Market Structures

Market Structure
Determinants of market structure
• Number of Buyers and Sellers
• Control over price
• Control over supply/output
• Nature of the product – homogenous (identical),
differentiated?
• Freedom of entry and exit
• Degree of competition in the industry
Market Structure

Perfect Competition Perfect Market

Monopolistic Competition

Oligopoly

Duopoly Imperfect Market

Monopoly
Perfect Competition
Features:
• Large number of buyers and sellers –
• No individual seller can influence price
• Homogenous product – identical so no consumer preference
• Sellers are price takers – have to accept the market price
• Perfect information available to buyers and sellers
• Free entry and exit to industry

Examples of perfect competition:

Financial markets – stock exchange, currency markets, bond
markets?; Agriculture? What Extent?
Perfect Competition
Advantages of Perfect Competition:
• High degree of competition helps allocate resources
to most efficient use
• Price = marginal costs=marginal revenue
• Normal profit made in the long run
• Firms operate at maximum efficiency
• Consumers benefit
What happens in a competitive environment?
• New idea? – firm makes short term abnormal profit
• Other firms enter the industry to take advantage of
abnormal profit
• Supply increases – price falls
• Choice for consumer
• Price sufficient for normal profit to be made but no more!
Monopoly
Features:
• High barriers to entry
• Firm controls price OR output/supply
• Abnormal profits in long run
• Possibility of price discrimination
• Consumer choice limited
• Prices in excess of MC
Why Monopoly Exists:
• Legal: from the ownership of a patent or a copyright,
• Technological, from a secret method of production,
- due to large size, age, or good reputation,
• Natural: Iron Ore, Gas
• Government Regulatory : Gas, Electricity, Rail
Advantages and Disadvantages of Monopoly
Advantages:
• May be appropriate if natural monopoly
• Encourages R&D
• Encourages innovation
• Development of some products not likely without some
guarantee of monopoly in production
• Economies of scale can be gained – consumer may benefit
Disadvantages:
• Exploitation of consumer – higher prices
• Potential for supply to be limited - less choice
• Potential for inefficiency – complacency over controls on
costs
Monopolistic Competition
Features:
• Many buyers and sellers
• Products differentiated
• Relatively free entry and exit
• Each firm may have a tiny ‘monopoly’ because of the
differentiation of their product
• Firm has some control over price

Examples: Restaurants, professions – solicitors, plumbers,

Building firms –etc.
Oligopoly – Competition amongst the few
Features:
• Industry dominated by small number of large firms
• Many firms may make up the industry
• High barriers to entry
• Products could be highly differentiated – branding or
homogenous
• Abnormal profits
• High degree of interdependence between firms

Examples:Supermarkets; Banking industry; Chemicals; Oil

Medicinal drugs; Broadcasting
Measuring Oligopoly: Concentration ratio – the proportion of
market share accounted for by top X number of firms:
E.g. 5 firm concentration ratio of 80% - means top 5 five firms
account for 80% of market share
Duopoly
Features:
• Industry dominated by two large firms
• Possibility of price leader emerging – rival will follow
price leaders pricing decisions
• High barriers to entry
• Abnormal profits likely

Examples:
• Visa and Mastercard are the two largest payment processors in the
world. Because their competitors are so small in comparison, Visa and
Mastercard may be considered a duopoly.
• Airbus and Boeing in the market for large commercial airplanes
• Intel and AMD in X86 CPU market
Profit Maximization
Market Structure

Perfect Competition Perfect Market

Monopolistic Competition

Oligopoly
Imperfect Market
Duopoly

Monopoly
Profit Maximization
Profit maximization is the short run or long run process by which
a firm determines the price and output level that returns the
greatest profit.
• Concepts: Cost and Revenue
• The total revenue–total cost perspective relies on the fact that
profit equals revenue minus cost and focuses on maximizing
this difference
• The marginal revenue–marginal cost perspective is based on
the fact that total profit reaches its maximum point where
marginal revenue equals marginal cost.
Profit Maximization
To obtain the profit maximizing output quantity

Profit = Total revenue (TR)

- Total cost (TC)

 = TR(Q) − TC (Q)
 = P(Q).Q − TC (Q)
Profit Maximization: Choice requires
balance at the margin
The necessary condition for choosing the level of q that maximizes profits can be
found by setting the derivative of the  function with respect to q equal to zero

 = TR(Q) − TC (Q)
 = P(Q).Q − TC (Q)
d dTR dTC
= − = 0
dQ dQ dQ
dTR dTC
= orMR = MC
dQ dQ
d 2 d 2TR d 2TC
2
= 2
− 2
<0
dQ dQ dQ
d 2TR d 2TC
2
< Slope of MC > Slope of MR
dQ dQ 2
Profit Maximization
1. MR = MC
2. Slope of MC > Slope of MR
Costs and
Revenue
Marginal cost
F
Demand

E
Marginal revenue

0 QMAX Quantity
Profit
P = a − bQ
TR = P.Q = aQ − bQ 2
dTR
= MR = a − 2bQ
dQ
Profit Maximization: Choice requires balance at
the margin
Costs and
Costs and
Revenue The firm maximizes Revenue
profit by producing
the quantity at which
marginal cost equals MC
marginal revenue. Profit- P Marginal cost
B
maximiz
ing price
E AC profit Average cost
P P=AR= MR E
profit
C B Average
cost D C
Demand

Marginal revenue

0
0 QMAX Quantity
QMAX Quantity

Competitive Firm Monopoly Firm

Profit Maximization: Example
• If the demand function faced by a firm is Q = 90 − 2 P
or P = 45 − 0.5Q and the cost function TC = Q3 − 8Q 2 + 57Q + 2
– Find out the profit maximizing level of output and profit
– Find out the revenue maximizing level of output

• If the demand function faced by a firm is Q = 100 − P

and the cost function TC = 1/ 3Q 3 − 7Q 2 + 111Q + 50
– Find out the profit maximizing level of output and profit
– Find out the revenue maximizing level of output
– Do you find any differences between profit maximizing
level of output and revenue maximizing level of output