribution or these scarce
resources.

Types of Efficiencies
 There are different types of efficiency
 1. Productive efficiency.
 This occurs when the maximum number of goods and
services are produced with a given amount of inputs. This
will occur on the production possibility frontier.
 ON the curve it is impossible to produce more goods
without producing less services.
 Productive efficiency will also occur at the lowest point
on the firms average costs curve


Types of Efficiencies
 2. Allocative efficiency
 This occurs when goods and services are
distributed according to consumer preferences.
An economy could be productively efficient but
produce goods people don’t need this would be
allocative inefficient.
 Allocative efficiency occurs when the price of the
good = the MC of production


Types of Efficiencies
 3. X inefficiency:
 This occurs when firms do not have
incentives to cut costs, for example a
monopoly which makes supernormal
profits may have little incentive to get rid
of surplus labor. Therefore a firms average
cost may be higher than necessary


Types of Efficiencies
 4. Efficiencies of scale
 This occurs when the firms produces on the
lowest point of its Long run average cost
and therefore benefits fully from
economies of scale


Types of Efficiencies
 5. Dynamic efficiency This refers to
efficiency over time for example a Ford
factory in 1920 would be very efficient for
the time period but would now be
inefficient by comparison therefore it is
necessary for firms to constantly introduce
new technology and reduce costs over time

Types of Efficiencies
 6. Social efficiency
 This occurs when externalities are taken
into consideration and the social cost of
production (SMC) = the social benefit
(SMB)


Types of Efficiencies
 7. Technical Efficiency
 Optimum combination of factor inputs to
produce a good: related to productive
efficiency.

Efficiency of Perfect Competition
 1. Allocative Efficient. This is because P = MC
 2. Productive Efficient. This is because firms
produce at the lowest point on the AC
 3. X Efficient. Competition between firms will
act as a spur to increase efficiency
 4. Resources will not be wasted through
advertising because products are homogenous
 5. Normal profit means consumers are getting the
lowest price.
This also leads to greater equality in society

Disadvantages of Perfect Competition
 1. No scope for economies of Scale, this is because there are many
small firms producing relatively small amounts. Industries with high
fixed costs would be particularly unsuitable to perfect competition.
· This is one reason why p.c. is unlikely in the real world
 2. Undifferentiated products is boring giving little choice to
consumers. Differentiated products are very important in industries
such as clothing and cars
 3. Lack of supernormal profit may make investment in R&D unlikely
this would be important in an industry such as pharmaceuticals which
require significant investment
 4. With perfect knowledge there is no incentive to develop new
technology because it would be shared with other companied
 5. If there are externalities in production or consumption there is
likely to be market failure without govt intervention
Competitive Markets

 In the real world perfect competition is very rare and the model is
more theoretical than practical.
 However in general economists often talk about competitive markets
which do not require the strict criteria of perfect competition.
 A competitive market is one where no one firm has a dominant
position but the consumer has plenty of choice when buying goods or
services. Therefore in competitive markets we would expect
 1. Firms to have a small share of the market
2. Few barriers to entry
3. Low prices for consumers
4. Allocative efficiency
5. Incentives for firms to cut costs and develop new products
6. Profits will be lower than in markets with Monopoly power
 · This is linked closely to the idea of Contestable markets which is
concerned with low barriers to entry and freedom of entry.

Monopoly
 A monopoly has only one seller, who is
able to influence the total supply and price
of the goods and services. Further, there are
no close substitutes for the goods produced
by the monopolist and there are barriers to
entry.

Main factors that lead to monopoly
are:
 Ownership of strategic raw materials and exclusive
technical know-how
 Possession of product/process patent rights
 Acquisition of government license to procure certain
goods
 High entry costs
 The size of the market may not allow more than one firm
to exist. Hence, the market creates a natural monopoly.
Thus, the government usually supplies and produces the
commodity to avoid consumer exploitation