Chapter 7

Price System and the micro economy (A2)

- Market Structures
learning outcomes

01 02
Classifications of different Characteristics of different
market structures market structures

03
Performance of PC firms in
the market

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 LO 2
Classifications of market
structure
Buildings have different structures ….
 Healthcare
Clothes

Stationaries Industries / Markets

have different
structures too …. Veg. Farming

Smartphone
Car
Cosmetic
& Availability of information
LO 2
Characteristics of
various market
structures
Notes
examples of market structures

Perfectly Competitive Market:

Maple Syrup industry

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Notes
examples of market structures
Monopolistic Market:
Restaurant industry

Photo by Chan Walrus: https://www.pexels.com/photo/white-and-brown-cooked-

dish-on-white-ceramic-bowls-958545/
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Notes
examples of market structures

Oligopoly Market:
Photo by Life Of Pix: Car industry (differentiated)
https://www.pexels.com/photo/cement-flowing-at-
construction-site-2469/
Cement (identical)
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Notes
examples of market structures
Monopoly Market:
Ferry industry / Power industry

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 Notes
characteristics Imperfect Competition

Characteristics Perfect Competition Monopolistic Oligopoly Monopoly

Competition
Number of firms Very large number of Large Few One
(market share) firms
Type of product Identical Differentiated Differentiated or Unique
(product diff.) identical
Barriers to entry None Low High Very high

Control over price Price taker Limited Some Considerable / very

(market power) high degree
Availability of Perfect Some Some Little
information

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Notes
ways to identify type of market structures

Criteria Approach
Number of firms Higher number – closer to PC
Concentration ratio Higher ratio – closer to monopoly
• the ratio of the biggest three, four or
five firms’ sales volume/revenue to
the market total

Importance of economies of scale Greater importance – closer to monopoly

Power to control price Higher power – closer to monopoly
Barriers to entry Higher – closer to monopoly

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 LO 3
Performance of PC firms
in the market
TR, AR and MR
perfectly competitive firm

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Output and profits in the SR
perfectly competitive firm

Output and profits in the short run

1. To maximize profit, a perfectly competitive firm will produce at the

level of production where MR = MC
2. In the short run, a perfectly competitive firm may experience one of
the following profit scenarios:
• Supernormal profits
• Normal profits
• Subnormal profits (with production)
• Shut down

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SR Scenarios
Supernormal profit (TR > TC)
Take note:
1. Start by identifying the point where
$ MR = MC. This will revel the profit
ATC maximizing level of production. In
MC this example, it is Q1.
2. Find TR (AR x Q) = ABCD
AR = MR = P B AVC 3. Find TC (ATC x Q) = EFCD
A
4. TR > TR, the firm earns
supernormal profit.
5. Supernormal profit = ABFE
E F

Tip:
1. To illustrate supernormal profit,
place the AR=MR=P above the min
point of ATC.

D C
Q1 Q
SR Scenarios
Normal profit (TR = TC)
Take note:
1. Start by identifying the point where
$ MR = MC. This will revel the profit
ATC maximizing level of production. In
MC this example, it is Q1.
2. Find TR (AR x Q) = ABCD
AVC 3. Find TC (ATC x Q) = ABCD
4. TR = TC, the firm earns normal
profits.
5. Normal profits = no area shown
A
B AR = MR = P
Tip:
1. To illustrate normal profit, place the
AR=MR=P at the minimum point of
ATC curve.

D C
Q1 Q
SR Scenarios
Subnormal profit (TC > TR, losses)
Take note:
1. Start by identifying the point where
$ MR = MC. This will revel the profit
ATC maximizing level of production. In
MC this example, it is Q1.
2. Find TR (AR x Q) = EFCD
AVC 3. Find TC (ATC x Q) = ABCD
4. TC > TR, the firm earns subnormal
profit (incurs losses).
A B 5. Subnormal profit = ABFE

E F AR = MR = P Tip:
1. To illustrate subnormal profit, place
the AR=MR=P in between the ATC
and AVC curve.

D C
Q1 Q
SR Scenarios
Shutdown (TC > TR, losses)
Take note:
1. If the firm were to produce at the
$ level of production where MR = MC,
ATC the firm will incur a loss of ABFE.
MC
2. For this scenario, firm is better off
AVC by shutting down because the loss
A B is minimized by paying only the FC
(the area shaded in purple).

