MICRO ECONOMICS ASSIGNMENT

Student name Registration number

1. Munasinghe I.A.E. ADBM-F-132166

2. DulangaB.A.I. Jayawardana ADBM-F-132283
3. Wickramarathna W.L.Imashi ADBM-F-132265
4. Senadhira S.D.P.Sapumali ADBM-F-132231

ADVANCED DIPLOMA IN BUSINESS MANAGEMENT

NATIONAL INSTITUTE OF BUSINESS MANAGEMENT (13.2.2)

CONTENT

CONTENT............................................................................................................................................2
MARKET STRUCTURES...................................................................................................................4
REASONS FOR MARKET STRUCTURES....................................................................................4
PERFECT COMPITITION...........................................................................................................................5
WHAT IS PERFECT COMPITITION..............................................................................................5
CHARACTERISTCS OF MARKET COMPITITIONS....................................................................5
DEMAND CURVE OF THR PERFECT COMPETITION MARKET.............................................6
PERFECT COMPETITION MARKET EQUILIBRIUM..................................................................6
TOTAL COST AND TOTAL REVENUE STATERGY..............................................................6
TOTAL COST AND TOTAL REVENUE STATERGY IN A DIAGRAM.................................7
MARGINAL APPROCH..............................................................................................................8
MARGINAL APPROCH IN A DIAGRAM..................................................................................8
SHORT TERM ACTIVITIES OF A PERFECT COMPETITION MARKET..................................9
PRODUCING WHILE HAVING ECONOMIC PROFITS.........................................................10
PRODUCING WHILE HAVING ZERO ECONOMIC PROFITS..............................................11
PRODUCING WHILE HAVING ECONOMIC LOSSES...........................................................12
SHUT DOWN POINT OF THE PERFECT COMPETITION MARKET.......................................13
SHORT TERM SUPPLY CURVE OF A PERFECT COMPETITION MARKET.........................14
MONOPOLY......................................................................................................................................15
WHAT IS MONOPOLY.................................................................................................................15
MAIN CHARACTERISTICS.........................................................................................................15
MONOPOLY MARKET DEMAND...............................................................................................16
MARGINAL REVENUE AND THE PRICE..................................................................................17
OUTPUT AND THE PRICE DETERMINATION.........................................................................17
PRICE ELASTICITY OF DEMAND..........................................................................................17
MONOPOLISTIC AND THE PROFIT.......................................................................................18
MONOPOLISTIC COMPETITION..................................................................................................19
WHAT IS MONOPOLISTIC COMPETITION...............................................................................19
THE MONOPOLISTICALLY COMPETITIVE FIRM IN THE SHORT RUN..............................20

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 THE SHORT RUN OF THE MONOPOLISTIC COMPETITION IA DIAGRAM.....................20
THE MONOPOLISTICALLY COMPETITIVE FIRM IN THE LONG RUN................................21
LONG RUN OF THE MONOPOLISTIC COMPETITION IN A DIAGRAM...........................21
OLIGOPOLY MARKET...................................................................................................................22
WHAT IS AN OLIGOPOLY MARKET.........................................................................................22
CHARACTERISTICS OF OLIGOPOLY.......................................................................................22
CHARACTERISTICS OF THE OLIGOPOLY MARKET.............................................................23
BEHAVIOR OF THE OLIGOPOLY..............................................................................................24
PRICE AND OUTPUT IN OLIGOPOLY.......................................................................................25
A COMPARISON OF VARIOUS MARKET STRUCTURES..........................................................26

MARKET STRUCTURES
Market structure is a place where buyers and suppliers meeting and taking decisions about
demand and supply quantities and about price levels of the commodities.

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There are four main market structures

1. Perfect competition
2. Monopoly
3. Monopolistic competition
4. Oligopoly

When we are focusing on market structures there so many answers for the question “why are
there market structures?”

REASONS FOR MARKET STRUCTURES

1. Number of institutes that can be seen in the market.

In this manner we are considering about the number of institutes in the market. Are there
single, many or so many institutes. According to the value divide markets into the structures.

Market Market structure

Railway service Monopoly
Mango market Perfect competition
Commercial banks Oligopoly
Cafeterias Monopolistic competition

2. Nature of the product.

In a market, are they selling same product or different products.

3. Nature of the competition among the institutes.

PERFECT COMPITITION
WHAT IS PERFECT COMPITITION
A market structure with many buyers and sellers who are selling homogeneous products,
because of that sellers cannot do anything to the price level they are becoming price takers.

CHARACTERISTCS OF MARKET COMPITITIONS

1. Homogeneous products.

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All the suppliers of the perfect competition market are producing same products for each
other without any differences. They are perfectly substitute product to each other.

