CHAPTER FIVE

Market Structure
Introduction
• A firm‘s decision to maximize profit is dependent on the type of market
in which it operates. So we distinguish between four major types of
markets: perfectly competitive, monopolistically competitive,
oligopolistic, and pure monopoly market.
• A market describes place or digital space by which goods, services
and ideas are exchanged to satisfy consumer need.
• Digital marketing is the marketing of goods, services and ideas using
digital technologies, mainly on the internet but also including mobile
phones, display advertising, and any other digital media, using digital
networks.
• Digital marketing channels are systems on the internet that can create,
accelerate and transmit product value from producer to consumer by
digital networks. 1
 Cont.

• Physical market is a set up where buyers can physically meet

their sellers and purchase the desired merchandise from them in
exchange of money.
 Which one is best, either digital or physical marketing?
– The choice of the marketing mainly depends on the nature of the
products and services.
• A market structure is the setting in which a seller finds itself. it
refers the organizational and other characteristics of a market.
• Market structures is a function of:
 Number of firms in the market
 The nature of the product i.e. heterogeneous or
homogenous.
 Extent of information available to market participants.
 Freedom of entry and exit, existence of barriers to entry.
 Markets can be divided into four categories depending on
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 . structure [Link] by a
• Perfect competition is a market
complete absence of rivalry among the individual firms.
• It is theoretical and hypothetical, but the most ideal form
of market.

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 Assumptions of perfectly competitive market:

 A large number of buyers and sellers: the market share of each

firm and buyer is too small.
 Homogeneous Product - identical products.
 Sellers and buyers are price takers, i.e., the price is determined
by the interaction of the market supply and demand forces.
 Perfect Mobility of Factor of Production
 Free entry and Free Exit of Firms
 Perfect Knowledge: Consumers are aware of market prices and
firms know what competitors are doing.
 No Government intervention
 The goal of the firm is profit maximization
Examples: Certain raw materials and agricultural goods, the stock
exchange. 4
 Demand and Revenue functions under PCM

 Due to the existence of large number of sellers selling

homogenous products, each seller is a price taker in
perfectly competitive market.
 That is, a single seller cannot influence the market by
supplying more or less of a commodity.
 Obviously, the firm will not also attempt to reduce the price.

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 Continued

 Thus firms operating in a perfectly competitive market are

price takers and sell any quantity demanded at the ongoing
market price.
 Hence, the demand function that an individual seller faces is
perfectly elastic ( or horizontal line): showing that the firm
can sell infinite amount of output at the same price.
 Graphically, P

P=AR=MR=DD
Q
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 C o n ti n u ed

 Given the horizontal demand function at the ongoing market

price, the total revenue of a firm operating under PCM is
given by the product of the market price and the quantity of
sales, i.e. TR = P*Q
 Since the market price is constant at P*, the TR function is
linear and the amount of total revenue depends on the
quantity of sales.
 To increase its total revenue, the firm should sell large
quantity.
 Graphically, the TR curve is as shown below 7
 C o n ti n u ed

TR
TR=PxQ

Q
 The total revenue of firm operating in a PCM is linear and
increasing function of the quantity of sales.
 The marginal revenue (MR) and average revenue (AR)
of a firm operating under perfect competition are equal
to the market price. But how?

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 Short run Equilibrium of the Firm

 A firm is said to be in equilibrium when it maximizes its

profit ().
 Profit is defined as the difference between total cost and
total revenue of the firm: = TR-TC

 Under perfect competition, the firm is said to be in

equilibrium when it produces that level of output which
maximizes its profit (determination of the profit maximizing
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output since the firm is a price taker).
 Continued

 The level of output which maximizes the profit of the firm

can be obtained in two ways:
 Total approach
 Marginal approach
i. Total approach
 In this approach, the profit maximizing level of output is
that level of output at which the vertical distance between
the TR and TC curves is maximum.

10
 Continued

 The profit maximizing output level is Q* and For all output

levels below a and above b profit is negative because TC is
above TR.
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ii. Marginal Approach

 In this approach the profit maximizing level of output is that

level of output at which: MR=MC and MC is increasing

 This approach is directly derived from the total approach.

