CHAPTER 5
MARKET STRUCTURES
PERFECT COMPETITION, MONOPOLY
& IMPERFECT COMPETITION
Economics Lecture presentation
Market Structures
Market structure – identifies how a market is made up in terms of:
• Number of firms
• Nature of the product
• Entry
• Information
• Collusion
• Firm’s control over the price of the product
• Demand curve for the firm’s product
• Long-run economic profit
Four different market structures
• Perfect competition
• Monopolistic competition
• Oligopoly
• Monopoly
Key features of a market structure:
The equilibrium conditions
(for any firm)
Two decisions faced by firms:
1. Should we produce? – is it worth producing
under given conditions or shut down.
2. If yes, how much? – quantities where
profits are maximised or losses minimised.
Shut Down Rule
• Fixed costs must be paid in the short-run.
• Variable-costs can be avoided by laying off workers
and shutting down.
• Firms shut down if price (Average Revenue) falls
below the Average Variable Cost.
• If Price is greater than average variable cost the
difference contributes towards Fixed Cost.
NB (TR>/= TVC)
7.7
Profit Maximisation Rule
• For any output level, the firm attempts to minimize
costs.
• Assume the firm aims to maximize economic
profits.
• Profits depend on both COSTS and REVENUE
• each of which varies with the level of output
• Profit maximisation can be explained in-terms of
TR and TC or MR and MC
Total Revenue & Total Cost Approach
• Profit = TR – TC.
• The short run profit
maximising output
is
that
output
corresponding to
where the vertical
distance between
TR & TC is
greatest.
Marginal Analysis Approach
• Profit maximising
output using MR and
MC curves.
• If MR > MC, an
increase in production
will increase profit
• If MR < MC, an
increase in production
will decrease profit
• Profit Maximising
Rule : MR = MC.
Marginal Analysis Approach Cnt.
• If MR > MC, output should be expanded
• If MR = MC, profits are maximised
• If MR < MC, output should be reduced
Perfect competition
• This is when none of the individual market
participants (buyers & sellers) can influence the price
of the product
• Requirements
i.
Large numbers of buyers and sellers = price takers
ii.
No collusive behaviour between firms
iii. Products sold in the market are homogeneous
iv. No restrictions in relation to entry or exit of firms
(legal, technological, physical etc.)
Perfect competition (Contd)
• Requirements
v. Factors of production are perfectly mobile
i.e. from market to another.
vi. There is no government intervention in the
market.
vii. Buyers and sellers have perfect
information about market conditions.
Demand Curve for Individual Firm:
Firms Are Price Takers
• The firm`s demand curve is perfectly elastic.
• D = MR = AR = P.
• D, AR and MR curves are horizontal at the
market price.
The demand curve for the product of
the firm under perfect competition
The equilibrium of the firm under
perfect competition
• Profit is maximised (or losses minimised)
when a firm produces an output where
marginal revenue equals marginal cost,
provided marginal cost is rising and lies
above minimum average variable cost
i.e. P = MC………… (since P = MR)
Why Profit is maximised at MR = MC?
Revenue and Cost of a hypothetical
firm
Marginal Revenue and Marginal Cost of a firm
operating in a perfectly competitive market
The equilibrium of the firm under perfect
competition cntd.
The firm’s actual profit position can be ascertained
by adding in the average cost (AC)curve to the
diagram
• Average profit is equal to AR - AC
Different possible short-run equilibrium positions of the
firm under perfect competition
•
• Economic profit – as long as AR is above AC
• Break even (normal profit) – when AR is equal to AC
• Economic loss – when AR less than AC
Different possible short-run equilibrium positions
of the firm under perfect competition
The supply curve of the firm and the market
supply curve
• Firm’s supply
curve – the rising
part of the firm’s
MC curve above
the minimum of
AVC
• Market supply
curve – add the
supply curves of
the individual firms
horizontally
Long-run equilibrium of the firm and the
industry under perfect competition
• The industry will be in equilibrium in the long run
only if all the firms are making normal profits
The firm and industry in equilibrium
(long run)
The individual firm and the industry when the
firm initially earns an economic profit
• If firms are making an economic profit – new
firms enter the market
The individual firm and the industry when the
firm initially makes an economic loss
• If firms are making an economic loss –
existing firms exit the market
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Monopoly
• Is a market structure in which there is only one
producer/seller for a product.
