CHAPTER FIVE

Market Structures

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 Presentation Outline
5.1. The concept of market in physical and
digital space
5.2. Perfectly competitive market
5.2.3 Short run equilibrium of the
industry
5.3. Monopoly market
5.3.2. Sources of monopoly
5.4. Monopolistically competitive market
5.5. Oligopoly market
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5.1. The concept of market in physical
and digital space

 According to American Marketing

Association (1985), market is the process of
planning & performing the conception,
pricing, promotion, & distribution of goods,
services and ideas to create exchanges that
satisfy individual and organizational
objectives.
 So market describes place or digital space by
which goods, services and ideas are
exchanged to satisfy consumer need.
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 Cont’d…
 Digital marketing is the marketing of goods & services using
digital technologies, mainly on the internet but also including
mobile phones, display advertising, & any other digital media.
 Digital marketing channels are systems on the internet that
can create, accelerate & transmit product value from
producer to the terminal consumer by digital networks.
 Physical market is a set up where buyers can physically meet
their sellers & purchase the desired merchandise from them
in exchange of money.
 In this market, marketers will effortlessly reach their
target local customers & thus they have more personal
approach to show about their brands.
 The choice of the marketing mainly depends on the nature
of the products and services.

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 5.2. Perfectly competitive market

 Perfect competition is a market structure in w/c

competition is at its greatest possible level.
5.2.1 Assumptions of perfectly competitive market
1. Large number of sellers and buyers: Implies, no
single seller can influence the market price by changing
the quantity supply.
• Similarly, the number of buyers is so large that the
share of each buyer in the total demand is very small
& that no single buyer or a group of buyers can influence
the market price by changing their individual or group
demand for a product.
• Sellers and buyers are price takers, i.e., the price is
determined by the interaction of the market supply &
demand forces.
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 Cont’d…
2. Homogeneous product: implies that buyers do not
distinguish between products supplied by the various
firms of an industry.
• Product of each firm is regarded as a perfect substitute
for the products of other firms. >>>Therefore, no firm
can gain any competitive advantage over the other firm.
3. Perfect mobility of factors of production: factors of
production are free to move from one firm to another
throughout the economy.
• This means that labor can move from one job to another
& from one region to another.
Capital, raw materials, and other factors are not
monopolized.

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 Cont’d…
4. Free entry and exit: there is no restriction or market
barrier on entry of new firms to the industry, and no
restriction on exit of firms from the industry. A firm may
enter the industry or quit it on its accord.
5. Perfect knowledge about market conditions: all the buyers
and sellers have full information regarding the prevailing and
future prices and availability of the commodity.
6. No government interference:- government does not
interfere in any way with the functioning of the market.
There are no discriminator taxes or subsidies, no allocation
of inputs by the procurement, or any kind of direct or
indirect control.
• That is, the government follows the free enterprise policy.
Where there is intervention by the government, it is intended
to correct the market imperfection.
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 Cont’d…
 In a perfectly competitive market at
the market price, the firm can supply
whatever quantity it would like to sell.
Once the price of the product is
determined in the market, the producer
takes the price.
 Hence, the demand curve that the firm
faces in this market situation is
 a horizontal line drawn at the
equilibrium price, Pm.
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PRICE =MR= AR=DEMAND

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Short run equilibrium of the firm
 The main objective of a firm is profit
maximization. If the firm has to incur a loss, it aims
to minimize the loss.
 Profit is the difference between total revenue and
total cost.
 Total Revenue (TR): it is the total amount of money
a firm receives from a given quantity of its product
sold.
 It is obtained by multiplying the unit price of the
commodity and the quantity of that product sold.
 TR=P*Q, where P = price of the product Q = quantity
of the product sold.

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 Cont’d….
 Average revenue (AR):- it is the revenue per
unit of item sold. It is calculated by dividing the
total revenue by the amount of the product sold.
AR = TR/Q = P.Q/Q =>AR = P Therefore, the firm‘s
demand curve is also the average revenue curve.
 Marginal Revenue: it is the additional amount of
money/ revenue the firm receives by selling one
more unit of the product.
 In other words, it is the change in total revenue
resulting from the sale of an extra unit of the
product.
 It is calculated as the ratio of the change in total
revenue to the change in the sale of the product.
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Cont’d…

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 Since the purely competitive firm is a price
taker, it will maximize its economic profit only
by adjusting its output. In the short run, the
firm has a fixed plant.
 Thus, it can adjust its output only through
changes in the amount of variable resources. It
adjusts its variable resources to achieve the
output level that maximizes its profit.
 There are two ways to determine the level of
output at which a competitive firm will realize
maximum profit or minimum loss.
 One method is to compare total revenue and
total cost; the other is to compare marginal
revenue and marginal cost. 13
 Cont’d…
A. Total Approach (TR-TC approach) In this
approach, a firm maximizes total profits in the short
run when the (positive) difference between total
revenue (TR) and total costs (TC) is greatest.

