MARKET STRUCTURE

● Market is a mechanism which brings together the buyers and sellers wherein they have this
transaction upon an agreed price.
● As long as there's a buyer, there's a seller, there's a transaction that is the exchange of goods and
services.
● Kapag nagkaroon ng transaction there is an agreed price na tinatawag na Equilibrium Price.
● Hindi need na may place, basta may buyer, sellers and transaction, there is an agreed price, market
na yon.

This chapter examines a broad range of markets and explains how the pricing and output decisions of
firms depend on market structure and the behavior of competitors.

To determine the output to be produced is not only dependent on the question of efficient utilization of
productive inputs but also on whether the quantity produced can be bought (demand facing the firm) and
at what price. Of course higher price is preferred by the firm as discussed in the law of supply but this
pricing scheme is dependent on the types of market structure: pure competition, pure monopoly,
oligopoly and monopolistic competition.

Comparative Characteristics of Four Market Structures

 PURE COMPETITION
Pure competition is a market structure characterized by very large number of small sellers just like a
farmer whose products are homogenous.

Perfect competition is a market characterized by a complete absence of rivalry among the individual
firms. (same; rice is rice, pechay is pechay)

The Essential Characteristics of Pure Competition are as follows:

1. There is a very large number of independent sellers in the industry. A single seller is very small
relative to the size of the market. The buyers are also numerous so that no monopolistic power can affect
the working of the market.

2. Products are homogenous or identical, therefore, there is no reason for the firm to charge higher or
lower prices compared to other firms in an industry.

3. Freedom of entry or exit in the industry implies that there are no legal, technological, and financial
obstacles that prevent other firms from entering the market. Enter especially when firms that are
already in the market are gaining profit or exit when the firms are incurring losses in the industry.

4. Product pricing is not dictated by any one seller or buyer but determined by the demand and
supply condition. Buyers and sellers are price takers.

5. The demand curve for the industry is downward sloping but for a single firm in a pure competition, it
is perfectly elastic. The demand curve is a normal downward sloping demand curve showing that for the
industry as a whole quantity demanded increases as price falls.

6. Agricultural products like atis, mangoes, eggplants, okra, squash, and even galunggong are products in
pure competition. You may have noticed that prices of agricultural products fluctuate, there are times they
are expensive, sometimes cheap depending on the market conditions. Fruits that are in season are less
expensive while those that are not are more expensive.

Pure Competition vs Perfect Competition

Pure competition could be a perfect competition if there is perfect knowledge about the market by all
units involved. Any change in the Pure competition could be a perfect competition if there is perfect price
and quantity sold and bought are known to all in the industry, a condition which is hardly achieved. In
this book, discussion is confined to Pure Competition.
 Figure 7.1 The Demand Curve for the Industry and the Firm under Pure Competition

An entire industry can affect price by changing industry output but the individual firm CANNOT with
the perfectly elastic demand as shown on the right

An industry is the summation of all firms and in pure competition it comprises a very large number of
sellers. The demand curve for the firm is perfectly elastic showing that no seller or buyer can dictate
the price, hence, each is a price taker. Example in Table 7.2 the established market price is P4 regardless
of quantity demanded in that particular market. Prevailing price cannot be higher than market price of P4
because no one will buy at higher prices given a homogenous product in pure competition.

Table 7.2 Price and Revenue in Pure Competition

Table 7.2 shows that in Pure Competition whatever is the Demand = Price = AR = MR = 4 as in the
illustration above.
Effect of Change in Number of Sellers on the Demand Curve

A buyer or seller in pure competition has freedom to enter or exit the industry. If price is very low, this
discourages sellers hence the number of sellers decreases, supply curve shifts to the left from S_{1} to
S_{2} Equilibrium price increases for an industry to P*e_{2} hence, the demand curve for the firm
shifts upward as shown in Figure 7.2 on the right side.

Figure 7.2 The Change in Equilibrium Price in Pure Competition

If price of tomatoes is very low, at P 4, due to a lot of harvest of many farmers (supply) relative to the needs
of the market (demand) at particular time and place, many farmers may be discouraged. Hence, supply
curve shifts to the left from S, to S, as shown in Figure 7.2 on the left side.

Remember that products in agriculture are highly perishable so there is need to sell regardless of the price.
A seller cannot dictate the price but may only decide how much to produce or not to produce.

A seller has freedom to enter or exit in the industry. If price is very low which may mean losses for all
sellers, some may decide to get out of the industry, therefore, there is a decrease in number of sellers.
This action of the sellers may shift the supply curve to the left which will lead to an increase in the market
price for tomatoes at P6.00 as shown on right side of Figure 7.2.

