Market

Structure-I
Unit Contents
• Market Structure and Degree of Competition
• Perfect competition
• Monopoly
• Monopolistic Competition
 Market Structure and Degree of
Competition
• Economists have classified market on the basis of degree of competition.
• Thus, the market classified on the basis of competition is termed as market
structure.
• Dominick Salvatore, "Market structure refers to the competitive environment
in which the buyers and the sellers of the product operate.”
• There are four market structures that are usually identified. They are perfect
competition at one extreme, monopoly at the opposite extreme and
monopolistic competition and oligopoly in between.
• Monopolistic competition and oligopoly are known as imperfect
competition.
• The types of market structures are defined in terms of number of firms,
control over price, type of product, entry barriers and non-price competition.
Basic Differences of Various Market Structures
a. Number of Firms
• There are different types of market structure on the basis of number of firms. In monopoly, there is
a single firm whereas there are few firms under oligopoly.

• Similarly, there is large number of firms under perfect competition and monopolistic competition.

b. Control over Price

• Market structure can be classified on the basis of capacity of firm's control over price.
• In perfect competition, firms have no control over price so that they are price takers.
• In monopoly, a firm has complete control over price and supply of output, hence it is price maker.
• In monopolistic competition and oligopoly, there is some control over price, i.e., the capacity of
controlling price in these market structures is less than a monopolist and greater than that of a
perfectly competitive firm.

c. Type of Product
• The firm under perfect competition produce homogeneous product whereas differentiated products
are produced in monopolistic competition.
• Similarly, a monopolist produces unique product and firms under oligopoly produces homogeneous
or differentiated products.
Basic Differences of Various Market Structures (Contd..)
d. Entry
• A market can be classified on the basis of easy entry or not for the firm.

• In monopoly, there are strong barriers for new firms to enter the market.

• In oligopoly, existing firms use policies and strategies in such a way that they prevent entry
of new firms.

• In perfect competition and monopolistic competition, there is free entry of new firms.

e. Non-price Competition

• In perfect competition, there is no possibility of non-price competition because all firms sell
homogeneous products at constant price.

• In monopoly, the firm advertises in order to provide information and increase market
demand.

• In oligopoly and monopolistic competition, firms compete with each other through
advertisement.
 Determinants & Features of Market Structure

Market Number of Control over Barrier Non-price

Type of product
Structure sellers price to entry competition

Perfect
Many Homogeneous No No No
competition

Monopolistic
Many Differentiated Partial No Advertisement
competition
Homogeneous
Oligopoly Few or Partial High Advertisement
Differentiated

Unique Very
Monopoly One Considerable Advertisement
production High

5
 Perfect
Competition
Introduction
• Perfect competition is a market structure in which there are many buyers and
sellers selling homogeneous (identical) products and there is free entry and exit of
firms.
• In other words, perfect competition is a market situation in which firms have no
control over the supply of their output. This implies that firms are price takers i.e.
price is determined by the opposite forces of market demand and supply.
• Perfect competition exists if the firms have no market power. Market power is the
ability of firm to influence price and output in the market.
• It is a market structure in which there is no rivalry among the existing firms. It is
because there is no possibility of price and quality war.
• Due to constant price in the market, the demand curve of an individual firm is horizontal
such that Q P TR(=P.Q) MR
P = MR
0 10 0 -
1 10 10 10
2 10 20 10
3 10 30 10
For equilibrium under perfect competition,

MR = MC

Hence , P = MC at equilibrium which indicates that perfect competition is an ideal

situation where total surplus is maximum (there is no possibility of Deadweight Loss).
Since price is given, the level of output to be supplied by the firm is determined by the MC
curve. Hence, MC curve works as the supply curve for the firm.
 Price and Output Determination
a. Short-run Equilibrium
Price C,R,P C,R,P C,R,P
D S
MC MC AC
MC
AC
c d
P
e P e1 AC
P e1 P
AR=MR AR=MR e1AR=MR
b a
S D
O Q O Q1 Output O Q1 Output O Q1 Output
Output
Industry Firm Firm Firm
Excess/Positive Normal/ Zero Loss
Economic Profit Economic Profit (P<AC)
(P>AC) (P=AC)
b. Long-run Equilibrium
• Due to free entry and exit, a firm always enjoys zero economic profit or normal profit(P=
AC) in the long-run.
• Even if economic profit is zero, firms stay in business because they are not only able to
cover their accounting cost but they are able to cover their opportunity cost as well.