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 Note: The profit maximizing output level is Qe b/c
it is at this output level that the vertical distance
b/n the TR and TC curves (or profit) is maximized.
B. Marginal Approach (MR-MC): In the short run,
the firm will maximize profit or minimize loss by
producing the output at w/c marginal revenue
equals marginal cost.
 More specifically, the perfectly competitive firm
maximizes its short-run total profits at the output
 when
MR =the
MCfollowing two conditions are met:
 The slope of MC is greater than slope of MR; or
MC
 is rising).
 MR = MC (that is, slope of MC is greater than
zero).
  The slope of MC is greater than slope of MR; or
MC is rising). (that is, slope of MC is greater than
zero). 15
Mathematically derivation Profit of
perfectly competitive firm

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 Cont’d…
 Therefore, Slope of MC > slope of MR -------
Second order condition (SOC)
 Slope of MC > 0 (because the slope of MR is
zero)
 Graphically, the marginal approach can be
shown as follows.

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 Cont’d…
 The profit maximizing output is Qe , where
MC=MR and MC curve is increasing.
 At Q*, MC=MR, but since MC is falling at this
output level, it is not equilibrium output.
 Whether the firm in the short- run gets
positive or zero or negative profit depends on
the level of ATC at equilibrium.
 Thus, depending on the r/nship b/n price and
ATC, the firm in the short-run may earn
economic profit, normal profit or incur loss
and decide to shut-down business.
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 Cont’d…

I) Economic/positive profit - If the AC is below the

market price at equilibrium, the firm earns a positive
profit equal to the area between the ATC curve and the
price line up to the profit maximizing output.
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 Cont’d…

II)Loss - If the AC is above the market price at

equilibrium, the firm earns a negative profit (incurs
a loss) equal to the area between the AC curve and
the price line.
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 Cont’d…

III) Normal Profit (zero profit) or break- even

point - If the AC is equal to the market price at
equilibrium, the firm gets zero profit or normal profit.

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IV) Shutdown point - The firm will not stop production simply
because AC exceeds price in the short-run.
>>>The firm will continue to produce irrespective of the existing loss
as far as the price is sufficient to cover the average variable
costs. This means, if P is larger than AVC but smaller than AC, the
firm minimizes total losses. But if P is smaller than AVC, the firm
minimizes total losses by shutting down. Thus, P = AVC is the
shutdown point for the firm.
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Example: Suppose that the firm operates in
a perfectly competitive market. The market
price of its product is $10. The firm
estimates its cost of production with the
following cost function: TC=2+10q-4q2 +q3
A) What level of output should the firm
produce to maximize its profit?
B) Determine the level of profit at
equilibrium.
C) What minimum price is required by the
firm to stay in the market?
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 Exercises

A firm operates in a perfectly competitive

market. The market price of its product is 4
birr and the total cost function is given by
, where TC is the
total cost and Q is the level of output.
a) What level of output should the firm
produce to maximize its profit?
b) Determine the level of profit at equilibrium.
c) What minimum price is required by the firm
to stay in the market?

