Chapter Five: Market structure

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 5.1. The concept of market in physical and digital space
ü Comprehensive definition of market according to American Marketing Association
(1985) is the process of planning and executing the conception, pricing, promotion, and
distribution of goods, services and ideas to create exchanges that satisfy individual and
organizational objectives.
ü So market describes place or digital space by which goods, services and ideas are
exchanged to satisfy consumer need.
ü Digital marketing is the marketing of products or services using digital technologies,
mainly on the internet but also including mobile phones, display advertising, and any
other digital media.
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 5.1. The concept of market in physical and digital space

ü Digital marketing channels are systems on the internet that can create,
accelerate and transmit product value from producer to the terminal consumer
by digital networks.
ü Physical market is a set up where buyers can physically meet their sellers and
purchase the desired merchandise from them in exchange of money.
ü In physical marketing, marketers will effortlessly reach their target local
customers and thus they have more personal approach to show about their
brands.
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 MARKET TYPES
5.2. Perfectly competitive market

ü Perfect competition is a market structure characterized by a complete absence

of rivalry among the individual firms.
5.2.1 Assumptions of perfectly competitive market
ü A market is said to be pure competition (perfectly competitive market) if the
following assumptions are satisfied.
1. Large number of sellers and buyers: under perfect competition the number
of sellers is assumed to be too large that the share of each seller in the total
supply of a product is very small.
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 5.2. Perfectly competitive market

2. Homogeneous product: homogeneity of the product implies that buyers do

not distinguish between products supplied by the various firms of an industry.

3. Perfect mobility of factors of production: factors of production are free to

move from one firm to another throughout the economy.
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.
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.
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 5.2. Perfectly competitive market

2.

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 5.2.2 Short run equilibrium of the firm

üThe main objective of a firm is profit maximization. If the firm has to incur a
loss, it aims to minimize the loss.

ü 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 x Q, where P = price of the product, Q = quantity of the product sold.

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 5.2.2 Short run equilibrium of the firm….

üAverage 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.
�� ��
�� = = =P Therefore, the firm‘s demand curve is also the average revenue
� �
curve.
ü Marginal Revenue: it is the additional amount of money/ revenue the firm
receives by selling one more unit of the product.
�� (��) �(�)
M� = = = =P
� � �
üThus, in a perfectly competitive market, a firm‘s average revenue, marginal
revenue and price of the product are equal, i.e. AR = MR = P =Df
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 5.2.2 Short run equilibrium of the firm…..
üSince the purely competitive firm is a price taker, it will maximize its
economic profit only by adjusting its output.

üThere 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.

a) Total Approach (TR-TC approach): In this approach, a firm maximizes

total profits in the short run when the (positive) difference(TR) and (TC) is
greatest 9
5.2.2 Short run equilibrium of the firm……

Figure 5.2: Total revenue and total

cost approach of profit maximization

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5.2.2 Short run equilibrium of the firm……
• In Figure 5.2, above, the TR curve starts from origin O which shows zero revenue when no
output is produced. Since TR increases at a constant rate because, under perfect
competition, price remains constant irrespective of the firm‘s level of output. The TR curve
is a straight line from the origin.
• On the other hand, the TC curve starts from A, indicating OA as the fixed cost which must
be incurred even when output is zero. In the initial stages, TC is greater than TR, indicating
the situation of loss, but when it produces OQ1 level of output, TR just equals TC. This is
called a break-even point. As the firm increases its level of output beyond OQ1, TR
becomes greater than TC signalling the emergence of profit. With every further increase in
level of output, the distance between the TR curve and the TC curve widens. At the OQ
level of output, the vertical distance PN between the TR curve and the TC curve is at its
largest. This should be clear from the fact that the tangent at N is parallel to the TR line. If
the firm still continues producing beyond the OQ level of output, the total profit starts to
decline. Clearly, total profit will fall if the firm produces more or less than the OQ level of
output. Hence the competitive firm will produce at the OQ level of output, where the
difference between TR and TC (i.e., total profit) is maximum.
• Since profit is the difference between total revenue and total cost, therefore, profit at any
level of output is given by the gap between the two curves of TR and TC. Thus, from the TR
and TC curves of a firm, it is possible to find out the level of output which gives the firm
maximum profit. This output level is called optimal output. 11
5.2.2 Short run equilibrium of the firm……
• This should be clear from the fact that the tangent at N is parallel to the TR line. If the firm
still continues producing beyond the OQ level of output, the total profit starts to decline.
Clearly, total profit will fall if the firm produces more or less than the OQ level of output.
Hence the competitive firm will produce at the OQ level of output, where the difference
between TR and TC (i.e., total profit) is maximum.
• Since profit is the difference between total revenue and total cost, therefore, profit at any
level of output is given by the gap between the two curves of TR and TC. Thus, from the TR
and TC curves of a firm, it is possible to find out the level of output which gives the firm
maximum profit. This output level is called optimal output.