However, if price is very high, sellers may decide to re-enter the industry. This collective action of the
sellers may shift the supply curve to the right, hence, the equilibrium price will decrease.

We can say that demand and prices in pure competition are subject to fluctuations depending on the
condition in the market. Prices can be very high or very low depending also on the supply and demand
conditions.
Two Approaches to Profit Maximization and Loss Minimization
The two approaches to profit maximizing and loss minimization are used in all market structures.

1. Total Revenue - Total Cost Approach

To obtain the profit maximizing output (Q), let us start by recognizing profit (TT).

FORMULA: TT = TR - TC

Finding the profit-maximizing output is as simple as finding the output at which TR exceeds TC by the
largest amount.

Figure 7.3 shows that the profit maximizing output is at Q = 7 units where TR = 56 and TC = 43. Profit is
P13.00 which is measured by vertical distance between TR and TC. TR curve is above TC at Q between 3 to
8, the firm is making a profit but when TC is above TR at Q < 2 , the firm incurs loss.

Figure 7.3 Total Revenue, Total Cost and Profit

The above graph is based on Table 7.4 on page 128 at price = P8 where the profit maximizing output is at 7
units and gain of P13.00.

2. Marginal Revenue - Marginal Cost Approach

Marginal Revenue (MR) is the additional or the extra revenue from an additional unit of output while
Marginal Cost (MC) is the additional or the extra cost in producing one unit of output.
The equilibrium condition for the firm is MR = MC, a situation in which the firm may produce output where
profit is maximum or loss is minimum.

For illustration, Table 7.3 shows that MR = MC at Q = 5 units with loss P9.00; loss which is the minimum
compared to other production level.

If MC > MR, it would not benefit the firm since additional cost incurred (sacrifice) is higher than its
additional revenue (benefits) in the production of additional output, therefore firm must be advised to
decrease the output produced.

If MR > MC, firm can be advised to increase its production level to maximize profit or minimize losses.

The Price and Output Determination in the Pure Competition

How many units of the goods the sellers wish to produce is determined by the demand and the cost that
sellers may incur. Using the illustration on cost from the previous chapter, adding the demand curve for the
firm in pure competition, the rational producer is at equilibrium condition if MR=MC, where firm
maximizes profit or minimizes losses. The firm will minimize losses by producing the output where marginal
revenue equals marginal cost at Q=5 where losses is minimum at 9.

Formula: Profit (TT) = Total Revenue - Total Cost

Table 7.3 Revenue and Cost Schedule for Firm Incurring Losses in Pure Competition

Table 7.3 shows the Revenue and Cost of the firm given the prices at P4.00. The quantity or output where
MR = MC is at Q = 5 with losses minimum at P9.00. (Notice that at Q = 2, MR = MC but this is a level
where Marginal cost is still decreasing hence, it is not where loss is minimum since loss at this level is P11.00).
At any production level, the firm incurs loss or negative profit since TC exceeds TR. This is because the price
is very low at P4.00 per unit of the product. The firm which is a price taker cannot change it.

Figure 7.4 Loss Minimizing Condition for Pure Competition

The intersection of MR and MC is shown in Figure 7.4 at point A. The firm's demand curve is a horizontal line
which is identical to its MR, AR and Price = P4.00. Given ATC, AVC and MC curves from the previous
chapter, the loss minimizing point is point A at Q = 5 and shaded area represents the losses.

At Q=5, P=P4 is less than ATC=P5.8. The loss per unit is P1.80 and total loss is P1.80 x 5 = P9 which is
represented by the loss area in the graphical in Figure 7.4.

SHUTDOWN: The firm can continue producing even when there is a loss as long as loss is lower than
its TFC. But if price is too low with losses greater than or equal to TFC, the firm has to shut-down. The
shut-down situation is when the firm stops producing.

● At a price P, the firm is incurring a loss, but it does not shut down because of fixed costs. In the
short run, a firm knows it must pay these fixed costs regardless of whether or not it produces.
● The firm only considers the costs it can save by stopping production and those costs are its
variable costs.
 ● The point at which MC = AVC is the shut-down point (that point at which the firm will gain more by
temporarily shutting down than it will by staying in business).
● As long as a firm's total revenue is covering its total variable cost, temporarily producing at a
loss is the firm's best strategy because it is making less of a loss than it would make if it were
to shut down.