Price C,R,P At equilibrium point e,

i. P= MC : No Deadweight Loss (T.S. is
S maximum)
LMC ii. P = minimum AC : Consumers pay
LAC the least possible price
e e1 iii. Firm operates at minimum point of
P AC which implies that there is no
P
AR = excess capacity or there is full
MR utilization of resources.
Hence , perfect competition is an
ideal market situation.
D
O Q Outpu O Q1 Outpu
Industry t Firm t
(Normal Profit)
Shut down Vs. Exit of Firms
Shut down
• Shut down is a temporary decision of a firm to postpone the production
and supply of output due to unfavorable market condition.
• The condition for shut down is P < AVC
• The firm that shuts down has to bear fixed cost, not variable cost.
Exit
• Exit is a permanent decision of the firm to leave the market .
• The condition for exit is P < AC
• The firm that exits does not have to bear any cost(fixed or variable).
 Monopoly
Introduction
• The term ‘monopoly’ is derived from two Greek words-mono meaning single and
poly meaning seller.
• Monopoly is a market structure in which there are many buyers and a single seller
selling product that has no close substitutes and there are strong barriers to entry.
• Three main causes or sources of monopoly:
i. Ownership of strategic raw materials by a single firm
ii. Patent right ( an exclusive right provided by the government to innovating or
inventing firm to work as a monopolist for a specific period of time.)
iii. Natural monopoly ( if a single firm is capable of supplying the entire market
demand at lower cost than other several firms, it is the case of natural monopoly. Due
to huge economies of scale, the LAC declines rapidly as the firm expands output.)
• Monopoly is a market situation in which a single firm has complete
control over the supply of its output.
• This implies that monopolist enjoys the highest degree of market
power . In other words, monopolist is a price maker or price setter.
• The market demand curve is the demand curve of the monopolist, i.e.
the demand curve of the monopolist is downward sloping.
• Since the demand curve is downward sloping, P > MR at each level of
output sold, i.e. the MR curve lies below the demand curve.
 Monopoly and Deadweight Loss
• The equilibrium under monopoly takes place when MR = MC.
• Thus P > MC at equilibrium which leads to the creation of Deadweight
Loss(DWL) as shown by the diagram that follows:
C, R, P
MC
DWL

PM ec
P >MC D
MC eM

MR

Q
O Qe Qc

Underproduction Socially optimum output

 Price and Output Determination under
Monopoly
a. Short-run Equilibrium
C,R,P C,R,P C,R,P
MC MC
AC
AC
B
MC C
Pe A
A
A Pe
Pe AC

B e
C e
e

AR (=D) AR (=D)
AR (=D)
MR MR MR
O Qe Output O Qe Output O Qe Output
Excess Profit Loss Normal Profit
(P>AC) (P <AC) (P=AC)
b. Long-run Equilibrium
Due to single firm and strong barriers to entry, a monopolist always enjoys
excess or positive economic profit in the long-run.
C, R, P Excess
profit
MC
AC
PM

