ECONOMICS FOR MANAGERS

COURSE NO : 401

Rup Ratan Pine

01552438118
ahirmrittika@yahoo.com
Market Structure
 Market
A market is a medium that allows buyers and sellers of a specific good or service to interact in order to
facilitate an exchange. This type of market may either be a physical marketplace where people come together
to exchange goods and services in person, as in a bazaar or shopping center, or a virtual market wherein
buyers and sellers do not interact, as in an online market.

Markets include mechanisms or means for

(1) determining price of the traded item,

(2) communicating the price information,
(3) facilitating deals and transactions, and
(4) effecting distribution.
 Market Structure

The interconnected characteristics of a market,

i) The number and size of sellers and buyers

ii) Level and forms of competition,
iii) Extent of product differentiation, and
iv) Conditions of entry into and exit from the market.
 Types of Market Structure

 There are quite a few different market structures that can characterize an economy. However, if we are just
getting started with the topic, we may want to look at the four basic types of market structures first. Namely,

i) Perfect competition,
ii) Monopolistic competition,
iii) Oligopoly, and
iv) Monopoly.

 Each of them has their own set of characteristics and assumptions, which in turn affect the decision making of
firms and the profits they can make. It is important to note that not all of these market structures actually exist in
reality, some of them are just theoretical constructs. Nevertheless, they are of critical importance, because they
can illustrate relevant aspects of competition firms’ decision making. Hence, they will help you to understand the
underlying economic principles.
 Market Structures

Market Structures are classified in term of the presence or absence of competition.  When competition
is absent, the market is said to be concentrated. There is a spectrum, from perfect competition to pure
monopoly.
 Profit Maximization Rule

In microeconomics, the Profit Maximization Rule states that if a firm chooses to maximize its profits, it must
choose that level of output where Marginal Cost (MC) is equal to Marginal Revenue (MR) and the Marginal Cost
curve is rising.
The formula for the profit maximization rule is, MC = MR. Marginal Cost is the increase in cost by producing
one more unit of the good. Marginal Revenue is the change in total revenue as a result of changing the rate of
sales by one unit. It is also the slope of Total Revenue.
Profit = Total Revenue – Total Costs Therefore, profit maximization occurs at the biggest gap between the total
revenue and the total cost.
At A, Marginal Cost < Marginal Revenue, then for each extra unit produced, revenue will be greater than the cost,
so you will produce more. At B, Marginal Cost > Marginal Revenue, then for each extra unit produced, the cost
will be greater than revenue, so you will produce less.
Thus, optimal quantity produced should be at MC = MR.
The MC = MR rule is quite versatile, firms can apply the rule to many other decisions. It can be applied to hours
of operation: stay open as long as the added revenue from the additional hour exceeds the cost of staying open
another hour. Or it can be applied to advertising: increase the number of times you run your TV commercial as
long as the added revenue from running it one more time outweighs the added cost of running it one more time.
Profit Maximization Rule
Profit Maximization
Perfect Competition
 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 competition.

Perfectly competitive markets exhibit the following characteristics:

Number of Firms
• There are very many small firms (think of a grain of sand on a beach), too many to count.
Homogenous
• All producers of a good sell the same product, i.e. they are homogenous/identical.
Barriers to Entry
• There are no barriers to enter or exit the market (sometimes high costs or strict regulations prevent firms from entering)
Perfect Information
• All consumers and producers have ‘perfect information’, i.e. everyone knows the price of the product, the demand &
supply
Price Takers
• No single firm can influence the market price, or market conditions. Firms sell all they produce, but they cannot set a
price. They are said to be ‘price takers’
 Revenue Curves of Perfect Competition

Here are the demand and revenue curves for the market and each firm:
The Cost Curves of Perfect Competition
 Equilibrium in Perfect Competition (In Short-run)
 The diagrams show the four situations in which a firm could find itself in the short run.
 In the first diagram, the given price is P. The firm wants to maximize profits, so it produces at the level of output
where MC = MR. This occurs at point A. Drop a vertical line to find the firm's output (Q). At, AR > AC and the
firm earns super normal profit at this point(the yellow box).
 In the middle diagram, the given price is P*. In this case, it is clear that the firm makes normal profit. The AC
curve is tangent with the AR curve at all levels of output Q*. The firm earns normal profit.
 In the third diagram, the given price is P*. Again the firm will produce the level of output Q*. Notice that at this
point, AR < AC, so the firm is making loss.
 So, in the short run, a perfectly competitive firm could be making super normal profit, or a loss, or just normal
profit, depending on the given market price. Note that if the firm's losses get too big in the short run AR < AVC)
then it will have to shut down (see the above graph where price is P2).
Supernormal Profit in Perfect Competition
Normal Profit in Perfect Competition
Loss Making in Perfect Competition
Shut-Down Point of Perfect Competition
Equilibrium in Perfect Competition (In Long-run)
 Equilibrium in Perfect Competition (In Lon-run)
 In the long-run firms are attracted into the industry if the incumbent firms are making supernormal profits. This is
because there are no barriers to entry and because there is perfect knowledge.

