PRINCIPLES OF ECONOMICS

Market Structure

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LEARNING OBJECTIVES
The students will be able to learn :
Theory of a firm and classification of the market.

Characteristics, short run and long run optimization

under perfect competition.
Characteristics, short run and long run optimization
under monopoly.
Characteristics, short run and long run optimization
under monopolistic competition.
Characteristics, price rigidity and kinked demand
curve, price leadership, cartel and non price
competition under oligopoly.
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LEARNING OUTCOMES
At the end of the lecture, students will be able to :
Define theory of a firm and classification of the
market.
Explore characteristics, short run and long run
optimization under perfect competition.
Explain characteristics, short run and long run
optimization under monopoly.
Explain characteristics, short run and long run
optimization under monopolistic competition.
Explore characteristics, price rigidity and kinked
demand curve, price leadership, cartel and non price
competition under oligopoly. 3
INTRODUCTION

A firms decision on production depends on the characteristics of

the industry in which the firm operating.

A firm is an institution that buys or hires factors of production

and organizes them to produce and sell goods and services.

Objective of a firm is to minimize costs and maximize profits.

Market is an arrangement that facilities that buying and selling

of a product, service, factors of production or future commitment.

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MARKET STRUCTURE
The market is an arrangement that facilitates the buying
and selling of a product or services.

Market structure refers to the number and distribution size

of buyers and sellers in the market for particular goods and
services.

Classification of market structure can be in the form of

number of buyers and sellers in the industry, the nature of
the product whether homogenous or differentiated, control
over prices and the conditions of entry. 5
 MARKET STRUCTURE
Monopolistic
Competition

Monopoly Market Oligopoly

structure

Perfect
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Competition
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 PERFECT COMPETITION
A perfectly competition market is a market or
industry where a large number of sellers and
buyers buy or sell a good that is identical or
homogeneous at certain price set by the market.

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 PERFECT COMPETITION
1. Large
number of
buyers and
sellers 2.
7. Absence of homogenous/
transport cost. identical
product

6. Perfect Characteristic
mobility of 3. Free entry
factor of and exit
production

5. Perfect
4. Non price
knowledge of
competition 9
the market
 PERFECT COMPETITION

Large number of
buyers and
sellers It means no single buyer or seller can
affect the price. If a firm enters into the
market or exit the market, there will be
no effect on the supply.

Similarly if a buyer enters into the market or exit from the

market, demand will not be affected. Thus no individual
buyer or seller can affect the price. 10
 PERFECT COMPETITION

The buyers have no reason to prefer

the product of one seller to another. homogenous/
identical
This condition is present only when the product

commodity is a substance of definite

chemical and physical composition i.e.,
salt, tin, specified grade of wheat etc.

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 PERFECT COMPETITION
Fruits and vegetables are prime examples
of homogeneous substances:

Many suppliers offer fruits and vegetables homogenous/

identical
for sale, but regardless of company, all product
brands offer the same end product.

Most homogeneous products are very similar in physical

composition, as well as quality, and the only real difference
between the various manufacturer's products is price.

In addition to produce, other types of homogeneous products

are cosmetic items such as cotton balls and cotton swabs. 12
 PERFECT COMPETITION

Perfect
knowledge of the
market

A competitive market is which the buyers and sellers are in

close contact with each other. It means that, there is perfect
knowledge of the market on the part of buyers and sellers. It
implies that a large number of buyers and sellers in the market
exactly know how much is the price of the commodity in
different parts of the market.
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 PERFECT COMPETITION

Free Entry or
Exit of Firms

In the long run, under perfect competition, firm can enter into
or exit from the industry.

There is no let or hindrance on firms as far as their entry into

or exit from the market.

In other words, there are no legal or social restrictions on the

firm.

Large number of sellers can be possible only if there is free14

entry of firms.
 PERFECT COMPETITION

Perfect Mobility

There must be perfect mobility of factors of production within

the country which ensures uniform cost of production in the
whole economy. It implies that different factors of production
are free to seek employment in any industry that they may
like.

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 PERFECT COMPETITION

No Transport
Costs

There shall not be any cost of transport between sellers.

