Market structure

The degree of competition

Based on competition, market structure has been
divided into:
• Perfect competition
• Monopoly
• Oligopoly
• Monopolistic competition
• Duopoly
• To distinguish between these categories, we must consider:
• How freely the market can enter the industry: Is entry free or
restricted?
• The nature of the product: Identical or differentiated goods?
• The degree of control the firm has over the price.
Type No. of Firms Freedom of Entry Nature of product Examples Demand curve for
firms
Perfect competition Very Many Unrestricted Homogenous Cabbages, Carrots, Horizontal. Firms
Milk price takers
Monopolistic Many/several Unrestricted Differentiated Builders/restaurant Downward sloping,
competition s but relatively
elastic. Firm has
somehow control
over price

Oligopoly Few Restricted 1. Undifferentiate 1.Petrol Downward sloping.

d 2. Cars Relatively inelastic
2. Differentiated but depend on
reaction of the
rivals to a change in
price

Monopoly One Restricted Unique Local Water supply Downward sloping.

company/many More inelastic than
prescription drugs oligopoly. Firm has
considerable
control over market
price
• Market structure under which firms operates will determine its
behavior. Firms operating under perfect competition behave quite
differently than monopolistic and other.
• This behavior in turns effects the firms performance; the prices,
profits and efficiency. Thus, the collective conduct of all the firms in
the industry affects the whole industry performance.
Structure  Conduct  Performance 
Perfect competition
• Illustrates an extreme example of capitalism
• In it firms are entirely subject to market forces. They have no power to affect the price of the product. The
price is determine by the interaction of supply and demand in the whole market.
Assumptions:
• Firms are price takers. So many small firms in the industry that each one produce insignificantly small
proportion of total industry supply, and therefore, no power to influence the price. Price determined by
supply and demand interaction
• Complete freedom of entry into the industry for new firms. Existing firms are unable to stop new firms
setting up the businesses. Setting up a business take time, therefore, freedom of entry applies in the long
run
• All firms produce identical products i.e. homogenous products. Therefore, there is no branding or
advertisements
• Producers and consumer have perfect knowledge of the market i.e. producers are full aware of the prices,
costs and market opportunities. Consumers are fully aware of price, quality, and availability of product
• These assumptions are very strict a few markets might be very close to perfect competition e.g. market of
fresh vegetables such as potatoes
 Short Run equilibrium of the firm
• In short run, we assume numbers of firms in industry cannot be increases
because of time needed
• Units for sort run equilibrium of firm would be different scales: if units for firm is
in thousands of units, for the whole industry it might be in millions of units.
• Lets examine determination of price, output and profit in turn.
Price: price of industry is determine by intersection of demand and supply. Firm,
being price taker, faces a horizontal demand (or average revenue) curve at this
price . It ca sell any produce at this price, but nothing at price above this price
Output: firm maximizes its output when MC=MR at an output Q. Note: Since,
prices is not affected by firms output, MR=Price. Thus firms MR curve and MC
curve = demand curve, which are straight horizontal line
Profit: if the AC curve dips below AR curve, the firm will earn supernatural profit.
Supernatural profit per unit at Q is vertical difference between AR and AC at Q.
(SNP = Profit per unit * Quantity sold)
Short run supply curve:
The firm Short run supply curve will be its marginal cost.
Because, supply curve shows how much will be supplied at each price: it relates
quantity to price. Marginal cost curve relates quantity to marginal cost. But in
perfect competition, given that P=MR, and MR =MC, P must equal MC. Thus,
supply curve and marginal curve will follow the same line.
• See diagram:
• When market price is < AVC, firm will shut down. It has to produce
above AVC.
• Above AVC, at any level of MR, the profit maximizing point is found
where MR=MC.
• A perfectly competitive firm maximizes profit by producing the
quantity of output that equates price and marginal cost. As such, the
firm moves along its positively-sloped marginal cost curve in response
to changing prices
 Long run Equilibrium of the firm
• If most firms are making abnormal profits in the short run, this encourages
the entry of new firms into the industry
• This will cause an outward shift in market supply forcing down the price
• The increase in supply will eventually reduce the price until price = long run
average cost. At this point, each firm in the industry is making normal profit.
•
• At P1 supernormal profits are earned
• At P2 normal profits are earned in long run.