Lecture 4

Perfect competition,
MARKET Monopoly,
monopolistic

STRUCTURE competition and

oligopoly

Reading:
Sloman and Garratt,
chapter 6

ECN1014 Prepared by:

Dr. Bawani
INTRODUCTORY Lelchumanan & Dr.
ECONOMICS Chong Poh Ling (DEF,
SBS)
Market Structure
Market: is a place where the buyers and sellers meet one
another to transact business.
Market Structure: a set of market characteristics such as
number of firms, ease of firm entry and substitutability
of goods.
Market Structure
Perfect/Pure
Competition

Monopoly
Market Structure
Monopolistic
Competition

Oligopoly
Perfect/Pure Competition
A theory of market structure based on 5 assumptions/characteristics:
1. Large number of sellers and buyers
The quantity a single seller sells in a market is so small compared to the
overall industry. No one can influence the market price of goods.
2. Homogenous product
All the firms in a perfect competition will sell identical/ homogeneous
products. Buyers cannot distinguish products between firm A’s product
and firm B’s product.
3. Free entry and exit
There are no barriers/ restriction on the entry of new firms to the
industry or the exit of firms
Perfect Competition
4. Perfect knowledge of the market
Buyers and sellers have all relevant information about prices, product
quality, sources of supply, and so forth. – they know everything that
relates to buying, producing and selling of product.

5. Price Takers
Price taker: is a seller that does not have the ability to control the
price of the product it sells. It takes the price determined in the
market.
Perfect Competition
Perfect competition assumption closely met in some
industries:
Agricultural market - Wheat market, vegetables, meat, etc.
Perfect Competition: Price
Determination
When the equilibrium price has been established, a single perfectly
competitive firm faces a horizontal demand curve at the equilibrium
price.
Perfect Competition: Price
Determination
If a perfectly competitive firm tries to charge a price
higher than the market-established equilibrium price, it
won’t sell any of its product.
If the firm wants to maximize profits, it will not sell its
good at a price lower than Pe.
The equilibrium price, Pe, is the only relevant price for
the perfectly competition firms.
Perfect Competition: Short- Run
Equilibrium
A firm will maximize profit at a point where the marginal revenue
is equal to marginal cost.
The firm’s marginal revenue (MR) is the change in total revenue
that results from selling one additional unit of output.
 Perfect Competition: Short- Run Equilibrium

Remember!
MR curve
Column 4: is
The firm’s MR is RM5 at any output level. horizontal
at
It is equal to the equilibrium price, RM5 equilibrium
(column 1) /market
price.
P = MR
 Perfect Competition: Short- Run
Equilibrium
For the perfectly competition firm, the profit maximization
rule is:
P= MR = MC = DD
 SHORT-RUN EQUILIBRIUM OF
INDUSTRY AND FIRM UNDER
PERFECT COMPETITION
Firm is a price taker. Price is
given by the market.

P £
S MC AC

D = AR
Pe AR
AC = MR

D
O O Qe
Q (millions) Q (thousands)

(a) Industry (b) Firm

LOSS MINIMISING UNDER PERFECT
COMPETITION

Loss is minimised where

MC = MR.
P £ AC
S MC

AC
D1 = AR1
P1 AR1
= MR1

D
O O Qe
Q (millions) Q (thousands)

(a) Industry (b) Firm

PERFECT
COMPETITION

Long-run equilibrium of the firm

 all supernormal profits competed away
 LRAC = AC = MC = MR = AR
Perfect Competition: Long Run
Equilibrium
All inputs are variables in the LR.
All firms will be in equilibrium when the LR MC = LR MR.
Monopoly

The theory of monopoly is built on 4 assumptions/characteristics:

1. There is one seller
The difference between a firm and an industry does not exist in a
monopoly since there is only one seller.
The monopolist is a firm as well as an industry in itself.
2. Product has no close substitute
Monopolist sell unique product.
 Monopoly

3. Restriction on the entry of new firms

In is very hard and impossible to enter the industry.
A monopolist faces no competition because of barriers to entry.

4. Price searcher
A monopolist is a price searcher.
Price searcher: a seller that has the ability to control to some degree
the price of the product it sells.
 Monopoly: Barriers to Entry
4 types of barriers to entry:

1. Control over raw material

existing firms may be protected from entry of new firms by the
exclusive ownership of a resource needed to enter the industry.
DeBeers, company in South Africa controls more than 80% of the
world’s production of raw diamonds.

2. Patent and copyright:

Patent: exclusive right to the production of an innovative product.
Copyright: exclusive right to the author of a book or composer of a
music
 Monopoly: Barriers to Entry

3. Cost of establishing an efficient plant (economies of scale)

The case of a natural monopoly. Exists when one firm can meet the
entire market demand at a lower price as compared to two or more
firms.
Examples: utility companies such as water, and electricity.

