Chapter Six

Market Structures

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6.1. Basic concepts
 This division of market is based on:
1) The number of firms in the industry;
2) Product differentiation/standardization;
3) Ease of entering and exit into the market.
 Types of market structures
◦ Oligopoly
◦ Pure monopoly
◦ Monopolistic competition
◦ Pure competition

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6.2. Pure Competition
Characteristics/Assumption of the model
◦ Large number of sellers and buyers
◦ Standardized products
◦ A firm is price-taker
◦ Free entry and exist
◦ Perfect Knowledge of Market Conditions
◦ Absence of government regulation/intervention
Demand and revenue functions under perfect
competition
◦ Demand curve, total revenue, average revenue and marginal
revenue.
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Demand, TR, MR & AR curves
P _
TR
TR=PQ

_
P

Q Q

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Short Run Equilibrium of the Firm
 Total Approach (TR-TC approach)
◦ The firm maximizes total profits in the short
run when the (positive) difference between
total revenue (TR) and total costs (TC) is
greatest.
 Marginal Approach (MR-MC)
◦ The firm will maximize profit or minimize loss
by producing the output at which marginal
revenue equals marginal cost.
 MR = MC
 The slope of MC is greater than slope of MR
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 Graphical presentation
TC TR
Graphically
TC,TR
MC, MR
MC

MR

Q* Qe

Q
Q0 Qe Q1

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 Whether the firm in the short- run gets
positive or zero or negative profit
depends on the level of ATC at
equilibrium.
◦ Positive profit
◦ Loss
◦ Normal Profit (zero profit) or breaking even point
◦ Shutdown point

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 MC AC
AC

MC

P MR
Profit
AC
Loss
MR

Qe Q Q
Qe

MC AC

AC =P MR

Qe Q

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Examples
1. Suppose a firm has a TFC of $2,000, a TVC of $
5,000 and a TR of $6,000 at equilibrium. Should
the firm stop its operation? Why?
2. Suppose that the firm operates in a perfectly
competitive market. The market price of his
product is$10. The firm estimates its cost of
production with the following cost function:
TC=10q-4q2+q3
a) What level of out put 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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The short run supply curve of the
firm and the industry
◦ The firm’s short-run supply curve is given by
the rising portion of its MC curve over and
above its AVC, or shutdown point.
◦ The industry –supply curve is the horizontal
summation of the supply curves of the
individual firms.

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P, C P

MC
MC of the
AC
E3 AVC firm

$8 P3= MR3 $8

$7 E2 P2= MR2 $7

$6 E1 P1= MR1 $6

50 140 200 50 140 200

Fig,5.9 The short run supply curve of a perfectly competitive firm.

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Long- Run Equilibrium of the Firm
 Firms get only normal profit in the long
run due to free entry and exit
P P
S LMC
D
S1 C SAC1 LAC
SMC1

C
SAC

P
P
S1 SMC

0 Q Q1 X 0 X
P1
P1

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Perfect competition and
optimal resource allocation
 In the perfect competition, the market
mechanism leads to an optimal allocation
of resources. Because,
◦ The out put is produced at the minimum
feasible cost.
◦ Consumers pay the minimum possible price
◦ Plants are used at full capacity in the long- run
so that there is no waste of resources.
◦ Firms earn only normal profits.

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6.3. Pure Monopoly
Characteristics/Assumptions
◦ Single seller and many buyers
◦ No close substitutes
◦ Price maker
◦ Blocked/barrier to entry
Sources/causes of monopoly
◦ Ownership of strategic or key inputs.
◦ Exclusive knowledge of production technique.
◦ Patents and copyright.
◦ Government Franchise and License.
◦ Increasing returns to scale.
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Demand and Revenue for the firm
 Negatively sloped industry demand curve for
the commodity.
 MR curve lies below the demand curve.
P

D=AR

0 Q
MR

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Profit maximization
 The equilibrium demands two conditions to be
fulfilled:
◦ (i) MR=MC and
◦ (ii) slope of MC greater than slope of MR.
 Note: Unlike a competitive firm, the
monopolist firm can enjoy a positive profit even
in the long run because there are entry barriers

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Numerical example
 Suppose the monopolist faces a market
demand function given by P=40-Q. The
firm has a fixed cost of $ 50 and its
variable cost is given as TVC=Q2
determine:
◦ the profit maximizing unit of output and price
◦ the maximum profit

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6.4. Monopolistic Competition
Characteristics
◦ A relatively large number of sellers
 Small market shares
 No collusion
 Independent action
◦ Differentiated products
◦ Easy entry to, and exit from, the industry.
 Profit- maximizing or best level of output
is the output at which MR = MC (P>MC),
provided P > AVC.
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6.5. Oligopoly
Characteristics of Oligopoly
◦ Very few sellers of the product
◦ Barriers to entry
◦ Control over price, but recognized mutual
Interdependence
◦ Presence of monopoly power
◦ Homogeneous or differentiated product
Types of oligopoly
◦ Collusive Oligopoly
 Explicit collusion
 Implicit collusion
◦ Non collusive Oligopoly
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 Summary - Market structures
Pure/perfectly Pure monopoly Monopolistic Oligopoly
competitive Competition

Number of Many One Large Few

firms/sellers

Types of Standardized No Differentiated Similar

products differentiation
and substitute

Ease of entry Free Blocked Quite easy Difficult

Price No Yes Yes Yes
discrimination

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----- End of Chapter Six -----

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