Because of that,

a) Cannot be seen any promotions.

b) Can see perfectly elastic cross elasticity of demand between each product.

2. Large number of buyers and sellers.

In a perfect competition market can be seen huge number of buyers and sellers, because of
that one buyer or a seller cannot make any differences on the market or to the price levels.

3. Free entity and exit.

There are no any restrictions for the buyers and for the sellers to enter to the market or to exit
from the market.

In a perfect competition market they have not to take any license, patents, or there are no any
rules and regulations.

4. Perfect knowledge at zero cost.

Each component of a perfect competition market has an idea about what is happen at the
market. Availability of information is high and every one can access to the information at
zero cost.

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DEMAND CURVE OF THR PERFECT COMPETITION MARKET

S P

P E P
1 1

D
0 Q1 Qd/s 0 Qd/s

 Demand curve of perfect competition institute starts from the equilibrium price of the
market and going parallel to the quantity axis. It is a perfectly elastic demand curve.

PERFECT COMPETITION MARKET EQUILIBRIUM

There are two main strtagies to analyse the market equilibrium of a perfect competition
market structure

1. Total cost and total revenue statergy.

2. Marginal approch.

TOTAL COST AND TOTAL REVENUE STATERGY

Calculating market equilibrium according to the cost and revenue information is conceders in
this approach.

 The difference between total cost and revenue known as economic profit.
 The highest positive difference between total cost and total revenue is the point that
the market earns highest value as the profit.
 That point is where we can see perfect competition market equilibrium

It can be derive by using diagram that shows in next page

TOTAL COST AND TOTAL REVENUE STATERGY IN A DIAGRAM

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  According to the diagram point “B” is the market equilibrium.

MARGINAL APPROCH.
In this approch we are concedring about two variables, they are

1. Marginal revenue
2. Marginal cost

With above detailes we can derive the market equilibrium of a perfect competition
market.but there are two conditions what are to be cover to derive equilibrium

1. Margnal revenue should be equal to Marginal cost.

2. Marginal revenue curve should be touch marginal cost curve in the positive part
of the Marginal cost curve.

It can be derive by using following diagram

MARGINAL APPROCH IN A DIAGRAM

Price/
cost
MC

P1 A B
MR/AR/
D
0

0
Q1 Q2
Quantity

 According to the diagram point “B” is the market equilibrium.

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SHORT TERM ACTIVITIES OF A PERFECT COMPETITION
MARKET
There are two main resistances for the perfect competition market has to face in short term.

They are,

1. Accredited price
2. Cannot expand the technology and the capacity

If there were those resistances, an institute has to make two important decisions.

They are,

1. Are we going to do the production further or not?

2. If doing what is the amount that we are going to produce?

After an institute make that decisions it has to face one of the following situation.

1. Producing while having economic profits

2. Producing while having zero economic profits
3. Producing while having economic losses

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PRODUCING WHILE HAVING ECONOMIC PROFITS
If total revenue is larger than the total cost, then those companies earn economic profits
while they are producing.

It can be shown in the following diagram.

Price/
cost MC
AC

P1 A
MR/AR/D

P2 ECONOMIC
B
PROFIT

0
Q1
Quantity

Total Revenue = OQ1AP1

(-)Total cost = (OQ1BP2)

Economic profit = P1ABP2

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PRODUCING WHILE HAVING ZERO ECONOMIC PROFITS
If total revenue is equal to the total cost, then those companies earn zero economic profits
while they are producing.

It can be shown in the following diagram.

Price/ MC
cost AC

P1 A
MR/AR/D

P2
B

0
Q1
Quantity

Total Revenue = OQ1AP1

(-)Total cost = (OQ1AP1)

Economic profit = -0-

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PRODUCING WHILE HAVING ECONOMIC LOSSES
If total cost is larger than the total revenue, then those companies earn economic losses while
they are producing.

It can be shown in the following diagram.

MC AC
Price/
cost

P2 B

P1 A
MR/AR/D

ECONOMIC LOSS

0 Q1
Quantity

Total Revenue = OQ1AP1

(-)Total cost = (OQ1BP2)

Economic profit = P1ABP2

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SHUT DOWN POINT OF THE PERFECT COMPETITION MARKET
Perfect competition institute at least willing to have a price which is equal to average total
cost, otherwise they will stop their production.

This can be shown in the following diagram

MC AC
Price/
cost

A
P1 MR/AR/D

0 Q1
Quantity

 According to the diagram at least they are willing to have a price which is equal to
“p1”.otherwise they will stop there production.

