INTRODUCTION ECONOMICS

Arba Minch University

College of Business and Economics
Department of Economics
by
11/14/2022
Zigale Y.(M.Sc.) 1
 CHAPTER FIVE :MARKET STRUCTURE

5.1. The concept of market

 Market describes place or digital space by which goods, services and ideas
are exchanged to satisfy consumer need.
 Digital marketing is the marketing of products or services using digital
technologies, mainly on the internet but also including mobile phones,
display advertising, and any other digital media.
 Physical market is a set up where buyers can physically meet their sellers
and purchase the desired merchandise from them in exchange of money.
 Based on degree of competition, nature of the commodity and freedom of
entry they are 4 types of market structure i.e. …..
 perfectly competitive market, monopolistically competitive market,
oligopolistic market, and pure monopoly market.
 5.2. Perfectly competitive market
Perfect competition is a market structure characterized by a complete

absence of rivalry among the individual firms.

5.2.1 Assumptions of perfectly competitive market

A market is said to be pure competition (perfectly competitive market) if the

following assumptions are satisfied.

1. Large number of sellers and buyers: under perfect competition the

number of sellers is assumed to be too large that the share of each seller in

the total supply of a product is very small.

Therefore, no single seller can influence the market price by changing the

quantity supply.
 Cont.…..
2. Homogeneous product: homogeneity of the product implies that
buyers do not distinguish between products supplied by the various
firms of an industry.
 Product of each firm is regarded as a perfect substitute for the
products of other firms.

3. Perfect mobility of factors of production: factors of production are

free to move from one firm to another throughout the economy.
 This means that labor can move from one job to another and from
one region to another. Capital, raw materials, and other factors are
not monopolized.
 Cont’d …
4. Free entry and exit: there is no restriction or market barrier on entry of
new firms to the industry, and no restriction on exit of firms from the
industry.

5. Perfect knowledge about market conditions: all the buyers and sellers
have full information regarding the prevailing and future prices and
availability of the commodity.

6. No government interference:- government does not interfere in any way

with the functioning of the market.
 From these assumptions, a single producer under perfectly competitive
market is a price-taker.
 That is, at the market price, the firm can supply whatever quantity it would
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like to sell.
 Cont’d …
 Hence, the demand curve (Df) that the firm faces in this market
situation is a horizontal line drawn at the equilibrium price, Pm.

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 Cont’d …
5.2.2 Short run equilibrium of the firm
 The main objective of a firm is profit maximization.

 If the firm has to incur a loss, it aims to minimize the loss.

 Profit is the difference between total revenue and total cost.

Total Revenue (TR): it is the total amount of money a firm receives

from a given quantity of its product sold.
 It is obtained by multiplying the unit price of the commodity and the
quantity of that product sold.
 TR=P X Q, where P = price of the product
Q = quantity of the product sold.
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 Cont’d …
 Average revenue (AR):- It is the revenue per unit of item sold.
 It is calculated by dividing the total revenue by the amount of the
product sold.

 Marginal Revenue: it is the additional amount of money/ revenue

the firm receives by selling one more unit of the product.
 In other words, it is the change in total revenue resulting from the
sale of an extra unit of the product.

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 Cont’d …
 It is calculated as the ratio of the change in total revenue to the
change in the sale of the product.


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 Cont’d …
 Since the purely competitive firm is a price taker, it will maximize
its economic profit only by adjusting its output.
 In the short run, the firm has a fixed plant. Thus, it can adjust its
output only through changes in the amount of variable resources.
 It adjusts its variable resources to achieve the output level that
maximizes its profit.

 There are two ways to determine the level of output at

which a competitive firm will realize maximum profit
or minimum loss.
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 Cont’d …
 One method is to compare total revenue and total cost;
 The other is to compare marginal revenue and marginal cost.

a) Total Approach (TR-TC approach)

 In this approach, a firm maximizes total profits in the short run
when the (positive) difference between total revenue (TR) and
total costs (TC) is greatest.
 That i.e. TR-TC>0.

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 Cont’d …

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 Cont’d …
b) Marginal Approach (MR-MC)
 In the short run, the firm will maximize profit or minimize loss
by producing the output at which MR equals MC.
 More specifically, the perfectly competitive firm maximizes its
short-run total profits at the output when the following two
conditions are met:

1). MR = MC
2).The slope of MC is greater than slope of MR; or MC is rising).
(that is, slope of MC is greater than zero).

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 Cont’d …

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 Cont’d …

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 Cont’d …
 Whether the firm in the short- run gets positive or zero or
negative profit depends on the level of ATC at equilibrium.
 Thus, depending on the relationship between price and ATC
 the firm in the short-run may earn economic profit, normal
profit or incur loss and decide to shut-down business.
1).Economic/positive profit - If the AC is below the market
price at equilibrium,
 The firm earns a positive profit equal to the area between the
ATC curve and the price line up to the profit maximizing
output. 16
 Cont’d …

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 Cont’d …
 ii) Loss - If the AC is above the market price at equilibrium.
 The firm earns a negative profit (incurs a loss) equal to the area
between the AC curve and the price line.