Tip:
1. Firm will shut down when A=MR=P
coincides with the min AVC point
E F OR goes below the min AVC point .
AR = MR = P
D C
Q1 Q
SR Scenarios
Shutdown (TC > TR, losses)

$
ATC
MC

AVC

AR = MR = P Shutdown price,
the price that
Shutdown point sufficiently covers
the AVC
Q
SS curve in the SR
perfectly competitive firm

SS curve of a perfectly competitive firm in the short run

1. Reviewing the four scenarios given earlier, the point that the
perfectly competitive firm chooses to produce and supply at each
price level coincides with the MC curve.
2. The upward sloping segment of the MC curve that is located on and
above the min AVC point represents the firm’s supply curve.

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SR Scenarios
Shutdown (TC > TR, losses)

$
ATC
MC

AVC
AR3 = MR3 = P3

AR2 = MR2 = P2
AR1 = MR1 = P1

AR0 = MR0 = P0

Q1 Q
SR Scenarios
Shutdown (TC > TR, losses)

$
ATC
MC

AVC
AR3 = MR3 = P3

AR2 = MR2 = P2
AR1 = MR1 = P1

AR0 = MR0 = P0

Q1 Q
Output and profits in the LR
perfectly competitive firm

Output and profits in the long run

1. With no barriers to entry present (or freedom of entry and exit), all
perfectly competitive firms will earn normal profits in the LR.

2. If firms were to earn supernormal profit in the SR, this profit will
attract new firms to enter the industry. With no barriers to entry,
market supply rises, and this pushes price down. As price takers,
falling price hurts the supernormal profit of the firms because the
revenue per unit lowers. The entry of new firms will continue to take
place till all firms in the market earn normal profit in the long run.

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Output and profits in the LR
perfectly competitive firm

Output and profits in the long run

3. If firms were to earn subnormal profit in the SR, they will continue to
operate in the short run. In the long run, the scenario differs. With
exit made possible in the long run, existing firms with subnormal
profit leave the industry. Market supply decreases when many firms
leave, and this pushes price up. As price takers, rising price
improves the revenue earned per unit and lowers the subnormal
profit (or losses) of the firms that remain in the industry. The exit
process will continue till all firms in the market earn normal profit in
the long run. The remaining firms would be the most efficient ones.

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LR Scenario
Supernormal profit in the SR, new firms enter, normal profit in the LR

$ $
MC ATC MC ATC

AR = MR = P
AVC AR = MR = P
ls
Price fal

Q1 Q Q2 Q
LR Scenario
Subnormal profit (losses) in the SR, existing firms exit, price rises, normal profit in the LR

$ $
MC ATC MC ATC

AVC
r ice r ises
P
AR = MR = P

AR = MR = P

Q1 Q Q2 Q
Can you recall the concept
of efficiency?
Notes
review: productive and allocative efficiency

Productive efficiency Allocative efficiency Dynamic efficiency

• Achieved when output is • Achieved when allocated • Achieved when consumers
maximized from the given resources produce the are given more choices OR
quantity of resources used + combination of goods that better-quality products over
the combination of satisfies the wants of the time
resources result in least consumers
cost

• ATC is minimized • P = MC • Firms spend to innovate /

carry out R&D

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SR Efficiency Evaluation
productive efficiency, allocative and dynamic efficiency

$ $ $
MC ATC MC ATC MC ATC

AVC AVC AVC

Q1 Q Q1 Q Q1 Q
LR Efficiency
productive efficiency, allocative and dynamic efficiency

MC ATC

AR = MR = P

Q2 Q
learning outcomes

04 05
Characteristics of Performance of monopoly
monopoly market + market
Barriers

06
Comparing performance of
PC and monopoly

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LO 4
Characteristics of
monopoly market
Notes
characteristics: monopoly

Characteristics Monopoly Monopoly: different types

• Pure monopoly – a single firm that dominates the
Number of firms One whole market (it has 100% concentration)
(market share)
Type of product Unique It is important to differentiate monopoly firm from
(product diff.) monopoly power (relatively high power to control
Barriers to entry Very high price). An oligopoly firm can have monopoly power.
So, use these terms carefully.
Control over price Considerable / very Do pay attention to the following terms too:
(market power) high degree • Working monopoly (a firm that controls 25% or
Availability of Little more of the industry’s total sales)
information • Dominant firm (a firm that controls 40% or more
of the industry’s total sales)