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SHORT TERM SUPPLY CURVE OF A PERFECT COMPETITION
MARKET
Supply curve of a perfect competition institute contains three parts

1. Price axis (p=0 to average variable cost)

2. Demand curve which p= average variable cost (Q=0 to equilibrium point)
3. Mc curve above average variable cost curve

This can be shown in the following diagram

Price/
cost
MC
AVC
P4 D4/AR4/MR4

P3 D3/AR3/MR3

D2/AR2/MR3
P2

P1 D1/AR1/MR1

0 Q
Q2 Q Q4
1
3 Quantity

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MONOPOLY

WHAT IS MONOPOLY
Pure monopoly defines when a single firm/ market producer of a product for which there is a
no close substitutes exists an in which there is a one supplier.
Examples of monopoly
o Water service
o Electrical supply

MAIN CHARACTERISTICS
 Single Seller
A pure monopoly is an industry in which a single firm is the sole producer of a
specific good or the sole supplier of a product or service.
 No close substitutes -
In that market no close substitutes. The consumer who chooses not to buy the
monopolized product must do without it.

 Barriers to Entry
That is a protection a firm form potential new entrants. There are two barriers. Legal
& Natural
o Legal Barriers
Government also create a legal barriers to entry by awarding patents, or copy
right in which a firm has acquired ownership in their firm. It may also limit entry into an
industry or occupation through licensing.

o Natural barriers
That gives rise to natural monopoly. Ownership or control of essential resources can
use private property as a monopolist. Monopolist owns and controls the resources. Because,
ownership of essential resources in their own products. That will affect to the other firms to
the entry.

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  Price Maker
The pure monopolist controls the total quantity supplied and thus has considerable
control over price. Extensive economies of scale or ownership of essential resources, entry
may effectively be blocked. The monopolist may “create an entry barrier” by slashing its
price, stepping up its advertising or taking other strategies actions to make it difficult for the
entrant to succeed.
This is most evident in pure monopoly, where one firm controls total output. The monopolist
faces a down sloping demand curve in which each output is associated with some unique
price.

MONOPOLY MARKET DEMAND

In the monopoly market has not to search same products or close substitutes. Then the
customer has only to get two options. If the consumer want to buy the products, but only one
producer in the hole market.
In that time customer has only one choice if I buy it or not buy it?
Consumer can still choose to purchase less output at a higher price.
Pure monopolist’s is the industry. Monopoly market demand curve and the industry demand
curve all are one. And market demand curve is not perfectly elastic. The monopolist’s
demand curve is down sloping.
Price

Demand curve

1 Quantity

Demand curve for the monopoly market

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MARGINAL REVENUE AND THE PRICE
If the any firm demand curve will be sloping downward then it means marginal
revenue will be less than price. They sell more units at the lower price and sell all the output
at the lower price.

OUTPUT AND THE PRICE DETERMINATION

PRICE ELASTICITY OF DEMAND

Only one firm supplies all the output, the firm and the market demand curve are the same.

Price

E>1

E =1

E <1
MR D

Quantity

MR =MC determines the profit maximizing output for a monopolist,

If, MR > MC the monopolist gains profit by increasing output. [Elastic]

One more unit will add more revenues than cost.

MR < MC the monopolist gains profit by decreasing output. [Inelastic]

Producing one less unit will save more costs than it sacrifices in revenue so profit increase.

MR = MC the monopolist maximizing the profit. [Unit elastic]

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MONOPOLISTIC AND THE PROFIT

Price Price MC Price

MC MC

ATC
Loss
Profit
ATC ATC

MR D Qty MR D Qty MR Qty

D

Monopolist with earning profit Monopolist with zero Profit Monopolist with
Loss

Price

Quantity

MR D

Monopolist with zero profit

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MONOPOLISTIC COMPETITION

WHAT IS MONOPOLISTIC COMPETITION

There are large numbers of producers who supply similar but not homogeneous products. The
Products are differentiated, in style, image and price. There is not one prevailing market
price. Firms may compete on price to try and gain market share at the expense of rivals.
Consumers lack perfect knowledge but have a choice of products. This choice may be
extended if new firms enter the industry perhaps attracted by the prospect of abnormal
profits. There are no entry barriers; new firms can enter the industry and existing firms can
leave at little cost. The lack of barriers to entry would suggest that in the long run only
normal profits can be made. Prices are likely to be higher than under perfect competition but
the customer now benefits from more choice.

For example,

 Greeting cards market

 Book market
 Computer software market
 Restaurants market
 Furniture market

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THE MONOPOLISTICALLY COMPETITIVE FIRM IN THE SHORT
RUN
 Each firm in monopolistic competition faces a downward-sloping demand curve.
 The monopolistically competitive firm follows the monopolist's rule for maximizing
profit.
 It chooses the output level where marginal revenue is equal to marginal cost.
 It sets the price using the demand curve to ensure that consumer will buy
amount produced.
 We can determine whether or not the monopolistically competitive firm is earning a
profit or loss by comparing price and average total cost.

