MARKET STRUCTURE

OBJECTIVES

At the end of this lesson student should be able to:

Explain: • The characteristics of perfect competition
Explain, with the aid of a diagram:
• Short run perfect competition;
supernormal profit/loss
• Long run perfect competition: normal profits
• Individual firm in perfect competition as a price taker
• Equilibrium price and output for a firm in perfect competition
• Allocative efficiency in short run and long run perfect competition
• Productive efficiency in long run perfect competition
 WHAT IS MARKET STRUCTURE?

• Market structure refers to the way that various

industries are classified and differentiated in
accordance with their degree and nature of
competition for products and services. It consists of
four types: perfect competition, oligopolistic markets,
monopolistic markets, and monopolistic competition.
 TYPES OF MARKET STRUCTURES

According to economic theory, market structure describes

how firms are differentiated and categorized by the types
of products they sell and how those items influence their
operations. A market structure helps us to understand
what differentiates markets from one another.
• In economics, market structure is the number of firms
producing identical products which are homogeneous.
 The types of market structures include the following:
1.Monopolistic competition, also called competitive
market, where there is a large number of firms, each
having a small proportion of the market share and
slightly differentiated products.
2.Oligopoly, in which a market is by a small number of
firms that together control the majority of the market
share.
3. Duopoly, a special case of an oligopoly with two firms.
4. Monopsony, when there is only one buyer in a market.
5. Oligopsony, a market in which many sellers can be
present but meet only a few buyers.
6. Monopoly, in which there is only one provider of a
product or service.
7. Natural monopoly, a monopoly in which economies of scale
cause efficiency to increase continuously with the size of the
firm. A firm is a natural monopoly if it is able to serve the
entire market demand at a lower cost than any combination
of two or more smaller, more specialized firms.
8. Perfect competition, a theoretical market structure that
features no barriers to entry, an unlimited number of
producers and consumers, and a perfectly elastic demand
curve.
 PERFECT COMPETITION
This is a type of market which comprises of many buyers
and sellers, where neither the buyer nor the seller can
influence the price of then product. The price is
determined by the interaction forces of demand and
supply.
 CHARACTERISTICS OF PERFECT
COMPETITION.
• Infinite buyers and sellers – An infinite number of consumers with the
willingness and ability to buy the product at a certain price, and infinite
producers with the willingness and ability to supply the product at a certain
price.
• Zero entry and exit barriers – A lack of entry and exit barriers makes it
extremely easy to enter or exit a perfectly competitive market.
• Perfect factor mobility – In the long run factors of production are perfectly
mobile, allowing free long term adjustments to changing market conditions.
• Perfect information - All consumers and producers are assumed to have perfect
knowledge of price, utility, quality and production methods of products.
• Zero transaction costs - Buyers and sellers do not incur costs in
making an exchange of goods in a perfectly competitive market.
• Profit maximizing - Firms are assumed to sell where marginal
costs meet marginal revenue, where the most profit is generated.
• Homogenous products - The qualities and characteristics of a
market good or service do not vary between different suppliers.
• Non-increasing returns to scale - The lack of increasing returns to
scale (or economies of scale) ensures that there will always be a
sufficient number of firms in the industry.
• Property rights - Well defined property rights determine what may
The correct sequence of the market structure from most to
least competitive is perfect competition, imperfect
competition, oligopoly and pure monopoly. The main
criteria by which one can distinguish between different
market structures are the number and size of producers
and consumers in the market, the type of goods and
services being traded and the degree to which information
can flow freely.
 REVENUE AND OUTPUT DETERMINATION OF
PERFECT MARKET

Revenue and Output: In this structure, firms

are price takers with perfectly elastic demand
curves. They adjust their output to the point
where marginal cost (MC) equals marginal
revenue (MR), ensuring maximum efficiency.

Profit Maximisation: Profits are maximised

when MC equals MR. However, in the long
run, firms only make normal profits (break-
even) due to the ease of entry and exit in the
market.
The profit-maximizing choice for a perfectly
competitive firm will occur where marginal
revenue is equal to marginal cost—that is,
where MR = MC.
A profit-seeking firm should keep expanding
production as long as MR > MC.
 LOSS OF A COMPETITIVE FIRM

A perfect market will be making loss if

the price is below the average cost.
P<AC
In the graph, at price P, the firm suffers
losses since price is below the average
cost. Loss is therefore represent by apbc.
If the firm cannot cover average cost it
may close down. This may be the point
of exit from the market
 MONOPOLISTIC COMPETITION

Monopolistic competition, also called competitive

market, where there is a large number of firms, each
having a small proportion of the market share and
slightly differentiated products. This structure
features a large number of firms offering similar, but
not identical, product
• Product Differentiation: Each firm differentiates its
product from others through quality, features, branding,
or customer service, creating a unique selling
proposition.
• Market Power: Firms have some degree of market
power, allowing them to influence prices slightly.
• Relatively Low Entry and Exit Barriers: New firms can
enter the market with relative ease, providing constant
competitive pressure.
• Non-Price Competition: Emphasis on marketing,
advertising, and brand differentiation to attract
customers.
• In monopolistic competition, firms have a degree of
pricing power but remain competitive due to the
differentiation of their products. Long-term profits tend to
be normal due to the ease of entry and exit.
 EQUILIBRIUM OF A MONOPOLIST COMPETITION