In the long-run, the firm in pure competition always operates at break-even, that is where TR = TC, so there
is no gain or loss because of freedom of entry and exit. At high price, firms realize profit but more firms
will enter the industry, so there will be shift of supply curve to the right, hence, the market price will decrease,
at this very low price which may mean that firm will incur losses. These losses will prompt other sellers to get
out of the industry, hence, an increase in price. These adjustments in prices will make the purely competitive
firm operate at break-even condition in the long-run.

Break-even output is where P=ATC. Graphically, this is the output where the price line crosses the ATC
Curve. The firm’s revenue is equal to cost hence, it has no economic profit or loss.

Table 7.4 Revenue and Cost Schedule for Firm with Excess Profit

Table 7.4, shows that at whatever output is produced, the firm's Total Revenue is higher than its Total Cost.
Hence, there is excess profit or there is gain for the firm, except at output levels below 3 units where TR<TC.
Profit is maximum at output where MR = MC at 7 units with excess profit of P13.00
 Figure 7.5 Profit Maximizing Condition in Pure Competition

Equilibrium point is E where MR = MC with quantity produced of 7 units. Excess profit is shown by the
shaded area in Figure 7.5.

Figure 7.5 also illustrates profit maximizing output of the firm based on per unit cost and revenue. At Q=7,
P=P8>_ ATC =P6.15, the per unit profit is P1.85 and total profit is P13 which is the maximum profit level
represented by the gain area in the same figure. Hence Q=7 is the profit maximizing output where MR =
MC at point E.

If the firm operates where its MC > MR, it is advisable for it to decrease production level since its
additional cost in producing additional unit of output is higher than the additional revenue.

If the firm operates where its MR > MC, it is advisable for it to increase its production level since its
additional revenue or earning from each additional unit produced is higher than the additional
expense for the additional output produced.

Now, if the firm is already producing output where its MR = MC, it is at its optimum level. This is where
profit is maximum or loss is minimum. When the firm incurs losses it does not mean that it has to stop
producing, it may still go on producing at equilibrium as long as loss is lower than its Total Fixed Cost.
However, if despite being at optimum level the firm incurs loss which is already greater than its total
fixed cost then it is wise for the firm to shut down.
 PURE MONOPOLY

- One firm is the sole producer or seller of a product which has no close substitutes (1 producer, many
buyers). No close substitutes for the product of that firm should be available.

The following are the characteristics of pure monopoly:

1. There is only one seller in the industry.

2. Product produced does not have close substitute.

3. Entry of other firms in the industry is blocked because of barriers like government franchises and
patents.

4. A monopolist can dictate the price in the market, thus, seller is a price setter.

5. Demand curve for Pure Monopoly is like the industry's demand curve which is relatively inelastic and
its MR is below AR.

6. Utilities like electricity and water are examples of products of monopoly.

● There is only one firm in the industry and so there is no difference between the demand curve
for the industry and the firm.
● Since a normal demand curve is assumed, it is necessary for the monopolist to reduce price in
order to increase the quantity sold.
● In other words, in order to increase sales the monopolist must reduce the price of all goods sold
and therefore marginal revenue will always be less than average revenue under monopoly.

Sources of Monopoly
1. Legal Restrictions
● Some public sector services are statutory monopolies, which means their position is protected
by law.
● A monopoly position might also be protected by a patent which prevents other firms from
producing an identical good during the life of the patent.

2. Capital Costs
 ● Certain businesses, such as international airlines and chemical companies, have relatively high
set- up costs.

3. Natural Factor Endowment (Natural Gift - Ring, Diamonds, Banana)

● A particular country has a monopoly in the supply of a particular commodity due to natural
factor endowments and it is impossible to obtain supply of the commodity from any other
source.

4. Tariffs (Import ng good magbabayad muna ng tariff sa customs) and Quotas (Number of goods na
iimport)
● A tariff raises the price of goods imported into the domestic economy and a quota restricts
the volume that can be imported. They, therefore, protect domestic industry from international
competition.
● Protection as a soul monopolies para limited yung importation

Price Discrimination
● Price discrimination is 'personal' when different prices are charged from different persons, 'local'
when different prices are charged from people living in different localities, and 'according to
use' when, for example, higher rates are charged for commercial use of electricity as compared
to domestic use.
● Price discrimination is possible when the seller is able to distinguish individual units bought by single
buyer or to separate buyers into classes where resale among classes is not possible.
● Price discrimination is a microeconomic pricing strategy where identical or largely similar goods or
services are sold at different prices by the same seller in different markets.
● One of the factor is Purchasing Power
 Table 7.5 The Price and Revenue Schedule for Pure Monopoly

MR is lesser than AR for Pure Monopoly; Demand = P = AR, but MR is lower. See Table 7.5 and its graph
in Figure 7.6.

