CHAPTER 7

MARKET STRUCTURE 1:
PERFECT COMPETITION
AND MONOPOLY
 ECONOMIC PROFIT AND
ACCOUNTING PROFIT

Economic Profit Accounting Profit

Economic profit is defined Accounting profit is defined
as the total revenue minus as the firm’s total revenue
the implicit and explicit minus the explicit cost.
cost.
• Consider both explicit • Consider only explicit
and implicit cost cost

EC= TR – [Explicit Cost + AC = TR – Explicit Cost

Implicit Cost]
 MARKET STRUCTURE

 Definition of a Market
– An arrangement that facilitates buying and selling of a good,
service, factor of production or future commitment.
OR
– A market is a place where the buyers and sellers meet with one
another and involves transaction.
 Definition of a Market Structure
– Market structure refers to the number and distribution size of
buyers and sellers in the market of a good and service.
– Market structure is an indication of the number of buyers and
sellers; their market shares; the degree of product
standardization and the ease of market entry and exit.
 PERFECT COMPETITION
There are large numbers of buyers and sellers,
buying and selling identical product
without any restriction on entry and exit, and
having perfect knowledge of the market at a time.
TYPES OF MARKET
STRUCTURE
MONOPOLISTIC COMPETITION
There are large numbers of sellers, large number
of buyers; selling differentiated products due to
branding and labelling and there are no barriers
to entry and exit.
MONOPOLY
There is a single seller and a large
number of buyers; selling products that has
no close substitution and has a high
entry and exit barrier.
OLIGOPOLY
There are only a few firms in the industry
but a large number of buyers; products can be
either identical or differentiated, and there are
barriers to entry and exit.
 MARKET STRUCTURE
Market Form Perfect Monopolistic Oligopoly Monopoly

Characterictics Competition Competition

Large number
Number of firms Large Few One

Homogenous Unique: No close

Type of product Homogenous Differentiate or differentiated substitutes

Conditions to entry Very easy Relatively easy Significant Blocked

obstacles

Control over price None Some Some Considerable

Price elasticity of Infinite Large Small Very small

demand
Local phone
Examples Wheat, corn Food, clothing Automobiles, service,
cigarettes electricity
 PERFECT COMPETITION

 Definition
– A market in which there are many buyers and sellers, the
products are homogeneous and sellers can easily enter
and exit from the market.
 Characteristics
– Large number of buyers and sellers – firms are price
takers
– Homogenous or standardized product – the buyers do
not differentiate the products of one seller to another seller
– Free of entry and exit into the market
– Role of non-price competition is insignificant
 PERFECT COMPETITION
(cont.)
– Perfect knowledge of the market – all the sellers and
buyers in perfect competition market will have perfect
knowledge of that market
– Perfect mobility of factor of production – factor of
production can freely move from one occupation to
another and from one place to another
– Absence of transport cost
 PERFECT COMPETITION

The price is determined by Since the firms are price

the intersection of the
market supply curve and
Price
the market demand curve.
takers, they face a
horizontal demand curve
Price Demand curve in perfect
competition is horizontal or
perfectly elastic. Therefore:

SS
Price = MR = AR

Rs10
Rs10 P = MR =
AR=DD
curve
DD

Q* Quantity
Quantity

Market Firm
 SHORT RUN EQUILIBRIUM

 1)TOTAL COST AND REVENUE APPROACH

 SHORT RUN EQUILIBRIUM

 2)MARGINAL APPROACH MR=MC---EQUILIBRIUM

 PROFIT MAXIMIZATION IN
SHORT RUN
A competitive firm earns economic profit
At this output, the firm The profit maximizing price The firm’s demand curve
earns economic profit or and output is P* and Q*. is horizontal at the price of
supernormal profit equal to P and AR = MR.
Price (Rs)
the shaded area. MC
The marginal cost curve
intersects the demand curve
at point B.
A competitive firm
ATC maximizes its profit when
MR = MC.
B
P* P = MR = AR

PROFIT Economic profit or supernormal profit

is the profit earned by a competitive
firm when TR > TC.

Quantity
Q*
 A competitive firm at breakeven

At this output, the firm is at the The profit maximizing price

breakeven or earns normal profit. The firm’s demand curve
and output is P* and Q*.
is horizontal at the price
Price (RS) of RS20 and AR = MR.
MC
Normal profit or breakeven
profit is necessary for a firm to The marginal cost curve
stay in business TR = TC ATC intersects the demand
curve at point B.
A competitive firm
maximizes its profit when
MR = MC.
B
P* 20 P = MR = AR

Quantity
Q*
 A competitive firm suffers economic losses

At this output, the firm suffers The profit maximizing price The firm’s demand curve is
economic losses or subnormal profit and output is P* and Q*. horizontal at the price of
equal to the shaded area. RS20 and AR = MR.
ATC
MC
Price (RS)
The marginal cost curve
intersects the demand curve
at point B.
A competitive firm
maximizes its profit when
MR = MC.
LOSSES
B
P* 20 P = MR = AR
Economic losses or
subnormal profit is the
losses incurred by a
competitive firm when
TR < TC.
Quantity
Q*
Shutdown point in Short Run

AVC=AR
Short Run Supply Curve
Long run Equilibrium
 MONOPOLY

 Definition
– Monopoly is a market structure in which there is a single seller
and large number of buyers and selling products that have no
close substitution and have high entry and exit barrier.
 Characteristics
– One seller and large number of buyers – the monopolist is a
firm as well as an industry by itself
– No close substitution – monopoly firm would sell a product
which has no close substitute
– Price maker – monopolist is a price maker since there is one
seller or producer and it has the market power to control over the
price
– Restriction of entry of new firms
 MONOPOLY (cont.)

