Market Structure

Ref. Ch 14,15,16,17 of the text book

Market Structure
Market is a place where buyer and seller interact among themselves.

Market structure refers to the physical characteristics of the market within which firms interact. In other words, the selling environment in which a firm produces and sells its product is called a market structure.
P and Q of products are strongly affected by market structure.

Defined by three characteristics: The number of firms in the market The ease of entry and exit of firms The degree of product differentiation

The Four Types of Market Structure

Number of Firms? Many firms Type of Products?

One firm

Few firms

Differentiated products

Identical products

Monopoly (Chapter 15)

Tap water Cable TV

Oligopoly (Chapter 16)

Tennis balls Crude oil

Monopolistic Competition (Chapter 17) Novels Movies

Perfect Competition (Chapter 14) Wheat Milk

Types of Market Structure

Sellers Point of View Perfect Competition, with an infinite number of firms, Imperfect Competition with limited number of firms Monopoly, with a single firm Duopoly with two firms Monopolistic competition and oligopoly lie between these two extremes of perfect competition and monopoly. Many firms of a homogeneous or differentiated product Buyers Point of View Monopsony refers to a situation in which there is a single buyer of a commodity/ input for which there is no close substitutes Monopsonistic competition few or large buyer of a homogeneous or differentiated produce Oligopsony few buyer Duopsony two buyer
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Perfect Competition
Perfect Competition is a market structure characterized by: Many large firms, so large that no one firm has the ability to affect the market. Price is fixed. These firms are price takersthey have to go along with the market price. Identical products, the products are identical, generic products. Easy entry into the industry and exist from the industry. Ex. Same type of wheat produced in India by large farmers or local gasoline market.

Firms demand curve is horizontal, industry Demand curve is downward sloping

Monopoly
Monopoly is a market structure in which there is just one firm, and entry by other firms is not possible.

There are no close substitutes.

The firm has the power to set the price, but still sets an optimal price to maximize profit. If the monopolist sets the price too high, revenue will decline. The firm is a price maker. The firms demand curve is the market demand curve, and it is downward sloping. Ex. Local telephone, electricity, Public transport system etc.
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Monopolistic Competition
Monopolistic competition is a market structure in which there are many firms selling differentiated products.

Monopolistic Competition is characterized by:

A large number of firms Easy entry(There are few barriers to entry) Differentiated products, because each firms product is slightly different, each firm is kind of a mini-monopolythe only producer of that specific product. This allows the firm to be a price maker. The firms demand curve is downward sloping and depending on the differentiation of the firms product, it may be fairly inelastic. Or flat Ex. Gaosline stations and barber shop, CDs, movies, computer games, restaurants,
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Oligopoloy
Oligopoly is a market structure in which there are a few interdependent firms. Oligopoly is characterized by: Few firmsmore than one, but few enough so each firm alone can affect the market. Entry is more difficult, but can occur. There are often significant barriers to entry. The firms are interdependenteach is affected by what others do. The demand curve is downward sloping for each firm. Ex. Homogeneous product: Cement, Steel, Chemicals, Differentiated Product: automobiles, Cigarettes, soft drinks,

Duopoly:
A duopoly is an oligopoly with only two Sellers of similar products. It is the simplest type of oligopoly. Price competition is severe lead to price war. Each react to the other. The duopolies may agree on a monopoly outcome.

Collusion An agreement among firms in a market about quantities to produce or prices to charge. Cartel A group of firms acting in unison The Demand Curve Slopes downward from left to right Ex. Prisoners dilemma

Four Basic Market Types

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Problems Determining Market Structure

Defining a market has problems: What is an industry and what is its geographic market -- local, national, or international? What products are to be included in the definition of an industry? Classifying Industries One of the ways in which economists classify markets is by cross-price elasticities. Cross-price elasticity measures the responsiveness of the change in demand for a good to change in the price of a related good.
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Perfect Competition

Ex. Local gasoline market, stock market etc.

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A Perfectly Competitive Market

A competitive market has many buyers and sellers trading identical products so that each buyer and seller is a price taker. Buyers and sellers must accept the price determined by the market.

A perfectly competitive market is one in which economic forces operate unimpeded. A perfectly competitive market must meet the following requirements:
Both buyers and sellers are price takers. The number of firms is large. There are no barriers to entry. The firms products are identical. There is complete information.