Output Determination in Pure Monopoly

Regardless of market structure, the equilibrium condition for the firm is where MR = MC.

Table 7.6 Revenue and Cost Schedule for Pure Monopoly

Based on Table 7.6, the Pure Monopoly’s revenue and cost schedule, MR = MC = 4 is where output is 5 units
with profit of P31. As shown in the Table, P 31 is the maximum profit.
 Figure 7.6 Output Determination in Pure Monopoly

Figure 7.6 above shows that the equilibrium is point C where MR=MC at Q = 5 units.

TR = P x Q = 12 * 5 = 60 and TC = ATC x Q = 5.8 * 5 = 29 so that profit (TT) = TR - TC =P60-P29=P31

approximately, represented by the shaded area.

Reasons for Monopoly

● A single firm may control the entire supply of a basic input that is required to manufacture a
given product.

● A firm may become a monopolist because the average cost of producing the product reaches a
minimum at an output rate that is big enough to satisfy the entire market at a price that is
profitable. In a situation of this sort, if there is more than one firm producing the product, each
must be producing at a higher-than- minimum level of average cost. Each may be inclined to
cut the price to increase its output rate and reduce its average costs. Cases in which costs behave
like this is called natural monopolies.

● A firm may acquire monopoly power over the production of a good by having patent which
grants an investor the exclusive right to make a certain product or to use a particular process.

● A firm may become a monopolist because it is awarded a market franchise by a government

agency. The firm is granted the exclusive privilege to produce a given good or service in a
particular area. In exchange for this right, the firm agrees to allow the government to regulate
certain aspects of its behavior and operation.
 OLIGOPOLY

- Only a few firms (sellers) are competing in the market for a particular commodity.

The characteristics of Oligopoly include:

1. There are few competing sellers but they are too large in the size of giant company.

2. Products are homogenous, others are differentiated, so there is homogenous oligopoly and
differentiated oligopoly.

3. Entry of new firms can be very difficult, competition is too stiff although firms are few in number but
too large for their capital investment like the entry of the Sun Cellular in the telecommunications industry.

4. There is mutual interdependence among firms in the market. This is an important feature of
oligopolistic firms where they base their actions, at least in part, upon their perception of how the
industry's other firms will react to anything they do. The actions of the oligopolistic firms may lead to
collusion or price war.

A price war is a competitive exchange among rival companies who lower the price points on their
products, in a strategic attempt to undercut one another and capture greater market share. A price
war may be used to increase revenue in the short term, or it may be employed as a longer-term
strategy.

5. Demand curve for oligopoly is a kinked demand curve. (See Figure 7.7.)

6. Gasoline, cement, sugar and telecommunication are examples of products of homogenous oligopoly while
cars and machines are products of differentiated oligopoly.

OLIGOPOLY GAME THEORY: When firms in an oligopoly must decide about quantity and pricing, they
must consider what the other firms will do, since quantity and price are inversely related. If all the firms
produce too much, then the price may drop below their average total costs, causing them losses.
Theories in Oligopoly are divided in 3 Groups
1. Models of non-collusive oligopoly
a. Cournot Model
- It is a model wherein firms choose quantities simultaneously and independently and
industry output determines price through demand.
- Larger firms with larger market shares, have a larger deviation from competitive
behavior.
b. Kinked Demand Curve - There are two versions, the Sweezy model and the Hall and Hitch
model
- The essential difference between these two versions is that Sweezy's model is based on
the marginalist approach, with the hypothesis that even an oligopolistic firm aims
at profit maximisation.
- In contrast, the Hall and Hitch version rejects the marginalist approach of profit
maximisation. It argues that, under oligopoly, firms aim at 'fair' profit and follow the
full cost principle in determining the price.

2. Models of collusive oligopoly - (a) Cartels where firms jointly fix a price and output policy through
agreement, and (b) Price Leadership where one firm sets the price and others follow it.
a. Joint Profit Maximization
b. Price Leadership - Price leadership occurs when a pre-eminent firm (the price leader) sets the
price of goods or services in its market.
•Barometric - a firm is more adept than the others at identifying shifts in applicable market
forces
•Collusive - a result of explicit or implicit agreement among a handful of dominant firms to
keep their prices in mutual agreement.
•Dominant- one firm controls the vast majority of the market share in its industry

3. Managerial theories
a. Sales maximization with profit constraint
b. Maximization of managerial utility function
c. Firm as a satisfier

Barriers to Entry
1. Product Differentiation - A firm may have convinced consumers that its product is significantly
better than the product of new entrants. The new entrant will then be forced to sell at lower price and
reduce profit due to its inferiority.

