Market Structures

OVERVIEW
1. Perfect Competition
2. Oligopoly
3. Price discrimination and the rationale behind
it
4. The efficiency comparison of the market
structures
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Perfect competition
• Perfect competition is a market structure
where many firms offer a homogeneous
product.
• Because there is freedom of entry and exit and
perfect information, firms will make normal
profits and prices will be kept low by
competitive pressures.
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Features of perfect competition
1. Many firms.
2. Freedom of entry and exit; this will require low 
sunk costs.
3. All firms produce an identical or homogeneous
product.
4. All firms are price takers, therefore the firm’s
demand curve is perfectly elastic.
5. There is perfect information and knowledge.
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• In the short run the number of firms is fixed.
Depending on its costs and revenue, a firm might be
making large profits, small profits, no profits or loss
and in the short run it may continue to do so.
• In the long run, however, the level of profits will
affect entry and exit from the industry. If the profits
are high, new firms will be attracted into the industry,
whereas if losses are being made firms will leave.
• This leads to the distinction between normal and
supernormal profits.
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• Normal Profit -This is the profit that is just enough to
persuade firms to stay in the industry in the long run, but
not high enough to attract new firms. If less than normal
profits are made, firms will leave the industry in the LR.
• Supernormal Profit -This is any above normal profit. If
supernormal profits are made, new firms will be
attracted into the industry in the long run.
• On the other hand if a firm makes losses in the long run
some firms will leave the industry: and they will continue
to do so until only normal profits are being made. Thus
whether the industry expands or contracts in the long
run will depend on the rate of profit.
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Equilibium in the short run
Equilibrium in perfect competition is the point where market demands will be
equal to market supply. A firm's price will be determined at this point.
In the short run, equilibrium will be affected by demand.
In the long run, both demand and supply of a product will affect the
equilibrium in perfect competition.
Price -The price is determined in the industry by the intersection of demand
and supply. The firm faces a horizontal demand (AR) curve at this price. It
can sell all it can produce at the market price (Pe), but nothing at a price
above Pe.
Output -The firms maximize profit where MC=MR, at output Qe.
Note that, since the price is not affected by the firm’s output MR will equal
the price.
N.B When the firm’s AC>AR, then no profits are being made at any level of
output
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• In the short run a firms may incur losses. If P is
above minimum AVC then the firm may
continue to operate and avoid shutting down
• If P is below the minimum AVC then the firm
may consider shutting down
• N.B In the short run, it is possible for an
individual firm to make an economic profit.
This situation is shown in this diagram, as the
price or average revenue, denoted by P, is
above the average cost denoted by C .
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• In the long run -  in the long-run, productive efficiency
occurs as new firms enter the industry.
• Competition reduces price and cost to the minimum of
the long run average costs.
• At this point, price equals both the marginal cost and
the average total cost for each good (P = MC = AC).
• In sum, in the long-run, companies that are engaged in
a perfectly competitive market earn zero economic
profits.
• The long-run equilibrium point for a perfectly
competitive market occurs where the demand curve
(price) intersects the marginal cost (MC) curve and the
minimum point of the average cost (AC) curve.
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Oligopoly - Defined as the form of market organisation in which there are few sellers of a
homogeneous (pure oligopoly) or differentiated product. If there are 2 sellers this is duopoly. If
product is homogeneous we have pure oligopoly e.g. steel and aluminium. If we have a
differentiated product we have a differentiated oligopoly (e.g. automobile, cigarettes and cereals).
Entry is possible but never easy

Collusive oligopoly.
• This is when great numbers of sellers are able to organize and act as a unified seller. Sellers have the
incentive to act in this way because it will increase profits. This form of oligopoly is called collusive
oligopoly and the unified organisation that results is called a cartel. The profit maximisation under
collusive oligopoly is the same as the one for monopoly, since this effectively becomes the only seller
in the market.
• Conditions under which cartels are likely to Flourish
1. There should be few firms so that coordinating their decisions becomes easier.
2. The firms should have similar cost structures and technology of production so that a common,
mutually acceptable price can be a reality.
3. There should not be cheating by the members of the cartel, so that the firms observe or adhere to
their allocated production quotas to avoid over-production.
4. The legal framework should not be too restrictive, otherwise the cartels will be outlawed.
5. The macroeconomic environment should be relatively stable so the firms do not need to regularly
meet and agree on a new price, each time creating the possibility of the cartel collapsing through
lack of consensus.
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• Non-collusive Oligopoly. is when the firms decide to act
independently in the oligopoly market. This creates a lot of
uncertainty in the market. The result is price undercutting and
advertising wars as firms try to outdo each other. The general
assumption in the analysis of non-collusive oligopoly:
1. If a firm raises the price of its product, other do not follow, and
as a result it loses sales.
2. When the firm reduces its price others follow suit, i.e they
match the price reduction and therefore there is no gain in sales
to be expected.
3. This implies that rivals are more responsive to price reductions
than they are to price increases initiated by the firm. This
results in a kinked demand curve, a demand curve with two
different slopes, one elastic and the other inelastic.
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• The original definition of the efficient market has been given by Fama “A market in which prices always fully reflect
available information is called efficient” (Jarrow & Larsoon 2011). On the Efficient market price is anunbiased
estimate of the true value of the investment. According to the Efficient Markets Hypothesis” (EMH) prices reflect
information. Efficient market will reflect quickly into market prices and vise-versa (Bloomfield 2002).
• Overall, the efficient market is a market with the resources that have been wisely allocated, to satisfy needs and
changes and advantageous for all the participants in the market. The participants produced the right products
and in the right way (Scott 2003).
• There are two main types of efficiency that we might be concerned with: allocative and productive efficiency.
Allocative efficiency is when the right type of goods and service produced in society. This type of efficiency occurs
when consumers pay the price that reflects the marginal cost of production P = MC. The adjustments will take
place, when changes in a supply, demand, technology or innovations going to happen. This kind of efficiency can be
achieved in the perfect competitive environment. Since there is no interaction from aside, the market system will
be regulated by “invisible hand” (Economics Online 2016).
• Productive efficiency is when the market produce goods and services for the lowest cost possible P = minATC.
(Heakal 2014). The firm should combine the sources in an efficient way, to use least-cost technology to get at the
end the lowest cost possible in order to survive.
• To reach productive efficiency on the market, all the firms must have the same marginal cost of production. If one
firm or company has a lower cost, than it will be more efficient for the current industry, considered the lower cost
producer. (Economic growth 2009).
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Perfect competition 