As a result of its characteristics, the perfectly competitive market has the following outcomes: The actions of any single buyer or seller in the market have a negligible impact on the market price. Each buyer and seller takes the market price as given.
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The Necessary Conditions for Perfect Competition

A firm in a perfectly competitive market is said to be a price taker because the price of the product is determined by market supply and demand, and the individual firm can do nothing to change that price.

The number of firms is large. Large means that what one firm does has no bearing on what other firms do.
Any one firm's output is minuscule when compared with the total market.

Both buyers and sellers are price takers.

A price taker is a firm or individual who takes the market price as given. In most markets, households are price takers they accept the price offered in stores. The retailer is not perfectly competitive. A retail store is not a price taker but a price maker.
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The Necessary Conditions for Perfect Competition

There are no barriers to entry. Barriers to entry are social, political, or economic impediments that prevent other firms from entering the market. Barriers sometimes take the form of patents granted to produce a certain good. Technology may prevent some firms from entering the market. Social forces such as bankers only lending to certain people may create barriers. The firms' products are identical. This requirement means that each firm's output is indistinguishable from any competitor's product. There is complete information. Firms and consumers know all there is to know about the market prices, products, and available technology. Any technological breakthrough would be instantly known to all in the market.
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Price and Output Determination : The Short Run Analysis

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Demand Curves for the Firm and the Industry

P is determined by the equilibrium between D=S The demand curves (DC) facing the firm is different from the industry demand curve. DC: The market demand curve is simply horizontal summation of individual demand curve of all the consumer. So a perfectly competitive firms demand schedule is perfectly elastic even though the demand curve for the market is downward sloping. The result is that the individual firm perceives the demand curve for its product as being perfectly horizontal.

SC: Similarly The market supply curve is simply horizontal summation of supply curve of the individual producer.
Ex: Qd=625-25P and Qs=175+15, so P=45 and Q=400
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Market Demand Versus Individual Firm Demand Curve

Price $10
8 6 4

Market Market supply

Firm

Price $10
8 6

Individual firm demand

2 0
1,000

Market demand 3,000 Quantity

2 0
10 20 30 Quantity
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The Revenue of a Competitive Firm

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The Revenue of a Competitive Firm

Total revenue for a firm is the selling price times the quantity sold. TR = (P Q) Total revenue is proportional to the amount of output. Marginal revenue is the change in total revenue from an additional unit sold. MR =TR/ Q For competitive firms, marginal revenue equals the price of the good. Average revenue tells us how much revenue a firm receives for the typical unit sold. AR=TR/Q 20 Average revenue is total revenue divided by the quantity sold.

The Revenue of a Competitive Firm

In perfect competition, average revenue equals the price of the good. Total revenue Average Revenue = Quantity
Price Quantity Quantity Price
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Total, Average, and Marginal Revenue for a Competitive Firm

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Profit Maximizing and Shutting Down

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PROFIT MAXIMIZATION AND THE COMPETITIVE FIRMS SUPPLY CURVE

The goal of a competitive firm is to maximize profit. This means that the firm will want to produce the quantity that maximizes the difference between total revenue and total cost.

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The Marginal Cost-Curve and the Firms Supply Decision

Profit maximization occurs at the quantity where marginal revenue equals marginal cost.
When MR > MC, increase Q When MR < MC, decrease Q When MR = MC, profit is maximized

A firm maximizes profit when MC = MR.

A perfect competitor accepts the market price as given. As a result, marginal revenue equals price (MR = P).
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Profit Maximization: A Numerical Example

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Profit Maximization for a Competitive Firm

Costs and Revenue The firm maximizes profit by producing the quantity at which marginal cost equals marginal revenue. Suppose the market price is P. MC If the firm produces Q2, marginal cost is MC2. ATC P = AR = MR AVC

MC2

P = MR1 = MR2

MC1

If the firm produces Q1, marginal cost is MC1.

Q1

QMAX

Q2

Quantity
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Marginal Cost as the Competitive Firms As P increases, Supply Curve the firm will
Price
So, this section of the firms MC curve is also the firms supply curve. select its level of output along the MC curve.

