Market-Structure

Market Structure
Market: Education market – interactions between buyers and sellers
Market for a certain product
1. Perfect Competition
Characteristics:
(a) Many buyers and many sellers [Rice, Potatoes, raw sugar, vegetables]
(b) The product is homogeneous (identical in every respect)
(c) Buyers and sellers are price takers [a buyer can by any amount at the existing price, so is the
case with a seller]
(d) Full information about the market by buyers and sellers
(e) Perfect mobility of factors of production
(f) Entry of new firms is free, so is the exit of an old firm
2. Monopoly (No Competition at All)
Characteristics:
(a) Only one seller (buyers can be many) [Electricity supply, WASA, Railway]
(b) The product is homogeneous ( a unique product)
(c) The producer can be a price setter
(d) Entry of new firms is BLOCKED
3. Monopolistic Competition (Imperfect Competition)

Characteristics:
(a) Many small sellers none having an absolute control of the market [Potato chips, fast food]
(b) The product is differentiated (heterogeneous) but a close substitute of the rest in the group
(c) The producer can be a price setter
(d) Entry of new firms is unrestricted
4. Oligopoly [Imperfect Competition]

Characteristics:
(a) A few sellers with one or two having greater control of the market [mobile phone service
providers, cooking gas, steel products, cement]
(b) The product can be homogeneous or differentiated
(c) The producer can set the price
(d) Entry of new firms is restricted
5. Output Decision by a Firm in Perfect Competition
MR=MC
P, AC, MC, MR
MC AC
S
P1 S1 P C D=AR=MR=P
P2 PROFIT > 0
AC
Q Q1 Industry Q* Firm
Figure 1
Condition for Equilibrium: MR = MC (P=MC) (AR = MC)
P = 50, AC = 30 Profit per unit = 20 If Q* = 500, total profit = 20x500=10,000
TR=P.Q=50*500=25,000
TC=AC.Q=30*500=15,000
Profit=TR-TC=25,000-15,000=10,000
AC = 30 = 5(rent)+10(wage)+10(interest)+5(remuneration to the entrepreneur)
In Figure 1, P > AC ((P – AC)>0): Abnormal or supernormal profit (as the firm is making more profit than
expected. In other words, AC includes accounting profit. Therefore, P=AC still indicates positive
accounting profit). This is a short-run situation.
If P = AC: Profit per unit = 0 (Normal Profit = Economic Profit)
P=AC = 50 = rent (10) + 15 (wage) + 15 (interest) + 10 (remuneration for entrepreneur’s time)
If abnormal profit exists, new firms will enter the market (why?). As new firms enter the market,
demand for inputs will rise, and as a result input prices will also rise. AC curve shifts up. Entry of new
firms continues till abnormal profit is eliminated.
Assume that input prices do not change. As new firms come in, industry price falls. As price falls, P
approaches AC. Once P equals AC, we reach the long-run equilibrium.
AC
P, AC, MC, MR
MC
AC
P LOSS D=AR=MR=P
AVC
Q* Firm
Figure 3
In the short run, a firm can make abnormal profit or can lose or can even make just normal profit. But
in the long run, a firm can only make normal profit.
Can a perfectly competitive firm continue to operate in the short run despite losing?
AC = AFC +AVC = 20 + 30 = 50
P = 45 shall I continue? Yes. Loss is now 5 instead of 20.
P > AVC continue
P = AVC = 30 shut-down point
P = 25 (< AVC) Loss is greater as the firm cannot recover even the variable cost. Discontinue.
6. Price and Output Decision by a Monopolist

P Q TR=PQ MR AR
11 0 0 - -
10 1 10 10 10
9 2 18 8 9
8 3 24 6 8
7 4 28 4 7
The MR curve lies half-way the AR curve. That is, the slope of the MR curve is twice the slope of the
AR curve in absolute sense.
Q = 50 – 5p
Q = a – bP
Or bP = a – Q
Or P = a/b – Q/b
TR = PQ = (a/b)Q – Q2/b
MR = dTR/dQ = (a/b) – 2Q/b
Slope of MR = dMR/dQ = - 2/b
AR = TR/Q = a/b – Q/b
Slope of AR = dAR/dQ = - 1/b
AC MC
P MC AC
AC
P P
AC
MR AR=D
Q Q
Abnormal Profit Loss
Comparison between Perfect Competition and Monopoly
A P
Pm B
Pc + D + C MC = AC Q
MR AR=D AR = MR in perfect competition
0 Qm Qc
Assume MC is constant such that AC = MC
Monopoly Equilibrium: Competitive Equilibrium:

Monopoly price = Pm Competitive Price = Pc Pc < Pm
Monopoly Output = Qm Competitive Output = Qc Qc > Qm
Perfect competition is better than monopoly from welfare point of view.

