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BUSINESS ECONOMICS

Market Structure Perfect Market &


Imperfect markets

Learning Outcomes
At the end of this chapter, you should:

Understand the models of Perfect Competition,


Monopoly,Oligopoly & Monopolistic Competition

Understand the various profits earned by the above


market structures

Understand the various forms of price discrimination


and its effects

Business Economics

What is a Competitive Market?


The meaning of competition
Competitive market
Market with many buyers and sellers
Trading identical products
Each buyer and seller is a price taker
Firms can freely enter or exit the market

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What is a Competitive Market?


The revenue of a competitive firm
Maximize profit
Total revenue minus total cost

Total revenue = price times quantity = P


Q
Proportional to the amount of output

Average revenue
Total revenue divided by the quantity sold
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Perfect Competition
Allocation of resources is efficient as price is equal to
marginal cost
No advertising cost
Can earn supernormal profit in the SR if its able to
control the number of players in the market

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Why Monopolies Arise


Monopoly
Firm that is the sole seller of a product without
close substitutes
Price maker
Barriers to entry
Monopoly resources
Government regulation
The production process

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Business Economics

Why Monopolies Arise


Monopoly resources
A key resource required for production is
owned by a single firm
Higher price

Government regulation
Government gives a single firm the exclusive
right to produce some good or service
Government-created monopolies
Patent and copyright laws
Higher prices; Higher profits
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Business Economics

Why Monopolies Arise


The production process
A single firm can produce output at a lower
cost than can a larger number of producers

Natural monopoly
Arises because a single firm can supply a
good or service to an entire market
At a smaller cost than could two or more firms

Economies of scale over the relevant range of


output
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Business Economics

How Monopolies Make Production& Pricing


Decisions
Monopoly versus competition
Monopoly
Price maker
Sole producer
Downward sloping demand
Market demand curve

Competitive firm
Price taker
One producer of many
Demand horizontal line (Price)
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Business Economics

Demand curves for competitive and monopoly


firms
(a) A Competitive Firms Demand Curve
(b) A Monopolists Demand Curve
Price

Price

Demand
Demand

Quantity of output

Quantity of output

Because competitive firms are price takers, they in effect face horizontal demand curves, as in
panel (a). Because a monopoly firm is the sole producer in its market, it faces the downwardsloping market demand curve, as in panel (b). As a result, the monopoly has to accept a lower
price if it wants to sell more output.
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Monopoly
Monopolies are considered market failures.
X-efficiency - a term used to describe the minimization
of cost which occurs under conditions of competition.
(Cost curve increases)
Cost
MC

AC

C2
Output

C1
O2
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O1
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Monopoly
Increased in costs caused by x-efficiency
Cost

AC1

AC

Output

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Price Discrimination
Price discrimination
Business practice
Sell the same good at different prices to
different customers
Increase profit

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Price Discrimination
Lessons from price discrimination
1. Rational strategy
Increase profit
Charges each customer a price closer to his or her
willingness to pay
Sell more than is possible with a single price

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Price Discrimination
Lessons from price discrimination
2. Requires the ability to separate customers
according to their willingness to pay
Certain market forces can prevent firms from price
discriminating
Arbitrage buy a good in one market, sell it in other market at
a higher price

3. Can raise economic welfare


Can eliminate the inefficiency of monopoly pricing
More consumers get the good
Higher producer surplus (higher profit)

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Price Discrimination
The analytics of price discrimination
Perfect price discrimination
Charge each customer a different price
Exactly his or her willingness to pay

Monopolist - gets the entire surplus (Profit)


No deadweight loss

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Price Discrimination
Examples of price discrimination
Movie tickets
Airline prices
Discount coupons
Financial aid
Quantity discounts

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Between Monopoly & Perfect Competition


Imperfect competition
Between perfect competition and monopoly
Oligopoly
Monopolistic competition

Oligopoly
Few sellers
Offer similar or identical products

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Between Monopoly & Perfect Competition


Monopolistic competition
Many sellers
Product differentiation
Not price takers
Downward sloping demand curve

Free entry and exit


Zero economic profit in the long run

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The four types of market structure

Economists who study industrial organization divide markets into four types:
monopoly, oligopoly, monopolistic competition,
and perfect competition.
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Competition with Differentiated


Products
Monopolistic competition & societys welfare
Sources of inefficiency
Markup of price over marginal cost
Too much or too little entry
Product-variety externality
Positive externality on consumers

Business-stealing externality
Negative externality on producers

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Advertising
When firms
Sell differentiated products
At price above marginal cost

Then, they have incentive to advertise


To attract more buyers

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Advertising
Debate over advertising
The critique of advertising
Firms advertise to manipulate peoples tastes
Psychological rather than informational
Creates a desire that otherwise might not exist

Increase perception of product differentiation


Foster brand loyalty

Makes buyers less concerned with price


differences among similar goods

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Advertising
Debate over advertising
The defense of advertising
Provide information to customers
Customers - make better choices
Enhances the ability of markets to allocate resources
efficiently

Fosters competition
Customers - take advantage of price differences

Allows new firms to enter more easily

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Oligopoly
Oligopoly
Only a few sellers
Offer similar or identical products
Interdependent
Perfect oligopoly homogeneous good
Imperfect oligopoly differentiated good

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Markets with Only a Few Sellers


A small group of sellers
Tension between cooperation and self-interest
Is best off cooperating
Acting like a monopolist
Produce a small quantity of output
Charge P >MC

Each - cares only about its own profit


Powerful incentives not to cooperate

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Pareto Efficiency
Pareto Efficiency requires that it must not be
possible to change the existing allocation of
resources in such a way that someone is made
better off and no one is made worse off.
Condition when there is Perfect competition, no
externalities and no market failure connected
with uncertainty, then the resulting allocation of
resources will be Pareto Efficient.
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Pareto Efficiency
Pareto efficiency can be illustrated using a production possibility
boundary curve or frontier (PPB)
Capital goods

B
C
A
Consumer Goods

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Pareto Efficiency

Any point within the PPB e.g. A - is inefficient. Using idle


resources to increase output means some consumers gain while no
consumers lose.

All points on the PPB - e.g. B & C - are allocatively efficient


because the economy cannot produce more of one product without
affecting the amount of all other pro ducts available.

The production possibility curve (PPC) shows the combination of


two goods a country can make in a given time period with
resource fully employed.

A PPB is drawn assuming a country has a fixed amount of


resources and a constant state of technology.

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