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 5.2.3 Short run equilibrium of the
industry
 Since the perfectly competitive firm always
produces where P =MR=MC (as long as P
exceeds AVC), the firm‘s short-run supply
curve is given by the rising portion of its MC
curve above its AVC, or shutdown point.
 The industry/market supply curve is a
horizontal summation of the supply curves of
the individual firms.
 Industry supply curve can be obtained by
multiplying the individual supply at various
prices by the number of firms, if firms have
identical supply curve. 25
 Short run equilibrium of the
industry
 An industry is in equilibrium in the
short-run when market is cleared at a
given price i.e. when the total supply of the
industry equals the total demand for its
product, the prices at which market is
cleared is equilibrium price.
 When an industry reaches at its
equilibrium, there is no tendency to expand
or to contract the output.
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 5.3. Monopoly market
5.3.1. Definition and characteristics
 This is at the opposite end of the spectrum of market
structures. Pure monopoly exists when a single firm is
the only producer of a product for w/c there are no
close substitutes. The main characteristics of this
market structure include:
1. Single seller: A pure or absolute monopoly is a one
firm industry.
>>A single firm is the only producer of a specific product
or the sole supplier of the product; the firm &the
industry are synonymous.
2. No close substitutes: the monopolist‘s product is
unique in that there are no good or close substitutes.
From the buyer‘s view point, there are no reasonable 27
3. Price maker: the individual firm exercises a
considerable control over price b/c it is responsible
for, & therefore controls, the total quantity supplied.
>>> Confronted with the usual down ward sloping
demand curve for its product, the monopolist can
change product price by changing the quantity of the
product supplied.
4. Blocked entry: A pure monopolist has no
immediate competitors b/c there are barriers, w/c
keep potential competitors from entering in to the
industry.
>>>These barriers may be economic, legal,
technological etc.
Under conditions of pure monopoly, entry is totally
blocked. 28
 5.3.2. Sources of monopoly
 The emergence & survival of monopoly is attributed
to the factors w/c prevent the entry of other
firms in to the industry. The barriers to entry are
therefore the sources of monopoly power. The
major sources of barriers to entry are:
I) Legal restriction: Some monopolies are created by
law in public interest.
 Such monopoly may be created in both public and
private sectors.
 Most of the state monopolies in the public utility
sector, including postal service, telegraph,
telephone services, radio and TV services,
generation and distribution of electricity, rail ways,
airlines etc… are public monopolies. 29
 II) Control over key raw materials:
Some firms acquire monopoly power
from their traditional control over
certain scarce & key raw materials that
are essential for the production of
certain other goods.
 For example, Aluminum Company of
America had monopolized the aluminum
industry b/c it had acquired control
over almost all sources of bauxite
supply; such monopolies are often called
raw material monopolies. 30
III) Efficiency: a primary & technical reason
for growth of monopolies is economies of scale.
• The most efficient plant (probably large size
firm,) w/c produces at minimum cost, can
eliminate the competitors by curbing down its
price for a short period and can acquire
monopoly power. Monopolies created through
efficiency are known as natural monopolies.
IV) Patent rights: Patent rights are granted
by the gov’t to a firm to produce commodity of
specified quality & character or to use specified
rights to produce the specified commodity or to
use the specified technique of production. Such
monopolies are called to patent monopolies. 31
 5.4. Monopolistically competitive
market
 This market model can be defined as the market
organization in w/c there are relatively many firms selling
differentiated products. It is the blend of competition
and monopoly.
 The competitive element arises from the existence of
large number of firms & no barrier to entry or exit. >>The
monopoly element results from differentiated products,
i.e. similar but not identical products.
 A seller of a differentiated product has limited monopoly
power over customers who prefer his product to others.
 His monopoly is limited b/c the d/c b/n his product &
others are small enough that they are close substitutes
for one another. This market is characterized by:
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I) Differentiated product: the product produced and
supplied by many sellers in the market is similar but
not identical in the eyes of the buyers. There is a
variety of the same product. The difference could
be in style, brand name, in quality, or others.
<>Hence, the differentiation of the product could be
real (eg. quality) or fancied (e.g. difference in packing,
disgne).
(II) Many sellers and buyers: there are many sellers
and buyers of the product, but their number is not as
large as that of the perfectly competitive market.
(III) Easy entry and exit: like the PCM, there is no
barrier new firms that are willing & able to produce &
supply the product in the market. On the other hand, if
any firm believes that it is not worth to stay in the
business, it may exit. 33
 (iv) Existence of non-price competition:
Economic rivals take the form of non-price
competition in terms of product quality,
advertisement, brand name, service to
customers, etc.
 A firm spends money in advertisement to reach
the consumers about the relatively unique
character of its product & thereby get new
buyers & develop brand loyalty.
 Many retail trade activities such as clothing,
shoes, soap, etc are in this type of market
structure.
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 5.5. Oligopoly market
This is a market structure characterized by:
 Few dominant firms: there are few firms
although the exact number of firms is undefined.
Each firm produces a significant portion of the
total output.
 Interdependence: since few firms hold a
significant share in the total output of the
industry, each firm is affected by the price &
output decisions of rival firms. Therefore, the
distinguishing characteristic of oligopoly is the
interdependence among firms in the industry.
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Entry barrier: there are considerable obstacles
that hinder a new firm from producing and
supplying the product. The barriers may include
economies of scale, legal, control of strategic
inputs, etc.
 Products may be homogenous or
differentiated. If the product is homogeneous, we
have a pure oligopoly. If the product is
differentiated, it will be a differentiated oligopoly

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 Lack of uniformity in the size of firms: Firms
differ considerably in size. Some may be small,
others very large. Such a situation is
asymmetrical.
 Non-price competition: firms try to avoid price
competition due to the fear of price wars & hence
depend on non-price methods like advertising,
after sales services, warranties, etc.
This ensures that firms can influence demand and
build brand recognition.
>> A special type of oligopoly in which there are
only two firms in the market is known as duopoly.
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 End Of Chapter Five
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