In a monopolistic competitive the firms fix price and output that

will maximise profit. The equilibrium prices and output are
determined at the short run where MC=MR. As always, each
firm will seek to produce where MC=MR in order to maximise
profit. In this market, Firms can earn super-normal profit,
normal profit or loss in the short run depending on Average Cost
 PROFIT OF A MONOPOLIST COMPETITION

Abnormal profit: A firm can earn

above normal profit. The short run
MC Cuts the MR curve at F. This
equilibrium point establishes the
price OP and output0Q. As a
result, the firm earns super-normal
profit which is represented by the
area PaKC.
Revenue and Output: Firms face a
downward-sloping demand curve,
giving them some control over
pricing. Output is determined
where MC equals MR.
Profit Maximisation: In the short
run, firms can earn supernormal
profits. However, these profits are
eroded in the long run as new firms
enter the market.
 LOSS OF A MONOPOLIST COMPETITION
A competitive monopolist will be at loss
if the firm is not able to cover its short
run average cost and incure losses.
From the graph the average cost(ac) is
P2
higher than the price. A
loss
The price of the firm is at p1 but the p B
average cost of the firm is at p2
The firm has incurred loss at the
rectangle PP2AB
 LONG RUN EQUILIBRIUM OF MONOPOLISTIC
COMPETITION
In the diagram, the monopolistic
competitive firm is at equilibrium at
point b where the MC is equal to
MR. The corresponding output is
OQi and price OP. At this output
level, the total cost is shown as
rectangle OPaQ and the total
revenue OPaQ. At this point, the
firm makes normal profit in the long
run.
 MONOPOLY

A monopoly is a market structure where a single firm dominates. Single seller or producer of a product.

CHARACTERISTIC OF MONOPOLY
• Single Producer: Monopoly exists when a single firm is the sole producer of
a product with no close substitutes.
• High Barriers to Entry: These could be legal (patents, licenses),
technological (unique expertise or processes), or resource-based (control of a
scarce resource).
• Price Setting Power: As the only supplier, the monopolist can influence
market prices, often leading to higher prices than in competitive markets.
• Consumer Impact: Monopolies can lead to inefficiencies, such as higher
prices and reduced consumer surplus, although they might benefit from
 CAUSES OF MONOPOLY

• Granting of patent right

• Acquisition and merger of firms
• Act of parliament
• Professionalism
• Control over supply of raw material
• Effective advertising
• Level of technology
 EQUILIBRIUM OF THE MONOPOLIST
Price and output determination:
A monopolist cannot fix price and output at the same time. He has two
options.
1To fix price and leave the output to be determined by the demand
2. To fix output to be produced and allow the price to be determined by the
demand.
Moreover, the demand curve facing the monopolist is downward sloping
because the firm is also the industry, i.e. only one firm in the industry. The
most profitable output is where MC=MR
 FIRM AND INDUSTRY EQUILIBRIUM:
As the only firm in the industry, the equilibrium of the firm is also
that of the industry. The monopolist can earn abnormal profit, both
in the short run and long run. In the short run, a monopolist will be
at equilibrium if the following conditions are fulfilled:
1. The marginal cost is equal to marginal revenue (MC = MR).
2. Marginal cost cuts marginal revenue from below. The slope of
MC is greater than the slope of MR at the point of intersection.
In the diagramme, the monopolist is
at equilibrium at point S where MC =
MR and MC cuts MR from below. At
the point of equilibrium, quantity
produced is OQ1while the price is OP.
He is able to cover both the average
cost and marginal cost. The
monopolist realizes excess profit which
is equal to the shaded portion PBCD
Total Revenue = OPCQ1
TOTAL COST= BDOQ1
PROFIT= PBCD (abnormal)
 MONOPOLIST EARNING NORMAL PROFIT
A monopolist can also make normal profit.
This will be illustrated graphically. The
equality of marginal cost and marginal
revenue at point b determines the quanttyQ1
which is sold at price A. The monopolist:
earns normal profit when average cost curve
is tangential to the average revenue at this
level of output.
Total cost = OPaQ1
Total revenue = OPaQ1
 MONOPOLIST EARNING LOSS
In a monopoly market, loss can be made
if the variable cost is outside the
revenue area. The equilibrium position
is that MC= MR. The price of the
monopolist as fixed by the demand does
not cover the average cost. Therefore,
there can be loss. This is illustrated in
the graph
Total revenue = bdoQ1
Total cost = aocQ1
Loss = abcd
 OLIGOPOLY
Oligopoly is marked by a few large firms dominating the
market:
characteristics
• Limited Competitors: A small number of large firms hold the majority of market share,
making the actions of each firm influential on the others.
• Strategic Interdependence: Decisions by one firm directly impact others, leading to strategic
behaviours like price-fixing or collusion.
• Entry Barriers: High due to economies of scale, brand loyalty, and other factors.
• Price Stickiness: Prices in oligopolies tend to be more rigid and change less frequently
compared to more competitive markets.