If transport costs exist buyers are prevented from moving from

one seller to another to take advantage of price difference.
This means that transport cost has no influence on the pricing
of a product.

In other words, these are always uniform price in the market.

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 MONOPOLY

A monopoly market is a market structure that

consists of a single seller that sells a unique
product that does not have a close substitute and
there are barriers to block the entry of new firms
into the industry.

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 MONOPOLY
One seller and
large number of
buyers

advertising Product has no

close substitutes

characteristic

Restriction on the
Price maker
entry of new firms 18
MONOPOLY:
ONE SELLER AND LARGE NUMBER OF BUYERS

The number of buyers also large and this firm cannot

influence the market price.
So basically, individual firm does not bother about the
reactions of the firm.
Besides that, adjusts its sale to earn maximum profits
and the price given under perfect competition.
The demand of individual buyers relative to the total
demand.
And so small that cannot influence the price of the
product by his individual action.
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MONOPOLY:
PRODUCT HAS NO CLOSE SUBSTITUTES
In a monopoly market, their product and service are special and

unique.

They have their own idea and design for the product and service.

All the units of a product are similar and there are no alternative

to that commodity in the firm. The firm are controlling over the

market by offering a product that is not same with other.

The firm may use specialized information like trademark and

copyright in order to establish legal authority over the production

of some goods and services. 20

MONOPOLY:
ADVERTISING
In monopoly market, advertising is depends to the product sold. If
the product is good and services means, the monopoly needs make
advertisement to inform consumers on the goods.

So that, its try to establish goods of its own products. By the

advertising, consumers can know their selling costs.

However, if the products are not luxury goods such as water

service, electricity service, and local telephone service, then the
seller no need to create any advertisement.

This is because a lot of the buyers know that where are the places
and locations to get and purchase these few products.

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 MONOPOLY

Control over
Government material
franchises

Barriers to entry

Cost establishing an Patent and

efficient plant copyright

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 MONOPOLY:
BARRIER TO ENTRY
Normally, monopoly situation in a market can continue only when
other company does not enter into the industry.

In a monopoly market, they have no others competitor because

barriers of enter are very strong. It would be prevent and
discourage to enter this market to be a competitor.

Therefore, a monopoly presents barriers to prevent potential

competitors from entering the market.

The barriers may even be legal in that the firm to take benefit of
copyrights, tariffs and trade restrictions and others.

If want continue the monopoly market should not be no entry for

new firms.
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 MONOPOLISTIC COMPETITION
Monopolistic competition is a market structure in
which a large number of small sellers sell close
substitutes products.
The goods produced and sold are different but they
are close substitutes for each other.
Monopolistic is a combination of perfect competition
and monopoly.
There are many example of this type of market and
some of these are the market for goods such as
toothpaste, soaps, ice-creams, chocolates and others. 24
 MONOPOLISTIC COMPETITION
Large
number of
sellers

Selling cost Differentiated

products
characteristics

Non price Free entry

competition and exit

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 MONOPOLISTIC COMPETITION

A strategy that firms use to achieve

characteristics market power. Accomplished by

producing products that have
Differentiated
products distinct positive identities in
consumers minds.

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 MONOPOLISTIC COMPETITION
The Case Against Product Differentiation and Advertising

Product differentiation and

advertising waste societys scarce
characteristics
resources, argue critics. They say
Differentiated
products enormous sums of money are spent
to create minute, meaningless
differences among products.

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 MONOPOLISTIC COMPETITION
The Case Against Product Differentiation and Advertising

o The bottom line, critics of product differentiation

characteristics
and advertising argue, is waste and inefficiency.

Differentiated o Enormous sums are spent to create minute,

products meaningless, and possibly nonexistent differences
among products.
o Advertising raises the cost of products and frequently contains very little

information. Often, it is merely an annoyance.

o Product differentiation and advertising have turned the system upside down.
People exist to satisfy the needs of the economy, not vice versa. Advertising
can lead to unproductive warfare and may serve as a barrier to entry, thus
reducing real competition.

