Chapter Five

Market Structure
 Introduction
 This
chapter discusses how a particular firm
makes a decision to achieve its profit
maximization objective.
 To
this effect we distinguish between four
major types of markets: perfectly
competitive market, monopolistically
competitive market, oligopolistic market,
and pure monopoly market.
Chapter objectives:

 At the end of this chapter you will be

able to:
 differentiate market in physical and
digital space
 explain the characteristics and
equilibrium condition of perfectly
competitive market
 differentiate between different types
of imperfect market structures
5.1. The concept of market in
physical and digital space
 Comprehensive definition of market according
to American Marketing Association (1985) is
the process of planning and executing the
conception, pricing, promotion, and
distribution of goods, services and ideas to
create exchanges that satisfy individual and
organizational objectives.
 Somarket describes place or digital space by
which goods, services and ideas are
exchanged to satisfy consumer need.
Digital marketing
 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.
 Digital
marketing channels are systems on
the internet that can create, accelerate and
transmit product value from producer to the
terminal consumer by digital networks.
 Physical market
 Physical market is a set up where buyers can
physically meet their sellers and purchase the
desired merchandise from them in exchange
of money.
 In physical marketing, marketers will
effortlessly reach their target local customers
and thus they have more personal approach
to show about their brands.
 The choice of the marketing mainly depends
on the nature of the products and services.
5.2. Perfectly competitive
market

 Perfectcompetition 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.
 Similarly,
the number of buyers is so large that
the share of each buyer in the total demand is
very small and that no single buyer or a group
of buyers can influence the market price by
changing their individual or group demand for
a product.
 Therefore, in such a market structure, sellers
and buyers are not price makers rather they
are price takers, i.e., the price is determined
by the interaction of the market supply and
demand forces
2. Homogeneous product:
 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.
 Therefore, no firm can gain any
competitive advantage over the other
firm.
3. Perfect mobility of factors of
production:
 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.
 4. Free entry and exit:
 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.
A firm may enter the industry or quit it on its
accord.

 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:-
6. No government interference:- government
does not interfere in any way with the
functioning of the market.
 There are no discriminator taxes or subsidies,
no allocation of inputs by the procurement, or
any kind of direct or indirect control.
 That is, the government follows the free
enterprise policy.
 Where there is intervention by the
government, it is intended to correct the
Individual and market demand curve
 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.
Average revenue (AR):-
 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.

 Therefore, the firm‘s demand curve is also the average revenue

curve.
 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.
 It is calculated as the ratio of the change in total revenue to the
change in the sale of the product.
 cont.

Thus, in a perfectly competitive market, a

firm‘s average revenue, marginal revenue and
price of the product are equal, i.e. AR = MR = P
=Df
Since the purely competitive firm is a price
taker, it will maximize its economic profit only by
adjusting its output.
 cont.
 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.
 Thereare two ways to determine the level of
output at which a competitive firm will realize
maximum profit or minimum loss.
 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.

Note: The profit

maximizing output
level is Qe because it
is at this output
level that the
vertical distance
between the TR and
TC curves (or profit)
is maximized.
b) Marginal Approach (MR-MC)
 In
the short run, the firm will maximize profit or
minimize loss by producing the output at which
marginal revenue equals marginal cost.
 Morespecifically, the perfectly competitive firm
maximizes its short-run total profits at the output
when the following two conditions are met:
 MR = MC
 The slope of MC is greater than slope of MR; or MC
is rising). (that is, slope of MC is greater than
zero).
Mathematically, ∏ =TR- TC
cont.
Marginal approach of profit
maximization
 Cont.
 The profit maximizing output is Qe , where
MC=MR and MC curve is increasing.
 At Q*, MC=MR, but since MC is falling at this
output level, it is not equilibrium output.
 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.
 i) Economic/positive profit
 i) 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.
 A firm incurring a loss
 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.
iii) Normal Profit (zero profit) or break- even
point
 iii) 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.
 iv) Shutdown point
 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.
cont.
 Example:
 Example: Suppose that the firm operates in a
perfectly competitive market. The market
price of its product is $10. The firm estimates
its cost of production with the following cost
function: TC=2+10q-4q2 +q3
 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
to stay in the market?
 
cont.
Solution
 Given: p=$10 and TC= 2+10q - 4q2 +q3
 A) The profit maximizing output is that level of output
which satisfies the following condition
 MC=MR & MC is rising
 Thus, we have to find MC& MR first
 MR in a perfectly competitive market is equal to the
market price. Hence, MR=10