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 Cont’d …
 3).Normal Profit (zero profit) or break- even point - If the AC is
equal to the market price at equilibrium, the firm gets zero profit or
normal profit.

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 Cont’d …

 iv) Shutdown point - The firm will not stop production simply
because AC exceeds price in the short-run.
 The firm will continue to produce irrespective of the existing loss as
far as the price is sufficient to cover the average variable costs.
 This means, if P is larger than AVC but smaller than AC, the firm
minimizes total losses.
 But if P is smaller than AVC, the firm minimizes total losses by
shutting down.
 Thus, P = AVC is the shutdown point for the firm.

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Cont’d …

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Cont’d …

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 Cont’d …
 A firm operates in a perfectly competitive market. The market price
of its product is 4 birr and the per unit cost function is given by
AVC= 1/3Q2-5Q+20 and TFC = 50, Where ;AVC is the average
variable cost and Q is the level of output?

A. What level of output should the firm produce to maximize its

profit?
B. Determine the level of profit at equilibrium.
C. What minimum price is required by the firm stay in the market?
 Cont’d …
1).If the total cost function of a form under perfectly competitive
market is given by TC = 2Q2 – 28Q + 100.
A. Find the optimum level of output and the corresponding profit
when price of the product is Br. 20.

B. When price is Br 40?

C. If the total fixed cost has increased by Br. 100 and the price of the
product is reduced to Br. 4 per unit. Then, what is the optimum
production level and the firm’s profit? If you are the management
advisor for the firm, what do you suggest?

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 Cont’d …
 5.2.3 Firms and industries supply curve
 the firm‘s short-run supply curve is given by the rising
portion of its MC curve above its AVC, or shutdown point
(see figure 5.7).
 The industry/market supply curve is a horizontal
summation of the supply curves of the individual firms.
 Industry supply curve can be obtained by multiplying the
individual supply at various prices by the number of
firms, if firms have identical supply curve. 25
 Cont’d …
 5.2.4. Short run equilibrium of the industry
 Since the perfectly competitive firm always produces where,
P=MR=MC (as long as P exceeds),
 An industry is in equilibrium in the short-run when market is
cleared at a given price i.e.
 when the total supply of the industry equals the total demand for
its product,
 the prices at which market is cleared is equilibrium price.

 When an industry reaches at its equilibrium, there is no tendency to

expand or to contract the output.
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 5.3. Monopoly market
Pure monopoly exists when a single firm is the only producer of a product
for which there are no close substitutes.
 The main characteristics of this market structure include:
 Single seller: A pure or absolute monopoly is a one firm industry. A single
firm is the only producer IS the sole supplier of the product.
 No close substitutes: the monopolist‘s product is unique in that there are
no good or close substitutes.
 Price maker: the individual firm exercises a considerable control over price
because.
 Blocked entry: A pure monopolist has no immediate competitors because
there are barriers. These barriers may be economic, legal, technological etc.
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 5.3.2. Sources of monopoly

The emergence and survival of monopoly is attributed to the factors

which prevent the entry of other firms in to the industry.
The barriers to entry are therefore the sources of monopoly power.
The major sources of barriers to entry are:

1). Legal restriction: Some monopolies are created by law in public

interest.
Such monopoly may be created in both public and private sectors.

Most of the state monopolies in the public utility sector, including: postal
service, telegraph, telephone services, radio and TV services, distribution
of electricity, rail ways, airlines etc… are public monopolies.
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 Cont’d …
ii) Control over key raw materials: Some firms acquire monopoly
power from their traditional control over certain scarce and key raw
materials that are essential for the production of certain other goods.
For example, Aluminum Company of America had monopolized
the aluminum industry.
iii) Efficiency: The most efficient plant (probably large size firm,)
which produces at minimum cost, can eliminate the competitors by
curbing down its price for a short period.
Monopolies created through efficiency are known as natural
monopolies.
iv) Patent rights: It is also called monopolies are called to patent
monopolies.
 5.4. Monopolistically competitive market

It is the blend of competition and monopoly.

the market organization in which there are relatively many firms
selling differentiated products.
The competitive element arises from the existence of large number
of firms and no barrier to entry or exit.
The monopoly element results from differentiated products, i.e.
similar but not identical products.
This market is characterized by:
Product Differentiation
Many sellers and buyers
essay Entry and Exit of Firms:
Non-Price Competition and Independent Price Policy 30
 5.5. Oligopoly market

 Oligopoly is a market situation where a few large firms compete

against each other and there is an element of interdependence in the
decision-making of these firms.
 Each firm in the oligopoly recognizes this interdependence. Any
decision one firm makes (be it about price, product or promotion)
will affect the trade of the competitors.
 This is a market structure characterized by:
 Few dominant firms

 Interdependence and entry barrier:

 Products may be homogenous or differentiated
 Cont’d …
 Lack of uniformity in the size of firms:
 Non-price competition:

 Products may be homogenous or differentiated:

 If the product is homogeneous, we have a pure oligopoly.

 If the product is differentiated, it will be a differentiated oligopoly.

 A special type of oligopoly in which there are only two firms in the
market is known as duopoly
Cont’d …
 Thanks

Thanks

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