Chapter 7

MARKET STRUCTURE

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 DEFINITIONS
Firm : an institution that buys or hires FOPs and
organizes them to produce and sell goods and services.

Objectives :
Conventional perspective :
1. Minimize cost and maximize profits.
2. Pay taxes
3. Corporate Social responsibilities(CSR) : charitable
activities, sponsorships, provide scholarships, etc

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• Objectives :
Islamic perspective :
Overall objective is to seek mardhatillah and
al falah through :

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1. Production of halal goods
2. Minimizing cost and reasonable profits.
3. Paying zakat and taxes
4. Corporate Social responsibilities(CSR) :
charitable activities, sponsorships, provide
scholarships, etc
 MARKET STRUCTURE
Industry : A group of firms producing the
same goods and services

Market : an arrangement that facilitates the

buying and selling of a product, services, FOPs
or future commitments

Market Structure : the number and

distribution size of buyers and sellers in the
market for particular goods and services
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 CLASSIFICATION OF MARKET
STRUCTURE
• Four Classifications which are :
1. Perfect Competition (PC)
2. Monopolistic Competition (MC)
3. Monopoly (M)
4. Oligopoly (O)

 This classifications are based its

characteristics on number of firms, type of
product, condition for entry, control over
price and price elasticity of demand. 5
 1. PERFECT COMPETITION
• Perfect competition is an ideal market
structure characterized by large number
of firms within the same industry produce
homogenous good. Each firm is a price
taker.

• Example: producers of agricultural

products
 CHARACTERISTICS
• To be perfectly competitive, a market must meet the
following characteristics:

i. Many sellers and buyers

ii. Both buyers and sellers are price takers.
iii. Firms sell homogeneous products.
iv. Very easy entry and exit
v. Perfect information available to buyers & sellers

• A perfectly competitive firm’s demand curve is

perfectly elastic (since firms are price takers)
2. MONOPOLISTIC COMPETITION

Monopolistic competition is a market

structure in which there are many firms
within the same industry selling
differentiated products
Eg: firms sell shoes, watches, clothes,
furniture, spectacles, etc
 CHARACTERISTICS

Many sellers in a highly competitive

market
Differentiated products, but firms still act
independently (have close substitutes)
Easy entry of new firms in the long run so
there are no long-run profits
Need to engage in advertising
Less power to control price
 3. MONOPOLY

Monopoly is defined as a market

structure in which a single firm
makes up the entire market and
this firm sells unique product.
 CHARACTERISTICS

- only one seller in the market and has

the power to determine price (price
maker)
- produce only one good with no close
substitute
- no free entry due to barriers
- advertising is minimally practiced
 4. OLIGOPOLY

Oligopolies is a market structure

whereby there exist a few large
dominant firms which control the
industry
Example: petroleum industry, airplanes
makers, steel industry and automobile
industry
 CHARACTERISTICS
• Few large firms controlling the industry
• Barriers to entry – due to government
regulations, patent rights or franchise
• Mutual interdependence of firms – decision
based on other firms reaction
• Price rigidity/ stickiness/stability
• Identical or Differentiated products
• Non-price competition (advertisement,
packaging, product differentiation & after sale
service rather than lower cost)
 THE CONCEPT OF REVENUE

A) Total Revenue (TR)

It is an income received by a producer through
selling goods or services in the market
FORMULA: TR = P x Q

B) Average Revenue (AR)

The amount of income per unit received by a
producer after selling of products in the market
FORMULA: AR = TR/Q

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C) Marginal Revenue
It is an additional unit of income
received by a producer after selling
additional (one unit) of product.

FORMULA: MR = ΔTR/ΔQ

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 ANALYSIS OF REVENUE
• Split the market structure into 2 categories:

Perfect market Imperfect market

*Perfect Competition 1. Monopolistic

2. Monopoly
Because P.C follow the 3. Oligopoly
price determined in the
market 16
 TABLE : PURE/PERFECT
COMPETITION
P Q TR AR MR

10 1

10 2

10 3

10 4

10 5

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DIAGRAM:

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TABLE: MONOPOLISTIC COMPETITION
AND MONOPOLY
P Q TR AR MR
10 1
9 2
8 3
7 4
6 5
4 6
3 7
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DIAGRAM:

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 PERFECT MARKET
• Perfect Competition is a market consists of
large number of sellers(small firms)
• selling identical products,
• easy entry(no barriers) for the new firms to
join the market causes it to have no control
over price . As a result the price is constant
which is the determined by the industry.
• Perfect Competition is a price taker.