To determine equilibrium output just equate MC& MR And then

solve for q.
 Cont.
 10 – 8q + 3q2 = 10
- 8q + 3q2 = 0
 q (-8 + 3q) = 0
q = 0 or q = 8/3
 Now we have obtained two different output levels
which satisfy the first order (necessary) condition of
profit maximization
 To determine which level of output maximizes profit
we have to use the second order test at the two
output levels.
 That is, we have to see which output level satisfies
the second order condition of increasing MC.
 cont.
 To see this first we determine the slope of MC
 B) Above, we have said that the firm maximizes its profit by
cont.
producing 8/3 units. To determine the firm‘s equilibrium profit
we have to calculate the total revenue that the firm obtains
at this level of output and the total cost of producing the
equilibrium level of output.
 TR = Price * Equilibrium Output
= $ 10 * 8/3= $ 80/3
 TC at q = 8/3 can be obtained by substituting 8/3 for q in the
TC function,
i.e., TC = 2+10 (8/3) – 4 (8/3)2 + (8/3)3 =19.18
 Thus the equilibrium (maximum) profit is
 = TR – TC
= 26.67 – 19.18 = $ 7.48
 cont.
 C) To stay in operation the firm needs the price which
equals at least the minimum AVC. Thus, to determine the
minimum price required to stay in business, we have to
determine the minimum AVC.
5.2.3 Short run equilibrium of the
industry
 Since the perfectly competitive firm always produces where P
=MR=MC (as long as P exceeds AVC), 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.
 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.
 5.3. Monopoly market
5.3.1. Definition and
characteristics
 This is at the opposite end of the spectrum of market
structures.
 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:
 1. Single seller: A pure or absolute monopoly is a one firm
industry.
 A single firm is the only producer of a specific product or the
sole supplier of the product; the firm and the industry are
synonymous.
 2. No close substitutes: the monopolist‘s product is unique in
that there are no good or close substitutes.

 Cont.
 3. Price maker: the individual firm exercises a
considerable control over price because it is responsible
for, and therefore controls, the total quantity supplied.
 Confronted with the usual down ward sloping demand
curve for its product, the monopolist can change product
price by changing the quantity of the product supplied.
 4. Blocked entry: A pure monopolist has no immediate
competitors because there are barriers, which keep
potential competitors from entering in to the industry.
 These barriers may be economic, legal, technological
etc. Under conditions of pure monopoly, entry is totally
blocked.
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:
 i) 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, generation and distribution of
electricity, rail ways, airlines etc… are public monopolies.
 Cont.
 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
because it had acquired control over almost all
sources of bauxite supply; such monopolies are
often called raw material monopolies.
 iii) Efficiency: a primary and technical
reason for growth of monopolies is
economies of scale.
 cont.
 Themost efficient plant (probably large size firm,)
which produces at minimum cost, can eliminate the
competitors by curbing down its price for a short
period and can acquire monopoly power.
 Monopoliescreated through efficiency are known as
natural monopolies.
 iv)
Patent rights: Patent rights are granted by the
government to a firm to produce commodity of specified
quality and character or to use specified rights to
produce the specified commodity or to use the specified
technique of production.
 Such monopolies are called to patent monopolies.
 5.4. Monopolistically competitive
market
 This market model can be defined as the market
organization in which there are relatively many firms
selling differentiated products.
 It is the blend of competition and monopoly. 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.
 A seller of a differentiated product has limited monopoly
power over customers who prefer his product to others.
 His monopoly is limited because the difference between
his product and others are small enough that they are
close substitutes for one another.
This market is characterized
by:
(i) Differentiated product: the product produced and
supplied by many sellers in the market is similar but
not identical in the eyes of the buyers.
 There is a variety of the same product. The
difference could be in style, brand name, in quality,
or others. Hence, the differentiation of the product
could be real (eg. quality) or fancied (e.g. difference
in packing).
 (ii) Many sellers and buyers: there are many sellers
and buyers of the product, but their number is not as
large as that of the perfectly competitive market.
 (iii) Easy entry and exit: like the PCM, there is no barrier on
Cont.
new firms that are willing and able to produce and supply the
product in the market.
 On the other hand, if any firm believes that it is not worth to
stay in the business, it may exit.
 (iv) Existence of non-price competition: Economic rivals take
the form of non-price competition in terms of product quality,
advertisement, brand name, service to customers, etc.
A firm spends money in advertisement to reach the
consumers about the relatively unique character of its
product and thereby get new buyers and develop brand
loyalty.
 Many retail trade activities such as clothing, shoes, soap, etc
are in this type of market structure
5.5. Oligopoly market
 This is a market structure characterized by:
 Few dominant firms: there are few firms although the exact
number of firms is undefined. Each firm produces a significant
portion of the total output.
 Interdependence: since few firms hold a significant share in
the total output of the industry, each firm is affected by the
price and output decisions of rival firms.
 Therefore, the distinguishing characteristic of oligopoly is the
interdependence among firms in the industry.
 Entry barrier: there are considerable obstacles that hinder a
new firm from producing and supplying the product.
 The barriers may include economies of scale, legal, control of
strategic inputs, etc.

cont.
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.
 Lack of uniformity in the size of firms: Firms differ
considerably in size. Some may be small, others very large.
Such a situation is asymmetrical.
 Non-price competition: firms try to avoid price competition
due to the fear of price wars and hence depend on non-price
methods like advertising, after sales services, warranties, etc.
 This ensures that firms can influence demand and build brand
recognition.
 A special type of oligopoly in which there are only two firms in
the market is known as duopoly.
Chapter summary
Thank you