•Is the most advantageous market environment for all the participants:
•The solid number of sellers and buyers. That is why a certain seller is not able to influence on the
market price. Participants fully depend on the market environment.
•There is no a bid variety of products on the market. The goods sold are standard, in this case buyers do
not have any preferences to one sellers in comparison to another, as an example of standard product
we can take wheat, corn, fish etc.
•One firm is not able to influence on the market price, because there are numerous companies and they
all selling standard product.
•Buyers are well informed about the price, if someone from the manufactures will raise up a price, they
can lose buyers. In addition, the sellers are not able to negotiate a price.
•The companies do not have any issues to enter and leave a market (Tucker 2014).
•Contrast to the perfect competition is a monopoly – the market where exist and operating only one
firm and could influence the price. Monopoly is the best example of imperfect competition:
•The manufacture of goods is controlled by one seller;
•The goods and services produced by monopoly are unique and do not have close substitutes, in this
case the price on the good is not elastic, and the demand is descending with the time;
•The other firms are not able to enter the market, there is no competition on the monopoly market
(Harford 2010).
•The current conditions help to make a conclusion, that the firm monopoly has full market influence and
able control and change the price. In comparison with the perfect competition market, where each
company should accept the market price.
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• Monopoly competition – the market structure, where combining the features of perfect
competition and some elements from the monopoly structure. The main parameters of
monopoly competition. There are many medium companies on the market, but less than
in perfect competition market structure. Firms producing similar, but not the same
product, so a result:
• Each firm has a small part of the market for manufactured good, the control of the price is
limited, but the companies are independent in their decisions and do not pay much
attentions on the competitors;
• The goods produced are differentiated. In the conditions of monopoly competition,
companies on the market can produce goods, different from the competitors: different by
quality, the quality of services, difference is location and availability for selling products,
usage of advertisement, pack to highlight product among others (Richards 2014).
• The good example is cosmetics, perfumes, medicines, home suppliers. This kinds of
products are differentiating between each other, but still the same. The demand on goods
decrease with the time, but not as rapid as in the conditions of monopoly.
• The same as in conditions of the perfect competition, the companies are free to enter and
leave a market. But in the conditions of the competitive monopoly companies should
spend extra for advertisement: to manipulate with the difference in design, safety of
exploitation, ecological usage, esthetic qualities etc.
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• Oligopoly market system – one of the most widely spread structure in the modern economy:
• There are few competitive firms on the market (from 2-3, 10-12), so it cannot be considered as the pure
monopoly. Each company has a separate part of the market, so it gives the possibility for the participants
to influence the market.
• The demand on the suggested product is decreasing with the time, so the system cannot be considered
as the perfect competition
• In the market there is at least one big company. It actions will find the reflection from the side of
competitors, this is the main difference from the monopoly market system. Of the main specification of
oligopoly, is that the companies should consider not only the reaction and behavior of consumers, but
also the reactions and behavior of competitors.
• The product can be produced as standard (oil, aluminum) – pure oligopoly, as differentiated (for
example, cars) – differentiated oligopoly. So the companies have a certain power on the market (Heakal
2014).
• Basically, in order to achieve market efficiency, two main criteria’s should be achieved – productive
efficiency and allocative. Specifically in the conditions of perfect competition, these two requirements
can be achieved, what makes the perfect competition the most effective type of the market. All the rest
market systems are not able to achieve mentioned features – the minimum range of costs, effective
allocation of resources, the lack of deficit and product surplus, the lack of economic gain and losses. For
Customers perfect competition is the most advantageous type of the market: price is stable, goods and
services are always available, information is not hidden and the advertisement does not influence on
mind (Jarrow & Larson 2011).
• In comparison to the perfect competition – monopoly cannot achieve neither productive, not allocative
efficiency. Monopoly realizing the product with the higher price, with the surplus of product and
additional expenses to maintain the monopoly status (buying of patents and license).
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• Price discrimination and the rationale behind it
1. The purpose of price discrimination is to capture
the market's consumer surplus.
2.  Price discrimination allows the seller to generate
the most revenue possible for a good or service. 
3. The potential for price discrimination exists in
all market structures except perfect competition.
As long as a firm faces a downward-sloping
demand curve and thus has some degree of
monopoly power, it may be able to engage
in price discrimination.