MC

P2

ATC

P1
AVC

Q1

Q2

Quantity

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The Firms Short-Run Decision to Shut Down

A shutdown refers to a short-run decision not to produce anything during a specific period of time because of current market conditions. Exit refers to a long-run decision to leave the market. The firm shuts down if the revenue it gets from producing is less than the variable cost of production.
Shut down if TR < VC Shut down if TR/Q < VC/Q Shut down if P < AVC
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The Competitive Firms Short-Run Supply Curve and shut down point
Costs If P > ATC, the firm will continue to produce at a profit. Firms short-run supply curve MC

ATC If P > AVC, firm will continue to produce in the short run.

AVC

Firm shuts down if P < AVC 0

Quantity
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The Firms Short-Run Decision to Shut Down

The portion of the marginal-cost curve that lies above average variable cost is the competitive firms short-run supply curve.

The firm considers its sunk costs when deciding to exit, but ignores them when deciding whether to shut down.
Sunk costs are costs that have already been committed and cannot be recovered.
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The Firms Long-Run Decision to Exit or Enter a Market

In the long run, the firm exits if the revenue it would get from producing is less than its total cost.
Exit if TR < TC Exit if TR/Q < TC/Q Exit if P < ATC

A firm will enter the industry if such an action would be profitable.

Enter if TR > TC Enter if TR/Q > TC/Q Enter if P > ATC
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The Competitive Firms Long-Run Supply Curve

Costs Firms long-run supply curve MC = long-run S

Firm enters if P > ATC

ATC

Firm exits if P < ATC

Quantity
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Measuring Profit for the competitive firm. TR-TC or MR=MC

The goal of the firm is to maximize profits. Profit = TR TC => Profit = (TR/Q TC/Q) x Q =>Profit = (P ATC) x Q Or: A firm maximizes profit when MR=MC A perfect competitor accepts the market price as given. As a result, marginal revenue equals price (MR = P).
If MR>MC a firm can increase profit by changing output. If MR>MC The supplier will continue to produce. If MR<MC The supplier will cut back on production. MR=MC=P is the profit-maximizing condition of a competitive firm..
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Determining Profit and Loss From a Graph

The intersection of MC = MR (P) determines the quantity the firm will produce if it wishes to maximize profits. If the cost of producing one more unit is less than the revenue it generates, then a profit is available for the firm that increases production by one unit. If the cost of producing one more unit is more than the revenue it generates, then increasing production reduces profit. The firm makes a profit when the ATC curve is below the MR curve. The firm incurs a loss when the ATC curve is above the MR curve. Zero profit or loss where MC=MR. Firms can earn zero profit or even a loss where MC = MR. Even though economic profit is zero, all resources, including entrepreneurs, are being paid their opportunity costs.
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Profit as the Area between Price and Average Total Cost

(a) A Firm with Profits Price MC Profit P ATC

ATC

P = AR = MR

Quantity Q (profit-maximizing quantity)

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Profit as the Area between Price and Average Total Cost

(b) A Firm with Losses Price

MC

ATC

ATC P Loss P = AR = MR

Q (loss-minimizing quantity)

Quantity
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THE SUPPLY CURVE IN A COMPETITIVE MARKET

The competitive firms long-run supply curve is the portion of its marginal-cost curve that lies above average total cost. Short-Run Supply Curve
The portion of its marginal cost curve that lies above average variable cost.

Long-Run Supply Curve

The marginal cost curve above the minimum point of its average total cost curve.
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The Short Run: Market Supply (industry) with a Fixed Number of Firms

Market supply equals the sum of the quantities supplied by the individual firms in the market. For any given price, each firm supplies a quantity of output so that its marginal cost equals price. The market supply curve reflects the individual firms marginal cost curves.
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Short-Run Market (industry) Supply

(a) Individual Firm Supply Price Price

(b) Market Supply

MC

Supply
$2.00

$2.00

1.00

1.00

100

200

Quantity (firm)

100,000

200,000 Quantity (market)

If the industry has 1000 identical firms, then at each market price, industry output will be 1000 times larger than the representative firms output.
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The Long Run: Market Supply (industry) with Entry and Exit

Firms will enter or exit the market until profit is driven to zero. In the long run, price equals the minimum of average total cost. The long-run market supply curve is horizontal at this price.