D
eM
MR
Q
O QM
Price Discrimination
• Price discrimination is a business practice of selling same product at
different prices to different customers.
Examples of price discrimination
• Nepal Electricity Authority (NEA) charges two types of prices for same
electricity at household and industry.
• Different prices for cinema hall tickets according to seat arrangements.
• Airlines company charges higher prices for business class tickets and lower
prices for economy class tickets.
• Differences in public transportation fares.
 Conditions/ Possibilities of Price
Discrimination
1. Market Power
• The firm must possess some degree of monopoly or market power, i.e. it
must have some ability to control output and price in the market.
2. Market Segmentation
• The firm must be able to separate markets on the basis of price elasticities of
demand.
• Basic idea: Higher elasticity, lower price and lower elasticity, higher price.
3. No Resale
• The original purchasers cannot resell the product or service.
• If buyers in the low-price segment of market could easily resell in high price
segment , the strategy of monopolist’s price discrimination would be a failure.
 Degrees of Price Discrimination
i. Price Discrimination of the First Degree
• Price discrimination of the first degree is said to occur when the
monopolist is able to sell each separate unit of the product at a different
price.
• In other words, whole consumer’s surplus is taken by the monopolist.
• Thus, there is no hope for bargain left to the consumers and no discounts
provided by the seller.(“Take it or leave it situation”)
• Price discrimination of the first degree is also known as “perfect price
discrimination” because this involves maximum possible exploitation of
each buyer in the interest of the seller’s profits.
ii. Price Discrimination of the Second Degree
• Price discrimination of the second degree is said to occur when the quantities
of the commodity are divided into different groups and prices are charged
according to the groups.
• Some discount is provided to the consumers.
• Under it, some part of the consumer’s surplus is taken by the seller and some
part is left to the consumers.
• Wholesale and retail markets are the examples of this type of price
discrimination.
iii. Price Discrimination of the Third Degree
• Price discrimination of the third degree is said to occur when the total
market is divided into sub-markets on the basis of differences in price
elasticity and prices are charged accordingly.
• The basic philosophy is that higher the elasticity, lower will be the price
charged and lower the elasticity, higher will be the price charged.
• If the company is able to discriminate prices on the basis of differences in
price elasticity, its revenue or profit will be higher than the revenue or profit
at the uniform price.
• Airlines ticketing practice ( business class and economy class) can be an
example of this type of price discrimination.
Equilibrium under Third Degree Price Discrimination

Let there are two sub-markets(1 and 2 )for the same product of a
monopolist. Since the cost is identical , we consider same MC for each
market. However, demands being different according to differences in price
elasticities, we have two MRs (MR1 and MR2).
In this context,
For equilibrium in the first market,
MC = MR1
For equilibrium in the second market,
MC = MR2
Monopolistic Competition
Introduction
• Monopolistic Competition is a blend of monopoly and perfect competition.
• Monopolistic competition is a market structure which has the following
characteristics:
 Large number of buyers and sellers.
 Differentiated products, yet close substitutes of each other.
 Free entry and exit of firms.
• Due to differentiated products, firms are able to make their product unique in
the minds of consumers. This implies that firms are able to enjoy certain
degree of monopoly power through product differentiation.
• Hence, the demand curve faced by the firm is downward sloping like that of
monopoly with P> MR at each level of output.
 Price and Output Determination
a. Short-run Equilibrium
C,R,P C,R,P C,R,P
MC MC
AC
AC
B
MC C
Pe A
A
A Pe
Pe AC

B e
C e
e

AR (=D) AR (=D)
AR (=D)
MR MR MR
O Qe Output O Qe Output O Qe Output
Excess Profit Loss Normal Profit
(P>AC) (P <AC) (P=AC)
b. Long- run Equilibrium
A firm under monopolistic competition earns zero economic profit or
normal profit due to free entry and exit of firms.

C,R,P
MC
AC
PM

eM
D

MR
O QM Q
“Despite earning zero economic profit in the long-run,
monopolistic competition is undesirable as compared to
perfect competition.”(Why monopolistic competition is
undesirable?)
C,R,P C,R,P
MC MC
AC
AC PM

PC
eC
MR/ D
Mark-up { MC eM
D

MR
O QC Q O QM Q

1. Mark-up of Price over Cost 2. Excess Capacity

• Perfect Competition : at equilibrium: P = MC : • Perfect Competition: Firm operates at minimum point of
No mark-up: No DWL AC which implies that there is full utilization of resources,
• Monopolistic Competition: at equilibrium: i.e. there is no excess capacity.
P>MC: there is mark-up : Creation of DWL • Monopolistic Competition : Firm operates at the falling
portion of AC which implies that there is excess capacity or
there is underutilization of resources.
Thank You!