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FORMULA FOR CALCULATING MONOPOLISTIC
COMPETITION

Total Revenue (TR) = Price x Output

Marginal Revenue (MR) = TR / Q

Marginal Cost (MC) = Total Cost (TC) / Q

Profit = Total Revenue (TR) Total Cost (TC)

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EXERCISE :
Output (Units) Price (RM) Total Cost (RM)
1 50 25
2 35 40
3 30 50
4 28 72
5 22 70
6 18 84

Calculate :
a) Total revenue, marginal revenue, marginal
cost, profit
b) What is the profit maximizing price and
output?
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c) Is the firm realizing economic profits or
losses at profit maximizing output?
ANSWERS :
Output Price Total Total Marginal Marginal Profit
(units) (RM) Cost Revenue Revenue Cost (RM)
(RM) (RM) (RM) (RM)

1 50 25 50 50 25 25
2 35 40 70 20 15 30
3 30 50 90 20 10 40
4 28 72 112 22 22 40
5 22 70 110 2 2 40
6 18 84 108 2 14 24

b) Price = RM22, output = 5 units when MR= MC

c) Profit = TR TC
= 110 70 31

= RM 40
= Economic profit
 OLIGOPOLY
Oligopoly market structure consists of only a few
firms in the industry.

These few firms produce either identical or

differentiated products and entry of any new sellers is
difficult.

If only two firms exist in the market, it is known as a

duopoly.

Examples of this market include the market for

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automobiles, cement, petroleum and others.
 OLIGOPOLY

Few in number
but large in size

Homogeneous or
Barriers to entry Characteristics differentiated
product

Mutual
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interdependence
 OLIGOPOLY MODELS

Because many different types of oligopolies exist, a number of

different oligopoly models have been developed.

All kinds of oligopoly have one thing in common

The behaviour of any given oligopolistic firm

depends on the behaviour of the other firms in the
industry comprising the oligopoly.

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 OLIGOPOLY : CARTEL
Cartel is a group of firms whose objective is to limit the
scope of competitiveness in the market.

A cartel formed by firms that want to eliminate uncertainty

and improve profits by stabilizing market shares and
prices, reduce competitiveness and eliminate promotional
costs.

A cartel agreement is an arrangement among oligopoly

firms to cooperate with each other to act together as a
monopoly.

An ideal cartel will be powerful enough to establish a

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monopoly price and earn supernormal profits.

 OLIGOPOLY : CARTEL

Cartel can be most successful in the oligopoly market

if the following conditions are fulfilled.
1. small number of sellers.

2. similar cost conditions for all sellers.

3. inelastic demand.

4. stability in the industry.

5. product differentiation is minimal.

6. high barriers to entry.

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 OLIGOPOLY : TACIT COLLUSION

Collusion occurs when price and quantity fixing

agreements among producers are explicit.

Tacit collusion occurs when such agreements are

implicit.

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 OLIGOPOLY : COURNOT MODEL

A model of a two-firm industry (duopoly) in which a

series of output adjustment decisions leads to a
final level of output between the output that would
prevail if the market were organised competitively
and the output that would be set by a monopoly.

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 OLIGOPOLY:
PRICE RIGIDITY AND KINKED DEMAND CURVE

The kinked demand curve was introduced by Professor Sweezy to explain

price rigidity in an oligopoly.

Price rigidity explains the bahaviour of an oligopoly firm which has no

incentive to either increase or decrease the price of its products.

The theory of kinked demand is based on two assumption:

1. If an oligopolist reduces its price, firms rivals will follow and

reduce their prices too, so as to avoid losing customers.

2. If an oligopolist increases its price, firms rivals will not

increase their prices but instead maintain the same prices,

thus gaining customer from firm which increase their price.39

 OLIGOPOLY:
PRICE LEADERSHIP MODEL

-
-The largest firm may
Dominant price dominate the overall
leadership industry
Price -can act as a monopoly
leadership
model
- Firm will be the first to
Barometric announce a price change.
price
leadership -firm does not dominate the
industry

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 PRICE AND NON PRICE COMPETITION
PRICE COMPETITION
Exists when the marketers develop different
price strategies to beat the competition
Generally set a same of low price of a product
from competitors

NON PRICE COMPETITION

Focus on the factors other than the price of the
product. Focus on other factors such as features,
quality, service and promotion

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OLIGOPOLY: NON PRICE COMPETITION

If a firm reduce the price of its products, it

can attract customer and establish itself in
Opting for the industry.
Reaction of competitors is quick. They
price cuts reduce their price too. Risk of a price war
whereby customer are better off.