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Long-Run Market (Industry) Supply

(a) Firms Zero-Profit Condition Price Price

(b) Market Supply

MC ATC P = minimum ATC Supply

Quantity (firm)

Quantity (market)

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The Long Run: Market Supply (industry) with Entry and Exit

At the end of the process of entry and exit, firms that remain must be making zero economic profit. The process of entry and exit ends only when price and average total cost are driven to equality. Long-run equilibrium must have firms operating at their efficient scale.
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Why Do Competitive Firms Stay in Business If They Make Zero Profit?

Profit equals total revenue minus total cost. Total cost includes all the opportunity costs of the firm. In the zero-profit equilibrium, the firms revenue compensates the owners for the time and money they expend to keep the business going.
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A Shift in Demand in the Short Run and Long Run

An increase in demand raises price and quantity in the short run. Firms earn profits because price now exceeds average total cost.

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An Increase in Demand in the Short Run and Long Run

(a) Initial Condition Market Price Price Firm

MC Short-run supply, S1 A P1 Long-run supply Demand, D1 0 Q1 Quantity (market) 0 P1

ATC

Quantity (firm)

A market begins in long run equilibrium.

And firms earn zero profit.

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An Increase in Demand in the Short Run and Long Run

An increase in market demand raises price and output.
(b) Short-Run Response Market Firm

The higher P encourages firms to produce more and generates short-run profit.

Price

Price
ATC

P2 P1 A

S1 P2 Long-run supply P1

MC

D2 D1

Q1

Q2

Quantity (market)

Quantity (firm)

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An Increase in Demand in the Short Run and Long Run

Profits induce entry and market supply increases.
(c) Long-Run Response Firm Price S1 P2 P1 B A C S2 Long-run supply P1 MC Price Market

ATC

D2

D1 0
Q1 Q2 Q3 Quantity (firm) 0 Quantity (market)

The increase in supply lowers market price.

In the long run market price is restored, but market supply is greater.

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Why the Long-Run Supply Curve Might Slope Upward

Some resources used in production may be available only in limited quantities. Firms may have different costs. Marginal Firm
The marginal firm is the firm that would exit the market if the price were any lower.

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Monopoly market structure

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What is a Monopoly?
A monopoly is a market structure in which there is a single supplier of a product. The monopoly firm (monopolist):
May be small or large. Must be the ONLY supplier of the product. Sells a product for which there are NO close substitutes.

Monopolies are fairly common:

Ex. Indian Postal Service, local utility companies, local cable providers, Microsoft, etc
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The Creation of Monopolies

Monopoly is a market structure in which a single firm makes up the entire market.
Monopolies exist because of barriers to entry into a market that prevent competition. Barrier to entry: anything that impedes the ability of firms to begin a new business in an industry in which existing firms are earning positive economic profits. There are three general classes of barriers to entry: Natural barriers, the most common being economies of scale Actions by firms to keep other firms out 52 Government (legal) barriers

Economies of Scale
In some industries, the larger the scale of production, the lower the costs of production.

Entrants are not usually able to enter the market assured of or capable of a very large volume of production and sales.

Examples: Electric power companies and other similar utility providers.

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Actions by Firms
Entry is barred when one firm owns an essential resource. Examples are inventions, discoveries, recipes, and specific materials. Microsoft owns Windows, and has been challenged by the U.S. Dept. of Justice as a monopolist.

Government
Governments often provide barriers, creating monopolies. As incentives to innovation, governments often grant patents, providing firms with legal monopolies on their products or the use of their inventions or discoveries for a period of several years.

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Another way to look at barriers

Legal barriers, such as patents, prevent others from entering the market. Sociological barriers entry is prevented by custom or tradition.

Natural barriers the firm has a unique ability to produce what other firms cant duplicate. Technological barriers the size of the market can support only one firm.
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Types of Monopolies
Natural monopoly: A monopoly that arises from economies of scale. The economies of scale arise from natural supply and demand conditions, and not from government actions.

Local monopoly: a monopoly that exists in a limited geographic area. Ex, cable TV operator
Regulated monopoly: a monopoly firm whose behavior is overseen by a government entity. Ex. Electricity regulatory board
The Florida Public Service Commission exercises regulatory authority over utilities in the state of Florida in one or more of three key areas: rate regulation; competitive market oversight; and monitoring of safety, reliability, and service.

Monopoly power: market power, the power to set prices.

(Indian railways)

Monopolization: an attempt by a firm to dominate a market or become a monopoly.