– Advertising – advertising in monopoly market depends on

the products sold
 Barriers to Entry
– Barriers to entry refer to restriction that prevents other sellers from
entering into a market
1. Control over raw material – a monopoly status can also be maintained through
control over the supply of raw material
2. Patent and Copyright – a patent is an exclusive right to the production of an
innovative product. A copyright is an exclusive right to the author of a book or
composer of a music or producer of a movie
3. Cost of establishing an efficient plant – natural monopoly exists when one firm
can meet the entire market demand with lower price compared to two or more
firms
4. Government Franchises – the government will give exclusive rights to a firm to
sell a certain goods and services in a certain area
TR TC APPROACH
MR –MC APPROACH
 PROFIT MAXIMIZATION (cont.)
MARGINAL REVENUE – MARGINAL COST APPROACH

Using Table:
The profit maximizing output
level is obtained following the
MR = MC rule.

MR, MC
MC

Using Graph:
P* MR curve under imperfect market is
downward sloping as the output
AR=P
increases. The profit maximization
rule, MR = MC, where the MC curve
intersect with the MR curve.
MR
Quantity
Q*
 PROFIT MAXIMIZATION IN
SHORT RUN
Monopoly firm earns economic profit
At this output, the firm earns economic profit or
supernormal profit equal to the shaded area. The profit maximization
level occurs where MR
Price (RS) Economic profit or supernormal MC curve and MC curve
profit is the profit earned by a intersect at Point A.
monopolist when TR> TC. ATC
To find the price, we use the
same vertical line with output
up to the demand curve. The
profit maximizing price and
P*
output is P* and Q*.
PROFIT
AC
A

DD = AR

MR

Quantity
Q*
 PROFIT MAXIMIZATION IN
SHORT RUN (cont.)
Monopoly firm at break-even
At this output, monopolist is at the The profit maximization level
break-even or earns normal profit. occurs where MR curve and MC
curve intersects at Point A.
Price (RS) Normal profit or break-
MC
even is earned when TR = ATC
TC.
The profit maximizing price
and output is P* and Q*.

AC/P*
A

DD = AR

MR

Quantity
Q*
 PROFIT MAXIMIZATION IN
SHORT RUN (cont.)
Monopoly firm suffers economic losses
At this output, monopolist suffers economic losses or subnormal profit equal to the shaded area.

Economic losses or
subnormal profit is the
Price (RS)
losses incurred by a
monopolist when TR < TC.
The profit maximization
ATC
level occurs where MR
MC
curve and MC curve
intersect at Point A.

The profit maximizing

AC price and output is P*
and Q*.
LOSSES
P*

DD = AR

MR

Quantity
Q*
 PROFIT MAXIMIZATION IN
LONG RUN
Monopoly firm earns supernormal profit in long run
A monopoly firm earns
economic profits or
Price (RS) supernormal profit in the
LRMC
long run due to the barriers
to entry of new firms.
LRATC

P*
PROFIT
AC A

DD = LRAR

LRMR

Quantity
Q*
 PRICE DISCRIMINATION

 Definition
– Price discrimination refers to the selling or charging of
different prices by a firm to different buyers for the
same product.
 Necessary Conditions
– Existence of monopoly power – price discrimination
can occur only if monopoly power exists and there are
no competitors in the market 
– Existence of different markets for the same
commodity – a firm should be able to separate
customers according to price elasticity of demand
 PRICE DISCRIMINATION
(cont.)
– Existence of different degree of elasticity of
demand – monopolist can charge higher price for
inelastic market and lower price for elastic market
– Cost of separating market must be low
– No resale – product purchased in the low-priced
market should not be resold in the high-priced market
– Legal sanction – government allows the public utility
firms such as electricity to charge different prices from
different consumers
 PRICE DISCRIMINATION
(cont.)
 First-degree Price Discrimination
– Occurs when a firm charges each consumer the maximum price
that he or she is willing to pay for each unit.
– This price discrimination is also known as perfect price
discrimination.
– The best example for first-degree price discrimination is auction.
 Second-degree Price Discrimination
– Occurs when the products are grouped into blocks and each
block is charged at a different price.
– This type of price discrimination is charged by public utilities
such as electricity charges, water charges, telephone charges
and others.
 PRICE DISCRIMINATION
(cont.)
 Third-Degree Price Discrimination
– Under this price discrimination, the markets are divided
into many submarkets or subgroups.
– Each group is considered as a different market.
– The price charged on products depends on the price
elasticity of demand.
– An example of third-degree price discrimination is the
movie ticket where the adults are charged higher price and
children are charged at lower price.
– Other examples are transportation (air, railways, bus or
LRT), medical, legal and entertainment.
 COMPARISON BETWEEN
PERFECT COMPETITION AND
MONOPOLY
Perfect Competition
 Large numbers of sellers selling
homogenous products in perfect
competition market
 Price takers
 Earns a normal profit in the long
run due to free entry and exit
 In the long run, perfect competitive
firm produces at the lowest point
on the minimum of average cost,
is more efficient
Monopoly
 Only one seller who sells products
that have no close substitutes
 Price maker
 Earn a supernormal profit since
there are barriers to entry for new
entrants
 Price charged is always higher
than in perfect competitive market
 Monopolist does not operate at
the minimum point of ATC curve