1. If P > ATC, the firm is earning a profit.

2. If P < ATC, the firm is earning a loss.

3. If P = ATC, the firm is earning zero economic profit.

 The following curve shows the short run of the monopolistic competition.

THE SHORT RUN OF THE MONOPOLISTIC COMPETITION IA

DIAGRAM

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THE MONOPOLISTICALLY COMPETITIVE FIRM IN THE LONG
RUN
1. When firms in monopolistic competition are making profit, new firms have an
incentive to enter the market.

-This increases the number of products

-Thus, the demand curve faced by each firm shifts to the left.

2. When firms in monopolistic competition are incurring losses, firms in the market
will have an incentive to exit.
1. Consumers will have fewer products from which to choose.
2. Thus, the demand curve for each firm shifts to the right.

3. The process of exit and entry continues until firms are earning
Zero profit.

1. This means that the demand curve and the average total cost curve
are tangent to each other.

 This curve shows the long run of the monopolistic competition.

LONG RUN OF THE MONOPOLISTIC COMPETITION IN A DIAGRAM

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OLIGOPOLY MARKET

WHAT IS AN OLIGOPOLY MARKET

A market dominated by a few sellers and that has more buyers. That is a market dominated
by a few large producers of a homogeneous or differentiated product. On their fewness have
considerable control over their prices.
Each firm must consider the possible reaction of rivals to its own pricing, output, and
advertising decisions.

CHARACTERISTICS OF OLIGOPOLY
 A few large firms
 Standardized/ Homogeneous or differentiated products
 Significant barriers to entry
 Market power – Mutual Independent

Examples for the Oligopoly

 Steel market
 Oil market
 Automobile market
 Cement market
 News Papers market
 Commercial Banks market

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CHARACTERISTICS OF THE OLIGOPOLY MARKET

 A few large producers

In that market has few competitors. That means, in that market structured with
small number of interdependent firms complete. Some of the times they can’t get
decisions independently in that time they try to related with their other firms and try
to keep relation with the others. Consequently, each of the firm’s get react on rivals to
price, production, production decisions.

 Standardized/ Homogeneous or differentiated products

An oligopoly may be either a homogeneous oligopoly or differentiated product
oligopoly.
Homogeneous oligopoly - It means in which the firms produce a standardized
products.
Ex: [steel, zinc, copper, aluminum, cement industrial, alcohol]
Differentiated Oligopoly – It means in which the firms produce a
differentiated products.
Ex: [automobiles, tires, house hold]

 Entry Barriers
The same barriers are created on pure monopoly market and all are contribute
to the creation of oligopoly. Economies of scale are the important entry barriers in a
number of oligopolistic firms.
Another closely related barrier is the large expenditure for capital. They are
characterized by very high capital requirements.
And also ownership and control of the raw materials exists in many mining
industries.

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  Market power
In oligopoly market few industries in there. In the oligopolistic it can create
and set its price and output levels. There are like monopolists they and oligopolistic
are price market. In that is characterized by, strategic behavior and mutual
interdependence.
o Strategic behavior –
Self interested behavior that takes into account the reactions of the
others
o Mutual interdependence –
That a situation in which a change in strategy by one firm will affect
the sales and profits of other firms. So oligopolistic firms base their decisions on how
they think rivals will react.

 Mergers
The combining of two or more firms in the same industry may crease their
market share. The merger may increase their firm’s monopoly power [Pricing power].

BEHAVIOR OF THE OLIGOPOLY

Game - Theory
That study of how people or firms make decisions in situations. It study of the profits
of the each firm depend on its interactions with other firms. This is use a simple game
theory, example of analyzing the pricing behavior of oligopolies.
Business strategy
Actions will take by a business firms to achieve goals, and such as
maximizing their profits.

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PRICE AND OUTPUT IN OLIGOPOLY

Oligopoly making a profit

Price

MC

AC
Profits

D
MR
0
Quantity

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A COMPARISON OF VARIOUS MARKET STRUCTURES

Structure/ Monopolistic Perfect

characters Monopoly Oligopoly Competition Competition
Number of firms One Few Many Almost
infinite
Strategic
Pricing MC = MR pricing MC = MR MC = MR = P
decisions between
monopoly and
perfect
competition
Most output Output Output No output
Output restriction somewhat restricted restriction
decisions restricted somewhat
product
differentiation
Only firm in Interdependent Each firm act Each firm act
Interdependenc market, not strategic independently independently
e concerned pricing &
about output
competitors decision
Possibility of Some long run No long run No long run
Profit long-run economic economic economic
economic profit possible profit possible profit possible
profit
Water News papers, Restaurants, Paddy,
Examples supply, Commercial Retailer Carrot
Electrical banks, cement shops,
supply Saloons

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