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 IMPERFECT MARKET
• Imperfect Markets consist of Monopolistic
Competition, Monopoly and Oligopoly
• The common characteristic is that control
over price in which from little control (MC) to
most powerful(Monopoly).
• As a result the price is not constant, i.e. The
higher the price the less goods sold

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 CONCEPT OF PROFIT MAXIMIZATION

• Split the market into 2 categories :

Perfect (PC) and Imperfect(MC and M)
• Two approaches:
i) Total Approach

ii) Marginal Approach

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 TOTAL/AGGREGATE
APPROACH
The use of total cost and total revenue

Profit = TR – TC

Profit is MAXIMUM when the

differences between TR and TC is the
highest

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TR – TC APPROACH (PERFECT COMPETITION)

Quantity (Q) P (RM) TR TC Profit (TR – TC)

0 10 10
1 10 26
2 10 29
3 10 31
4 10 34
5 10 40
6 10 49
7 10 60
8 10 74
9 10 90
10 10 108
DIAGRAM:

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 PROFIT MAXIMIZATION IN IMPERFECT COMPETITION (MONOPOLISTIC
COMPETITION/MONOPOLY)

• TR – TC approach

Quantity (Q) P (RM) TR TC Profit = TR - TC

1 10 10
2 9 15
3 8 19
4 7 22
5 6 24
6 5 27
7 4 31
8 3 36
9 2 42
DIAGRAM:

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 MARGINAL APPROACH
 The usage of MR and MC curves
 Intersection of MR and MC curves is
equilibrium condition
 Profit is MAXIMUM when:
i) MR = MC (E, equilibrium)
ii) From E find Q
iii) From E find the AR(Price)
iv) From E find the AC
iv) Profit = TR – TC
= (AR X Q)-(AC X Q)
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 MC – MR APPROACH-
(PERFECT COMPETITION)
Quantity (Q) P (RM) TR AR MR TC MC
1 10 10
2 10 26
3 10 29
4 10 31
5 10 34

6 10 40
7 10 49
8 10 60
9 10 74
10 10 90
DIAGRAM:

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 MC – MR APPROACH-(MONOPOLY/
MONOPOLISTIC COMPETITION)
Quantity (Q) P (RM) TR AR MR TC MC
1 10 10 10
2 9 18 15
3 8 24 19
4 7 28 22
5 6 30 24
6 5 30 27
7 4 28 31
8 3 24 36
9 2 18 42
10 1 10 49
DIAGRAM:

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 PROFIT MAXIMIZATION IN THE
SHORT RUN
• 3 TYPES OF PROFIT
* Super Normal Profit (economic profit)
AR > AC
* Normal Profit (breakeven)
AR = AC
* Subnormal Profit (loss)
AR < AC

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 PERFECT COMPETITION
Supernormal Profit
P/Costs
MC

AC

5 P=Dd=AR=MR

100 Q

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CALCULATION

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 PERFECT COMPETITION
Normal Profit
P/Costs
MC

AC

5 P=Dd=AR=MR

100 Q

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CALCULATION

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 PERFECT COMPETITION
Subnormal Profit
P/Costs
MC AC

5 P=Dd=AR=MR

Q
100

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CALCULATION

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 MONOPOLISTIC COMPETITION /
MONOPOLY
Supernormal Profit
P/Costs
MC

AC

P=Dd=AR

MR

50 Q

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CALCULATION

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 MONOPOLISTIC COMPETITION /
MONOPOLY
Normal Profit
P/Costs
MC

AC

P=Dd=AR

MR

50 Q

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CALCULATION

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 MONOPOLISTIC COMPETITION /
MONOPOLY
Subnormal Profit
MC
P/Costs
AC

P=Dd=AR

MR

50 Q

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CALCULATION

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 SHUT DOWN POINT IN THE
SHORT RUN

• Shut down point is the point reached when

price (P) falls to a level just allows the firm
to cover the minimum possible AVC.

• If P > AVC , loss but the firm can continue

production because it can cover the AVC.

• If P < AVC the firm should shut down or

stop production because it incurs a loss on
variable cost. 47
 PERFECT COMPETITION
a) At RM5 Price(P) equals to the minimum average
variable cost, the losses incurred is equal to fixed cost.
Continue production/shut down point
AC
Cost MC

7 AVC

5 P=Dd=AR=MR

100 Q

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 PERFECT COMPETITION
a) If price fall below RM5, the firm will shut down its
operation because losses are grater than fixed cost.
Shut down MC

AC
Cost
AVC
7

P=Dd=AR=MR

100 Q

50
 MONOPOLISTIC COMPETITION /
MONOPOLY
a) Continue production/shut down point
MC
Costs
AC

7
AVC
5

P=Dd=AR

MR

50 Q

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 MONOPOLISTIC COMPETITION /
MONOPOLY
b) Shut down MC