Perfect competition is better than monopoly from efficiency point of view (MC =P).
Consumer surplus in monopoly: ABPm
Consumer surplus in perfect competition: ACPc = ABPm + BDC +PmBDPc > ABPm by (BDC +PmBDPc)
Loss in consumer surplus from a shift to monopoly from perfect competition: BDC +PmBDPc
Who gets it?
Monopolist gets: PmBDPc
What about BDC?
No one gets it. Therefore, this is a deadweight loss.
How to Calculate the Break-Even Level of Output?
TFC TFC
QBE  =
P  AVC Pr ofitContribution
TFC = 10,000 P = 50 AVC = 75% of P
QBE = 10,000/(50 – 37.5) = 800
Profit Contribution Analysis AVC = TVC/Q TVC = AVC .Q
Profit Contribution = P – AVC
Targeted Profit = πR = TR – TC = PQ – (TVC + TFC)
= PQ – TVC - TFC
= PQ – Q . AVC - TFC
πR = Q(P – AVC) – TFC
Or Q(P – AVC) = πR + TFC
Or Q = (πR + TFC) /(P – AVC)
πR = 20,000
TFC = 10,000 P = 50 AVC = 75% of P
Q = 2,400
Operating Leverage
Output Elasticity of Profit = % change in profit due to 1% change in output
%changeinprofit
E 
%changeinoutput
Q( P  AVC ) PQ  TVC TR  TVC TR  TVC

E  =  
Q( P  AVC )  TFC PQ  TVC  TFC TR  TVC  TFC TR  TC
A B C
TFC 200 500 1,000
AVC 15 10 5
Assume P = 20
a. Find QBE for each firm Ans: A = 40 B =50 C =66.67

b. Calculate Eπ for each firm (assume Q = 200).
Ans: A = 1.25 B=1.33 C = 1.50
c. Which firm is the most leveraged? Ans: C

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Market Structure

Market: Education market – interactions between buyers and sellers

Market for a certain product

2. Monopoly (No Competition at All)

3. Monopolistic Competition (Imperfect Competition)

4. Oligopoly [Imperfect Competition]

Condition for Equilibrium: MR = MC (P=MC) (AR = MC)

P = 50, AC = 30 Profit per unit = 20 If Q* = 500, total profit = 20x500=10,000

AC = 30 = 5(rent)+10(wage)+10(interest)+5(remuneration to the entrepreneur)

If P = AC: Profit per unit = 0 (Normal Profit = Economic Profit)

P=AC = 50 = rent (10) + 15 (wage) + 15 (interest) + 10 (remuneration for entrepreneur’s time)

6. Price and Output Decision by a Monopolist

Abnormal Profit Loss

Comparison between Perfect Competition and Monopoly

MR AR=D AR = MR in perfect competition

Assume MC is constant such that AC = MC

Monopoly Equilibrium: Competitive Equilibrium:

Perfect competition is better than monopoly from welfare point of view.

Who gets it?

Monopolist gets: PmBDPc

What about BDC?

No one gets it. Therefore, this is a deadweight loss.

How to Calculate the Break-Even Level of Output?

TFC = 10,000 P = 50 AVC = 75% of P

QBE = 10,000/(50 – 37.5) = 800

Profit Contribution Analysis AVC = TVC/Q TVC = AVC .Q

Profit Contribution = P – AVC

Targeted Profit = πR = TR – TC = PQ – (TVC + TFC)

πR = Q(P – AVC) – TFC

Or Q(P – AVC) = πR + TFC

Or Q = (πR + TFC) /(P – AVC)

TFC = 10,000 P = 50 AVC = 75% of P

Output Elasticity of Profit = % change in profit due to 1% change in output

Q( P  AVC ) PQ  TVC TR  TVC TR  TVC

TFC 200 500 1,000

a. Find QBE for each firm Ans: A = 40 B =50 C =66.67

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