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 b) Marginal Approach (MR-MC)

üIn the short run, the firm will maximize profit or minimize loss by producing
the output at which marginal revenue equals marginal cost.

ü More specifically, the perfectly competitive firm maximizes its short-run total
profits at the output when the following two conditions are met: MR = MC

ü The slope of MC is greater than slope of MR; or MC is rising. (that is, slope
of MC is greater than zero).

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 b) Marginal Approach (MR-MC)……
dΠ
Mathematically, Π =TR- TC, Π is maximized when =0
d�
dTR dTC
That is, − = 0, �� − �� = 0
d� d�
�� = �� First order condition (FOC)
Second order condition of profit maximization is
d2Π d2TR dTC2
< 0, − < 0, �� − �� < 0
d�2 d�2 d�2
dMR dMC
− <0
d� d�
dMC dMR
>
d� d�
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 b) Marginal Approach (MR-MC)……
üGraphically, the marginal approach can be shown as follows.

ü The profit maximizing output is

Q e , w h e re M C =M R a n d M C
curve is increasing.
ü At Q*, MC=MR, but since MC is
falling at this output level, it is
not equilibrium output.

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 Economic/positive profit
üIf the AC is below the market price a equilibrium, the firm earns positive
profit equal to the area between the AC curve and the price line up to the profit
maximizing output.

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 ii) Loss
ü 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.

Figure 5.6: A firm incurring a loss

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 Normal Profit (zero profit) or break- even point
üIf the AC is equal to the market price at equilibrium, the firm gets zero profit
or normal profit.

Figure 5.7: A firm earning a normal profit

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 Shutdown point
üIf the AC is equal to the market price at equilibrium, the firm gets zero profit
or normal profit.
üThe firm will not stop production simply because AC exceeds price in the
short-run.
üThe firm will continue to produce irrespective of the existing loss as far as the
price is sufficient to cover the average variable costs.
üThis means, if P is larger than AVC but smaller than AC, the firm minimizes
total losses.
üBut 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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 Shutdown point….
ü.

Figure 5.8: A shut down point

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 Shutdown point….
üExample: 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:
üTC=2+10q-4q2+q3
üA) What level of output should the firm produce to maximize its profit?
üB) Determine the level of profit at equilibrium.
üC) What minimum price is required by the firm to stay in the market?

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 Solution
üGiven: p=$10 and TC= 2+10q - 4q2+q3
üA) The profit maximizing output is that level of output which satisfies the
following condition MC=MR & MC is rising
Thus, we have to find MC& MR first
ü MR in a perfectly competitive market is equal to the market price. Hence,
dTR dPQ d10�
MR=10 Alternatively, = = = 10
d� d� d�
dT�
üMC= =3q2-8q+10 To determine equilibrium output just equate MC&
d�
MR And then solve for q. 10 – 8q + 3q2 = 10
ü - 8q + 3q2 = 0
ü q (-8 + 3q) = 0, q = 0 or q = 8/3 22
 Solution….
üNow we have obtained two different output levels which satisfy the first order
(necessary) condition of profit maximization
ü To determine which level of output maximizes profit we have to use the
second order test at the two output levels.
üThat is, we have to see which output level satisfies the SOC of increasing MC.
ü To see this first we determine the slope of MC
dM�
üSlope of MC = = 6q-8 At q = 0, slope of MC is -8 + 6 (0) = -8 which
d�
implies that marginal cost is decreasing at q = 0. Thus, q = 0 is not
equilibrium output because it doesn‘t satisfy the second order condition.
ü At q = 8/3, slope of MC is -8 + 6 (8/3) = 8, which is positive, implying that
MC is increasing at q = 8/3
üThus, the equilibrium output level is q = 8/3 23
 Solution….
B. Above, we have said that the firm maximizes its profit by producing 8/3 units.
üTo determine the firm‘s equilibrium profit we have to calculate the total
revenue that the firm obtains at this level of output and the total cost of
producing the equilibrium level of output.
üTR = Price * Equilibrium Output= $ 10 * 8/3= $ 80/3
üTC at q = 8/3 can be obtained by substituting 8/3 for q in the TC function, i.e.,
TC = 2+10 (8/3) – 4 (8/3) + (8/3)  19.18
2 3