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Monopoly Demand Curve

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The Demand Curve Facing a Monopoly Firm and Industry

In any market, the industry demand curve is downward-sloping. This is the result of the law of demand. Critical to understanding the profit maximization of the monopolist is remembering that the monopolist is the industry because it is the sole producer.

Therefore the monopolist confronts a downward-sloping demand curve. The industry demand curve is the firms demand curve.
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HOW MONOPOLIES MAKE PRODUCTION AND PRICING DECISIONS

Monopoly versus Competition
Monopoly
Is the sole producer Faces a downward-sloping demand curve Is a price maker Reduces price to increase sales Is one of many producers Faces a horizontal demand curve Is a price taker Sells as much or as little at same price

Competitive Firm

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Demand Curves for Competitive and Monopoly Firms

(a) A Competitive Firms Demand Curve Price Price (b) A Monopolists Demand Curve

Demand

Demand

Quantity of Output

Quantity of Output

Since a monopoly is the sole producer in its market, it faces the market demand curve.

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Monopolys Total, Average, and Marginal Revenue

Total Revenue P Q = TR Average Revenue TR/Q = AR = P Marginal Revenue TR/ Q = MR

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A Monopolys Revenue
A Monopolys Marginal Revenue
A monopolists marginal revenue is always less than the price of its good.
The demand curve is downward sloping. When a monopoly drops the price to sell one more unit, the revenue received from previously sold units also decreases.

When a monopoly increases the amount it sells, it has two effects on total revenue (P Q).
The output effectmore output is sold, so Q is higher. The price effectprice falls, so P is lower.

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Demand and Marginal-Revenue Curves for a Monopoly

Price $11 10 9 8 7 6 5 4 3 2 1 0 1 2 3 4

If a monopoly wants to sell more, it must lower price. Price falls for ALL units sold. This is why MR is < P.

Marginal revenue 1 2 3 4 5 6 7 8

Demand (average revenue) Quantity of Water

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Profit Maximization
A monopoly maximizes profit by producing the quantity at which marginal revenue equals marginal cost. It then uses the demand curve to find the price that will induce consumers to buy that quantity. Profit equals total revenue minus total costs.
Profit = TR TC Profit = (TR/Q TC/Q) Q Profit = (P ATC) Q
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Profit Maximization for a Monopoly

Costs and Revenue 2. . . . and then the demand curve shows the price consistent with this quantity. B 1. The intersection of the marginal-revenue curve and the marginal-cost curve determines the profit-maximizing quantity . . .

Monopoly price

Average total cost A

Marginal cost

Demand

Marginal revenue 0 Q QMAX Q Quantity

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The Monopolists Profit

Costs and Revenue Marginal cost Monopoly E price Monopoly profit Average total D cost B

Average total cost

Demand

Marginal revenue 0 QMAX Quantity

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Monopoly Price Discrimination

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Price Discrimination
Under certain conditions, a firm with market power is able to charge different customers different prices. This is called price discrimination. Price discrimination is the ability to charge different prices to different individuals or groups of individuals.

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Examples of Price Discrimination

Movie tickets Airline prices Discount coupons Financial aid Quantity discounts

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The Price-Discriminating Monopolist*

In order to price discriminate, a monopolist must be able to: Identify groups of customers who have different elasticities of demand; Separate them in some way; and Limit their ability to resell its product between groups. A price-discriminating monopolist can increase both output and profit.
It can charge customers with more inelastic demands a higher price. It can charge customers with more elastic demands a lower price.
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Necessary Conditions for Price Discrimination

For price discrimination to work, the firm must be able to set the price. The firm must be able to segment the market That is, the firm must be able to:
Separate the customers Prevent resale of the product
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Price Discrimination in Action

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The Early Bird Gets a Lower Price

Early Bird Specials Restaurants charge special, lower prices for early diners.
MatineesTheaters charge less for earlier shows. Air FaresAirlines charge less for flyers willing to fly off peak, i.e. early morning and late night.

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Perfect Price Discrimination

By discriminating, a monopoly firm makes greater profits than it would make by charging both groups the same price. A firm with market power could collect the entire consumer surplus if it could charge each customer exactly the price that that customer was willing and able to pay. This is called perfect price discrimination.
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Dumping
Dumping: Setting a higher price on goods sold domestically than on goods sold in foreign markets.

Predatory dumping: dumping to drive competitors out of business.

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Competition versus Monopoly: A Summary Comparison

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Thank You All

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