No changes in price.
Opting for non
Reaction of competitors is slow
price competition
and less direct.
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 OLIGOPOLY: GAME THEORY

Analyzes oligopolistic behaviour as a

complex series of strategic moves and
reactive countermoves among rival firms.

In game theory, firms are assumed to

anticipate rival reactions.

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 OLIGOPOLY: GAME THEORY

1. Dominant strategy
In game theory, a strategy that is best no matter
what the opposition does.
2. Prisoners dilemma
A game in which the players are prevented from
cooperating and in which each has a dominant
strategy that leaves them both worse off than if they
could cooperate.
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https://www.youtube.com/watch?v=clZR8ivcSEA
 OLIGOPOLY: GAME THEORY
3. Nash equilibrium
In game theory, the result of all players
playing their best strategy given what
their competitors are doing.
https://www.youtube.com/watch?v=clZR8ivcSEA

4. Maximim strategy
In game theory, a strategy chosen to
maximize the minimum gain that can be
earned. 45

https://www.youtube.com/watch?v=HE_uMiEMSZ4
OLIGOPOLY: REPEATED GAMES

Tit-for-tat strategy
A companys strategy that lets a competitor know
the company will follow the competitors lead.
https://www.youtube.com/watch?v=LSUKFzrfY_o

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Characteristics of Different
Market Organisations

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SUMMARY:
Perfect Monopolistic
Characteristics Monopoly Oligopoly
competition competition
Number of
sellers Large One Many Few

Unique or no Homogenous
Identical or
Type of product close Differentiated or
homogenous
substitution differentiated
Entry condition Very easy Impossible Easy Difficult
Control over
None Some Some Considerable
price
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SUMMARY:
Perfect Monopolistic
Characteristics Monopoly Oligopoly
competition competition
Local phone
Automobiles,
Examples Wheat, corn service, Food, clothing
Cigarettes
electricity
Profit
MR = MC MR = MC MR = MC MR = MC
maximization
Subnormal, Subnormal, Subnormal, Subnormal,
Short run supernormal supernormal supernormal supernormal
equilibrium or normal or normal or normal or normal
profit profit profit profit
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SUMMARY:
Perfect Monopolistic
Characteristics Monopoly Oligopoly
competition competition
Supernormal
Supernormal
Normal profit Normal profit profit
Long run profit because
due to free due to free because of
equilibrium of barriers to
entry and exit entry and exit barriers to
entry
entry
Production
efficiency (at Yes No No No
minimum AC)
SR: AR<AVC SR: AR<AVC SR: AR<AVC SR: AR<AVC
Shut down
LR: AR< AC LR: AR< AC LR: AR< AC LR: AR< AC
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KEY TERMS:

Term Definition
An institution that buys factors of production and
A firm organizes them to produce and sell goods and
services.
A place where buyers and sellers meet to make
Market
transactions.

Number of and distribution size of buyers and

Market structure
sellers in the market for goods and services.

No single seller can influence the market price of

Price taker
good.
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KEY TERMS:
Term Definition

Homogenous A product where buyers cannot differentiated in

product terms of quality, packaging or labeling.

An industry A group of firms producing identical goods.

Supernormal
TR > TC
profit

Subnormal
TC> TR
profit

Normal profit TR=TC

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KEY TERMS:

Term Definition

Shut down point Point where the AVC is equal or higher than AR.

Price maker Power to control the price in the market.

Monopolistic Large number of small sellers selling different

competition product with close substitutes.

Price rigidity No incentive to increase or decrease the price.

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KEY TERMS:
Term Definition
A demand curve an oligopolist faces which
Kinked demand
assumes that rivals will match a price cut but
curve
ignore a price increase.

A few firms in the industry producing either

Oligopoly
identical or differentiated products.

A pricing strategy in which the firms in an

Price leadership oligopoly industry follow the price set by the lead
firm.
A group of firms whose objective is to limit the
Cartel
scoop of competitiveness in the market.
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