Characteristics
The four characteristics of monopoly are:
• A single firm selling all output in a market
• A unique product
• Restrictions on entry into and exit out of the industry
• Specialized information about production techniques
unavailable to other potential producers
Monopoly: But Why?
BARRIERS TO ENTRY
• Existence of large economies of scale (natural monopoly).One firm can provide
a lower price than 2 or more.
• Limited size of the market
• A patent; e.g. a new drug
• Sole ownership of a resource; e.g. diamonds (De Beers Consolidated mines)
• Licensing
• Import restrictions
• Formation of a cartel; e.g. OPEC
Monopoly: Assumptions
• Only one seller i.e. not a price-taker
–It is a price setter
• A unique product with no close substitutes
• Entry is restricted or blocked
Monopoly: Features
monopolist’s demand curve is the
(downward sloping) market demand curve
–Demand curve is equal to market demand.
• The
• The monopolist can alter the market price by
adjusting its output level.
• It has two choices:
– Charge a higher price
– Produces lower output level
Average, Total and Marginal revenue when the demand curve
for the product of the firm slopes downward
AR and MR under monopoly
TR under monopoly
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Profit-maximising or equilibrium position in
the short-run
• Monopolies follow the same profit maximizing
rule as competitive firm, MR=MC.
• The downward sloping demand curve indicates
that monopolist can increase its quantity when it
lowers the price of the product.
• The demand curve of a monopoly is also the AR
curve.
• The MR is always below the AR under monopoly.
The short-run equilibrium of the firm under
monopoly
• In the Long Run, economic profits can be maintained!!
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The short-run equilibrium of the firm
under monopoly
Economic Profit
The monopolist will produce at Q1 where MR=MC.
• The monopolist will charge price P1, which is determined
by the demand curve.
• Is the monopolist making an economic profit or loss?
• We compare the AR and AC to determine whether the
monopolist makes a profit or loss.
• AR(=P) > AC, therefore the monopolist is experiencing
economic profit.
• NB in the long-run due to barriers to entry of firms,
monopolist may also make economic profit or losses.
Monopolistic competition
• Monopolistically competitive market – a large
number of firms produce similar but slightly
different products
• Differentiated (or heterogeneous) product –
different varieties of a product. The onus rests
with consumers. e.g. brands
• Price competition and non-price competition
Characteristics of monopolistic
competition
• Each firm produces a distinctive, differentiated
product
• Each firm faces a downward-sloping demand
curve for its particular product
• There are a large number of firms in the
industry
• There are no barriers to entry or exit
Short Run Equilibrium of Monopolistic
Competition
Long Run Equilibrium of Monopolistic
Competition
Oligopoly
• Oligopoly – a few large firms dominate the market
• Duopoly – there are only two firms in the market
The main features
• high degree of interdependence between the firms
• uncertainty
• barriers to entry
Two strategies:
• Collusion
• Competition
Conditions for successful collusion
• Small number of firms
• Similar production methods
• Homogeneous products
• Significant barriers to entry
• Stable market
• No government intervention e.g Competition Policy
• There is no general theory of oligopoly
• Importance of non-price competition
Popular misconceptions about a monopoly
• Can charge virtually any price it wants
• Can charge the highest price it can get
• Guaranteed an economic profit
• Has almost absolute economic power
The case against monopoly
• Output is lower and price is higher
• Little or no incentive for innovation
• Managerial inefficiency
• Questionable quality of products or service
• Unfair or socially unacceptable distribution of income
and wealth
• Rent-seeking behaviour
• Economic power, politically powerful
Imperfect competition
• Differences between perfect competitive
markets and imperfect competitive markets
Perfect
competition
Imperfect
competition
No. of sellers
and buyers
Many sellers and
buyers
Few seller and
buyers
Firm behavior
Price-takers
Price-setters
Demand curve
Horizontal
Negatively sloped
Collusion
No collusion
May have collusion
Products
Homogeneous
Heterogeneous
Entry and exit
No restrictions
Restriction
Information
Perfect information Imperfect information
Competition policy in South Africa
• Monopolies
or market dominance is
strongly discouraged by the South African
government.
• The South Africa Competition Act, No. 89 of
1998, as amended, was created to promote
and maintain competition in the country.