Costs
AC

7 AVC

P=Dd=AR

MR
50 Q

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 PROFIT MAXIMIZATION IN THE
LONG RUN

Perfect Competition / Monopolistic Competition

In the long run, the firms in perfect competition and

monopolistic competition only make a normal profit.
(It is a situation where AR=MR=MC=AC).
This is due to the fact that in perfect competition, there
are no barriers towards entry (easy entry and exit) and
for monopolistic competition (free entry and exit)

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If in the short run firms in an industry is
making a SUPER NORMAL profit, due to
easy entry this will attract more firms to enter
the market, the size will get larger and finally
in the long run the profit shared by them will
fall until each of them will only receive a
NORMAL PROFIT. (effect of entry)

If the firms is making a SUB NORMAL

PROFIT in the short run, this will make the
existing firms to leave the industry, therefore
the number of firms is getting smaller and at
the end, the profit shared by them will increase
and finally in the long run each of them will
receive a NORMAL PROFIT (effect of exit)
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 DIAGRAM:
PERFECT COMPETITION LONG RUN PROFIT
• Effect of entry

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• Effect of exit

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 DIAGRAM:
MONOPOLISTIC COMPETITION LONG RUN PROFIT

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 Monopoly

In the long run, the firm in the monopoly market

will receive a SUPER NORMAL profit. This is
due to the fact that there is only one firm in the
market. Therefore the firm has power to determine
the price level and the quantity of production. In the
long run, the firm has many choices of SRAC
curves.

The firm will only choose on SR cost curve which

not only maximize production but also minimize
the cost of production. In the long run, the firm is
not only making a super normal profit, but it will
get a greater super normal profit than in the short
run.
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DIAGRAM: MONOPOLY LONG RUN PROFIT

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 PRICE DISCRIMINATION
(A PRACTICE OF MONOPOLY)
Price discrimination is the selling of goods or
services of given quality at different price to
different buyers.
There are three types of price discrimination:
(i) First Degree
occurs when a firm charges a different price
for a unit sold and charges each consumer the
maximum price that he is willing to pay for
each unit.
Example : auction
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(ii) Second Degree
Occurs when a products are grouped into
blocks and each block is charged at a different
price.
Example: bus fare, cinema ticket.

(iii) Third Degree

To practice this price discrimination, there are
a few conditions :

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a) Seller must be a monopolist

b) Markets are separated where the buyers cannot

make profits by buying goods at cheaper market
and resell at expensive market.

c) Elasticity of demand in these different market are

different :
demand is inelastic – sells at higher price
demand is elastic – sells at lower price.

d) Cost of separating the market is low.

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COMPARISON PRODUCTION EFFICIENCY BETWEEN
PERFECT COMPETITION AND MONOPOLY

Diagram :
AC

MC

MR= ARpc

ARm

MR m
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i) Price & Quantity

ii) Efficiency

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 SWEEZY’S MODEL
• Oligopolist faces two demand curves
a firm’ s demand curve : dd
an industry’s demand curve : DD
d D
dd is elastic
DD is inelastic

d
D

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 SWEEZY’S MODEL
 Used to explain the kinked demand curve and
price rigidity in the oligopoly model
(mutual interdependence between firms)

Assumptions:
1. If the firm were to increase its price, other firms
will not follow (demand curve is elastic) in order
to gain the market share
2. If the firm were to reduce price, other firms will
follow to avoid losing the market share
(demand curve is inelastic)
• As a result the demand curve for
oligopoly consists of dd (higher price)
and DD (lower price) known as
KINKED DEMAND CURVE.

• Kink in demand curve creates a break

in MR curve.

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KINKED DEMAND CURVE MODEL

MC2
E MC1
P*

b D=AR

Q*

MR

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• To maximize profit : MR =MC
• Between a-b gap :
- fluctuation of MC does not effect the equilibrium

price or quantity.
- therefore MC is between MC1 to MC2, price
and
quantity remain constant ( P* and Q*)
-This explain the price rigidity.

• Kinked demand curve model predicts that price and

quantity will be insensitive to small cost but will
respond if the change in costs are large enough.

• Oligopolists can increase profit not by increasing

price but through cost reduction ( efficiency). 70
SAMPLE QUESTION

E AC
26 MC
24
22
21
20 a

10 b P=Dd= AR

200 300 400

MR

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a) The equilibrium output is _______ units and
the equilibrium price is RM _______.
b) The oligopoly’s model is known as __________
c) State two assumptions on the kinked demand
curve.

d) Calculate the total profit or loss.

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