 The effect of this entry into the industry is to shift the industry supply curve to the right, which drives down price
until the point where all super-normal profits are exhausted.  

 If firms are making losses, they will leave the market as there are no exit barriers, and this will shift the industry
supply to the left, which raises price and enables those left in the market to derive normal profits.

 The situations are depicted in the following graph.

Equilibrium in Perfect Competition (In Lon-run)
 How Realistic the Model is!

Very few markets or industries in the real world are perfectly competitive. For example, how homogeneous is the
output of real firms, given that even the smallest of firms working in manufacturing or services try to differentiate
their product.

Although unrealistic, it is still a useful model in two respects.

 Firstly, many primary and commodity markets, such as coffee and tea, exhibit many of the characteristics of
perfect competition, such as the number of individual producers that exist, and their inability to influence market
price.

 Secondly, for other markets in manufacturing and services, the model is a useful yardstick by which economists
and regulators can evaluate levels of competition that exist in real markets.
 Examples of Perfect Competition

Examples of Perfect Competition

In the real world it is hard to find examples of industries which fit all the criteria of ‘perfect knowledge’ and ‘perfect
information’. However, some industries are close.

 Foreign exchange markets. Here currency is all homogeneous. Also traders will have access to many different
buyers and sellers. There will be good information about relative prices. When buying currency it is easy to
compare prices

 Agricultural markets. In some cases, there are several farmers selling identical products to the market, and many
buyers. At the market, it is easy to compare prices. Therefore, agricultural markets often get close to perfect
competition.

 Internet related industries. The internet has made many markets closer to perfect competition because the
internet has made it very easy to compare prices, quickly and efficiently (perfect information). Also, the internet
has made barriers to entry lower.
Monopolistic Market Competition
 Monopolistic Competition
Monopolistic competition is a type of imperfect competition such that many producers sell products that are
differentiated from one another (e.g. by branding or quality) and hence are not perfect substitutes. In monopolistic
competition, a firm takes the prices charged by its rivals as given and ignores the impact of its own prices on the
prices of other firms.

These are major characteristics of monopolistic competition (MC):

 Product differentiation
 Many firms
 No entry and exit cost in the long run
 Independent decision making
 Some degree of market power
 Buyers and Sellers do not have perfect information (Imperfect Information) .
Revenue & Cost Curves in Monopolistic Market
Equilibrium in Monopolistic Market in Short-run
 Equilibrium in Monopolistic Market in Short-run
 In the above diagram, the short run average cost is MT and short run average revenue is MP. Since the AR
curve is above the AC curve, therefore, the profit is shown as PT. PT is the supernormal profit per unit of
output. Total supernormal profit will be measured by multiplying the supernormal profit to the total output, i.e.
PT × OM or PTT’P’ as shown in figure (a). 

 The firm may also incur losses in the short run if it is facing AR curve below the AC curve. In figure (b) MP is
less than MT and TP is the loss per unit of output. Total loss will be measured by multiplying loss per unit of
output to the total output, i.e., TP × OM or TPP’T’.
 Equilibrium in Monopolistic Competition Long-run
 Under monopolistic competition, the supernormal profit in the long run is disappeared as new firms are
entered into the industry. As the new firms are entered into the industry, the demand curve or AR curve will
shift to the left, and therefore, the supernormal profit will be competed away and the firms will be earning
normal profits.
  If in the short run firms are suffering from losses, then in the long run some firms will leave the industry so
that remaining firms are earning normal profits.

 The AR curve in the long run will be more elastic, since a large number of substitutes will be available in
the long run. 
 Therefore, in the long run, equilibrium is established when firms are earning only normal profits. Now
profits are normal only when AR = AC. It is further illustrated in the following diagram:
Long-run Equilibrium in
Monopolistic Competition
Difference Between Perfect & Monopolistic Competition
 Examples of Monopolistic Competition
Examples of monopolistic competition
Examples of monopolistic competition can be found in every high street. Monopolistically competitive firms are
most common in industries where differentiation is possible, such as:

 The restaurant business

 Hotels and pubs
 General specialist retailing
 Consumer services, such as hairdressing