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Notes
characteristics: monopoly
Examples of barriers to entry:
Characteristics Monopoly • Natural barriers – the natural barriers are
Number of firms One associated with substantial economies of scale.
(market share) If the monopoly firm’s ATC continuously decline
Type of product Unique over a huge production range that fulfil the
(product diff.) demand of the whole industry, it is ideal for one
single firm to operate in the market. This leads to
Barriers to entry Very high the existence of natural monopoly.
• Legal barriers – if the government were to award
Control over price Considerable / very
only one single license for a business to operate,
(market power) high degree
a monopoly market will be created. Other
Availability of Little possible forms of legal barriers are patent and
information copyright.
Definition: Barriers to entry are obstacles blocking potential firms from entering a
market easily or profitably or both.
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Notes
characteristics: monopoly
Examples of barriers to entry:
• Physical barriers – control over raw materials,
Characteristics Monopoly
distribution channel (vertical integration)
Number of firms One • Cost barriers – high set-up costs, high research
(market share) and development costs
Type of product Unique • Structural barriers / costs asymmetries – the cost
(product diff.) differences that exist between the incumbent firm
and potential entrant. Due to incumbent firm’s
Barriers to entry Very high
ability to exploit economies of scale, its lower
ATC allow the firm to use predatory pricing (to
Control over price Considerable / very drive out firms with high costs) OR limit pricing
(market power) high degree (to deter new firms from entering) to stop entry of
Availability of Little new firms.
information • Market barriers – strong branding, loyalty,
goodwill, reputation, massive advertising
campaign
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Notes
characteristics: monopoly

SESCO – Bakun Dam POS Malaysia

(natural monopoly) (legal barrier)

JKSB – Second Bridge De Beers

(high set-up cost) (control over resources)
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Notes
characteristics: monopoly

Barriers to exit

1. There are barriers to exit too, and this is often associated with huge
sunk costs (costs that cannot be recovered).
2. Examples of sunk costs:
• Money spent on advertising, marketing and R&D projects which
cannot be carried forward into another market / industry
• Costs of winding down the business
• Loss of business reputation and goodwill

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 LO 5
Performance of (pure)
monopoly firm
Illustrating TR, AR and MR graphs
Pure monopoly firm

Revenue
($) TR As output increases:

TR rises at falling rate, reach

maximum, and decreases at rising
rate.

AR = P As output increases:

AR falls continuously.
Q1 Q
As output increases:

MR MR falls continuously (positive 

zero  negative).
Output and profits in the SR
monopoly firm

Output and profits in the short run

1. To maximize profit, a monopoly firm will produce at the level of

production where MR = MC
2. In the short run, a monopoly firm may experience one of the
following profit scenarios:
• Supernormal profits
• Normal profits
• Subnormal profits
• Shut down (theoretically possible BUT unlikely in reality)

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SR Scenarios
Supernormal profit
$

ATC
MC

AVC

AR = P

MR
Q1 Q
SR Scenarios
Normal profit
$

ATC
MC

AVC

AR = P

MR
Q1 Q
SR Scenarios
Subnormal profit
$

ATC Subnormal profit (losses) can

MC occur in a monopoly market due to
TWO possible reasons:
AVC
• Falling demand (the AR=P shifts
inwards)
• Higher costs (the ATC shifts
upwards)

AR = P

MR
Q1 Q
Output and profits in the LR
monopoly firm

Output and profits in the long run

1. If supernormal profit exists in the short run, the monopoly firm will
continue to earn supernormal profit in the long run BECAUSE new
firms can’t enter to compete the profits away.
2. Normal profit may exist too.
3. If subnormal profit were to exist in the short run, government is
likely to step in and provide funding for the case of state-owned
monopolies. As for private monopolies, the firm will find ways to
either increase demand or reduce costs in order to ensure that
normal profit is achieved in the long run.

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LR Scenarios
Supernormal profit
$

ATC
MC

AR = P

MR
Q1 Q
LR Scenarios
Normal profit
$

ATC
MC

AR = P

MR
Q1 Q
Time to look at efficiency
SR Efficiency Evaluation
productive efficiency, allocative and dynamic efficiency

$ $

MC ATC
MC ATC
AVC
AVC

AR = P AR = P

Q1 MR Q Q1 MR Q
LR Efficiency Evaluation
productive efficiency, allocative and dynamic efficiency

$ $

MC ATC
MC ATC

AR = P AR = P

Q1 MR Q Q1 MR Q
 LO 6
Comparing the PC
market with a monopoly
market