2. Control inputs of existing suppliers - Examples are scarcity of natural resources, locational
advantages and managerial talent.

3. Legal Restriction - Examples are patents, licenses, exclusive franchises granted by government.
 4. Scale Economies - Companies can produce more output at a lower cost, and production is
effective and efficient. A new firm entering the industry on a small scale will have higher average
cost of production. On the other hand, large scale entry may require gouge, capital organisation, etc.
Thus, existing companies have the advantage of expanding more due to its industry standing.

Strategic Behavior
1. Limit Price - JS Bain pointed out that when an existing firm - be it a monopolist or oligopolist - is
making positive economic profit, it may decide to set the price below the profit maximising level
in order to reduce the possibility of entry of new firms into the market. The low price level over a
long period of time will deter entry of new firms producing at an output rate higher than that of
existing firms and thus cannot earn a normal profit. The size requirement makes entry more difficult
and thus less likely.

2. Price Retaliation - Firms may retaliate by reducing prices when entry actually occurs or if it appears
imminent. When the danger has diminished, prices can be increased to appropriate level. If a firm
establishes a consistent pattern of reacting to entry by drastically reducing prices, then potential
rivals may become convinced that they will face the same response and decide not to compete.

3. Capacity Expansion - In a rapidly growing market, a new entrant may be able to survive by serving
new customers that the existing firms cannot supply with their present production capacity. A
strategic response by established firms to prevent this from occurring would be to invest in additional
capacity. Once this investment has been made, it becomes a sunk cost and places existing firms in a
position to expand their production at a relatively low cost.

4. Market Saturation - The geographic location of the productive capacity can also cause barriers to
entry. When costs of transporting a good are high relative to its value, consumers who are not close
to a production facility may be required to pay substantially higher prices to have the good delivered
to their location.

Figure 7.7 Output Determination in Oligopoly

The profit maximizing output for the oligopoly (see Fig. 7.7) is where MR = MC at point F at quantity OA
and price OC. The firm's TR = OCEA and TC=OBGA and its profit or gain =BCEG.

Kinked-demand curve in Figure 7.7 shows that there could be a tendency for price to be relatively fixed
or rigid at point E or at price overline OC. Perceives a different market demand curve for each situation,
since they expect diff. behavior from competitors depending upon whether it raises or lowers the price

● If the firm raises its price, it does not expect competitors to go along and it sees elastic market
demand; buyers will likely substitute competitors' cheaper goods and the firm will lose market share.
● If the firm lowers its price, demand increases but not as much the percentage decrease in price
due to inelastic demand at price below overline OC .
● The two demand curves meet at point E where the firm is producing. They appear to the firm as a
single market demand curve which is "kinked" at point prime E.

Monopolistic Competition
 - It can define a monopolistic competitive market as a market in which there are a large number of
firms and the products in the market are close but not perfect substitute. Examples are retail trade,
including restaurants, clothing stores, and convenience stores.

The following are the characteristics of Monopolistic Competition:

1. There are many sellers in the industry.

2. Firms compete by selling differentiated products that are highly substitutable for one another but
not perfect substitutes. Products may differ in brand name, image making, advertising and so forth.

3. It is relatively easy for new firms to enter the market with their own brands and for existing firms to
leave if their products become unprofitable.

4. The firms demand curve is relatively elastic because the product of monopolistic competition has a lot
of substitutes.

5. Relative elastic demand.

6. Soap, shampoo, deodorants and shoes are some of the items sold in monopolistically competitive markets.

Figure 7.8 Output Determination in Monopolistic Competition

Fig. 7.8 shows the profit maximizing output for the Monopolistic Competition where MR = MC at point
N, price is OB and Q = OE. At this quantity level, TR = OBCE, TC = OASE and its profit is ABCS
representing the area with profit label above.

Figure 7.8 shows the relatively elastic demand curve for that firm in monopolistic competition. The elastic
demand shows that firm can dictate the price, it may increase the price but this may mean a greater
reduction in demand. This is due to relatively large number of sellers and the products have lots of
substitutes that a small increase in price may shift buyers to other sellers.
It cannot occur under Perfect competition market structure as there are a large number of buyers. So
if a firm charges a higher price the consumer will go to the other sellers.

Oligopoly has a control in price, they can price discriminate

Monopoly
Curve: relatively elastic, may increase price but may mean greater reduction in demand; large number
of sellers and the products also has lots of substitution, small increase in price may shift buyers to
other sellers.