4. Government Franchise/Licenses: a right granted to a firm by

government that permits the form to provide a particular good or
service and excludes all others from doing the same.
Government licenses: entry into some industries and corporation
require government-granted license. Example: Radio and TV Stations
Monopoly: Demand Curve
Since there is only one producer in a monopoly, the firm’s demand
curve represents the industry’s demand curve.
The demand curve for the output of a monopoly is downward sloping.
Monopoly: Short-run Equilibrium
Profit maximization rule:
- produce the quantity of output at which MR= MC
to maximize profit, monopolist charge the highest
price per unit at which this quantity of output can be
sold.
P > MR
 Monopoly: Short Run Equilibrium

The monopolist produces the

quantity of output (Q1) at which
MR = MC, and charges the highest
price per unit at which the quantity
of output can be sold (P1).

Notice that at the profit

maximizing quantity of output,
price is greater than marginal cost,
P > MC.
Monopoly: Short-Run Equilibrium
Monopoly: Long Run Equilibrium
Long run is the time period in which the firm can adjust its input used in
production. In the long run, a monopolist will only earn positive
/supernormal profit.
MONOPO
LY
Disadvantages of monopoly
 high prices
 lack of incentive to innovate

Advantages of monopoly
 economies of scale
 profits can be used for investment
 stability of price
Regulation of Monopoly

i. deregulate industry to encourage competition

ii. impose price ceiling on the products
Monopolistic Competition
Characteristics:
1. Large number of sellers. Although large number of firms exist in a
monopolistic competition market but it is less than perfect competition. A
combination of perfect competition and monopoly.
2. Differentiated products. Differentiation of the product may be through the
packaging, design, labeling, advertising and brand names. sell close substitute
products. Examples: markets for goods such as shoes, books, ice creams, 3 in 1 instant
coffee, etc.
3. Free entry and exit.
4. Non-price competition. The producers uses various methods to attract
customers to buy a particular brand. Types of non-price competition practices:
advertisements, promotions, free-gifts and others.
5. Price searcher.
Monopolistic Competition: Demand Curve
Demand curve is downward sloping, unlike perfect competition where it is
horizontal.
The demand curve facing the monopolistic competitive firm is more elastic
than the demand curve facing the monopoly seller.
Monopolistic Competition: SR Equilibrium
The firm is in equilibrium where MC = MR
 Monopolistic Competition: LR Equilibrium
The firm is in equilibrium where MC = MR
Because of easy entry into the industry, there
are likely to be zero economic profits in the
long run for a monopolistic competitor. In
other words, P=ATC at point A.
Oligopoly
A theory of market structure based on four assumptions
1. Few in number but large in size. In an oligopoly, there are only few
firms in the industry but the size of the firm is large. The marker share of
each firm is large enough to dominate the market.
2. Because of small number of producers, oligopolistic firms tend to have
considerable market power.
3. Homogenous or differentiated product. For example, in Malaysia,
petroleum and automobiles are in an oligopoly market. If products are
differentiated, then the firms are likely to engage in non-price competition
through heavy advertising.
Oligopoly
4. Mutual interdependence. The firms in an oligopoly always consider the
reaction of their rivals when choosing the price, sales target, advertising
budgets and other business policies.
5. Barriers to entry. The firms in an oligopoly will restrict new entrants into
the market. The types of barriers to entry are economies of scale, ownership
of patents and others.

Examples of oligopolistic industries:

 Car manufacturing
 Banking and financial services
 Oil production
 Telecommunication
OLIGOPOLY AND
STRATEGIC BEHAVIOUR
Remember that within an oligopolistic market is
composed of a few large sellers which are highly
interdependent on each other.
The commercial decision made by one firm can affect
the profitability or survival of other firms.
 Collusive oligopoly: should they collude and cooperate?
 Non-collusive oligopoly: should they cheat and compete?
 Collusion is better than competition.
 Competition tends to reduce industry profit.
COLLUSIVE
OLIGOPOLY
As firms are mutually interdependent, they may
wish to collude with each other and act as if they
were a monopoly and jointly maximise industry
profits.
NON-COLLUSIVE
OLIGOPOLY: BREAKDOWN
OF COLLUSION
There is no guarantee that collusive arrangements
can be maintained indefinitely.
As long as each firm’s commercial interests are
concerned, there is always a tendency to ‘cheat’ by
 Cutting prices below the agreed level
 Raising production above the agreed quota

Once a collusive agreement is breached by the

‘cheating firm’, other firms will do the same in
retaliation, thus resulting in price-wars and
competition.
Oligopoly: Price Leadership Model
Price leadership means a pricing strategy in which the firms in an oligopoly
industry follows the price set by the lead firm.
Dominant price leadership: the largest firm may dominate the overall
industry. The leader is able to keep its costs low.
Barometric price leadership: one firm will be the first to announce a price
change. Its price will be followed by others.