Thus the equilibrium (maximum) profit is

= TR – TC
= 26.67 – 19.18 = $ 7.48

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 Solution….
B. To stay in operation the firm needs the price which equals at least the
minimum AVC.
Thus, to determine the minimum price required to stay in business, we have to
determine the minimum AVC.
dAVC
AVC is minimal when derivative of AVC is equal to zero. That is:
d�

ü The minimum AVC is obtained by

substituting 2 for q in the AVC function
i.e.,Min AVC = 10 – 4 (2) + 22 = 6.
ü Thus, to stay in the market the firm should
get a minimum price of $ 6.
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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.
üPure monopoly exists when a single firm is the only producer of a product for
which there are no close substitutes.
üThe main characteristics of this market structure include:
1. Single seller: A pure or absolute monopoly is a one firm industry.
2. No close substitutes: the monopolist‘s product is unique in that there are no
good or close substitutes.
3. Price maker: the individual firm exercises a considerable control over price
because it is responsible for, and therefore controls, the total quantity
supplied.
• Blocked entry: A pure monopolist has no immediate competitors because
there are barriers, which keep potential competitors from entering in to the
industry. These barriers may be economic, legal, technological etc
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 5.3.2. Sources of monopoly
üThe barriers to entry are therefore the sources of monopoly power.
üThe major sources of barriers to entry are:
1. Legal restriction: Some monopolies are created by law in public interest.
ØSuch monopoly may be created in both public and private sectorsMost 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.
2. Control over key raw materials: Some firms acquire monopoly power from
their traditional control over certain scarce and key raw materials that are
essential for the production of certain other goods. For example, Aluminum
Company of America had monopolized the aluminum industry because it had
acquired control over almost all sources of bauxite supply; such monopolies are
often called raw material monopolies. 27
 5.3.2. Sources of monopoly…
ü3) Efficiency: a primary and technical reason for growth of monopolies is
economies of scale.
ü4) Patent rights: Patent rights are granted by the government to a firm to
produce commodity of specified quality and character or to use specified rights
to produce the specified commodity or to use the specified technique of
production.

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 5.4. Monopolistically competitive market
ØThis market model can be defined as the market organization in which there
are relatively many firms selling differentiated products.
Ø It is the mixture of competition and monopoly.
Ø The competitive element arises from the existence of large number of firms
and no barrier to entry or exit.
This market is characterized by:
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).
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 5.4. Monopolistically competitive market……
ØMany 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.
ØEasy entry and exit: like the PCM, there is no barrier on new firms that are
willing and able to produce and supply the product in the market.
Ø 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.
ØA firm spends money in advertisement to reach the consumers about the
relatively unique character of its product and thereby get new buyers and
develop brand loyalty.
ØMany retail trade activities such as clothing, shoes, soap, etc are in this type of
market structure.
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 5.5. Oligopoly market
ØThis is a market structure characterized by:
Ø Few dominant firms: the number of firms is small enough that each firm
recognizes the actions of other firms, implying that firms are mutually
interdependent
ØEntry barrier: there are considerable obstacles that hinder a new firm from
producing and supplying the product.
ØThe barriers may include economies of scale, legal, control of strategic inputs,
etc
ØProducts 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.
• A special type of oligopoly in which there are only two firms in the market is
known as duopoly. 31