When the vertical distance between the TC and TR curves is
maximum, the slope of the two curves is equal.

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 Continued

MR
MC MC

MR

Q* Qe Q
 The profit maximizing out put 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 out put.
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 Continued

 For all output levels ranging from Q* to Qe the marginal cost of

producing additional unit of output is less than the MR obtained
from selling this output.
 Hence the firm should produce additional output until it reaches
Qe.
 Thus, the condition for profit maximization under perfect
competition is:-
 MR= MC………………….necessary condition and

 MC is increasing…………. sufficient condition

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 Continued

 The fact that a firm is in the short run equilibrium does not
necessarily mean that the firm gets positive profit.
 Whether the firm gets positive or zero or negative profit
depends on the level of ATC at equilibrium thus;
1. If the ATC 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. If P>ATC = Positive profit

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 Continued

 The firm earns a positive profit because price exceeds AC of

production at equilibrium.
 2. If the ATC is equal to the market price at equilibrium, the
firm gets zero .

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 Continued

3. If the ATC >P, the firm earns a negative profit (incurs a loss)
equal to the area between the ATC curve and the price line.

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 Continued

 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
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Continued

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 Continued

Numerical example
 Suppose that the firm operates in PCM, the market price of
its product is $10. The firm estimates its cost of production
with the following cost function: TC=2+10q-4q 2 +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?

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 Short run equilibrium of the industry
• Since the PC 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.

• The industry/market supply curve is a horizontal

summation of the supply curves of the individual firms.
 It can be obtained by multiplying the individual supply at various
prices by the number of firms, if firms have identical supply
curve.

21
 Continued

 Example: If at a price of $10 a perfectly competitive firm

produces 4,000 units of output and there are 1,000 similar firms,
then total industry output is 4 million.
 Thus, the industry supply curve is simply the sum of all the firm
supply curves.
 Since the firm supply curves are their MC curves (above AVC),
then the industry short-run supply curve is also a measure of
industry MC.

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 Cont..

• Unlike the individual demand curve, the market demand

curve (the total demand curve that the industry faces) is
down-ward sloping, indicating that as the market price of
the commodity increases, the total quantity demanded for
the product decreases and vise versa.

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 Short run equilibrium of the industry

• 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 intersection of market demand and market supply of a
given commodity determines the equilibrium price and
quantity of the commodity in the market.

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 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 are:
 Single seller: the firm and the industry are synonymous.
No close substitutes: no reasonable alternatives.
Price maker: a considerable control over price
 Blocked entry: a firm has no immediate competitors
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.
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 .

 Which includes;
 Legal restriction: some monopolies are created by law in public
interest.
E.g. 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.
 Control over key raw materials(raw material monopolies) and
exclusive knowledge of production.
 Efficiency: The most efficient plant can eliminate the competitors by
decreasing price for a short period and can acquire monopoly power.
 Such type of Monopolies are known as natural monopolies.
 Patent rights and copy right- Patent rights are granted by the
government to a firm to produce specific commodity
 Such monopolies are called to patent monopolies.
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 Monopolistically competitive market

• The market organization in which there are relatively many firms

selling differentiated products which are close substitutes.
• It is the combination of competition and monopoly
• This market is characterized by:
 Differentiated product: There is a variety of the same product
(products are similar but not identical).
 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).
 Many sellers and buyers
 Easy entry and exit
 Existence of non-price competition: firms compete through
product differentiation-in terms of product quality, advertisement,
brand name, service to customers, etc.
E.g. Many retail trade activities such as clothing, shoes, soap, etc. 27
 Oligopoly market
• This is a market structure characterized by:
 Few dominant firms
 Mutual Interdependence of firms in the industry- 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.
 Entry barrier- there are considerable obstacles that hinder a
new firm entry.
 Products may be homogenous or differentiated- so we have a
pure oligopoly or a differentiated oligopoly respectively.
 Lack of uniformity in the size of firm- Firms differ
considerably in size.
 Non-price competition: firms try to avoid price competition
due to the fear of price wars and hence depend on non-price28
Summary of market structures

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 Continued

The end……

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