MARKET STRUCTURES
On completing this lecture, students should be able to:
• Discuss characteristics of perfect competition and explain why individual firms are
price takers.
• Analyze short and long run profit maximization.
• Describe a monopolist’s demand curve
• Analyze short term and long term profit maximization for a monopolist
• Discuss inefficiency and price discrimination of the monopoly.
MARKET STRUCTURES
Business organizations operate in two types of markets, one for factors of production such as labor,
and one for output. This chapter deals with the output markets. The structures of the markets in
which firms operate may vary. The implications of these variations are vital for an understanding of
the environment in which business operates. These different forms of market structures are
characterized as:
Perfect competition
Monopoly
Monopolistic competition
Oligopoly
PERFECT COMPETITION
The following are the characteristics of perfect competition.
(a) Large numbers of sellers and buyers: each seller supplies only a small part of the total quantity
offered in the market. Neither the buyer nor the seller can affect the price in the market. Price is
determined by market forces of demand and supply, and each individual firm consider price as
given.
(b) Product homogeneity: - the product of any one seller (i.e. firm) is identical to the product of every
other firm in the market. There is no way in which a buyer could differentiate among the products
of different firms.
(c) Free entry and exit of firms: - there is no barrier to entry or exit from industry seller and buyers
are free to join or leave the market whenever they want.
(d) Profit maximization: - all firms in the industry aim to maximize profit. No other goals are pursued.
(e) No government regulation: - government does not interfere with the market through imposing
tariffs, subsidies etc. the forces of demand and supply are the ones which are left to bring the
market back to equilibrium.
(f) Free mobility of factors of production: - factors of production are free to move from one firm to
another throughout the economy. Labour is not unionized.
(g) Perfect knowledge. All sellers and buyers have complete knowledge of the conditions of the
market. Information is free and costless. Under these conditions uncertainty about future
development in the market is ruled out.
SHORT-RUN EQUILIBRIUM OF FIRM UNDER PERFECT COMPETITION
The term equilibrium of the firm can be defined as a situation where the firm does not wish to
change the size of its output (i.e.) it is satisfied with the amount it is producing and therefore
there is no need to vary the size of its plant. It follows therefore that the point of equilibrium of a
firm is where the firm is making the highest profit and this is at a point where marginal
cost equals marginal revenue MC MR
1
, Cost & Revenue SMC
SAC
v e
P MR AR P
C n
0 Q1 Qe Output
From the figure, we note two points at which MC MR , these are point v and point e. even though
point v fulfills the condition MC MR , it cannot be the equilibrium point of the firm. Since
MC MR implying that additional output adds more cost than revenue and therefore loss.
Therefore it is at point e that the producer would be at equilibrium. The sufficient condition therefore
is for the MC to cut the MR curve from below. That is, slope of MC must be greater than slope of MR.
In the short-run, depending on the position of the average cost curve, the firm can make excess profit
or loss. In this example the firm makes excess profits represented by shaded region PCne.
LONGRUN EQUILIBRIUM OF THE FIRM
Since entry into the industry is free in case of perfect competition, the existence of excess profits
(sometimes called super normal profits) attract other firms to enter the industry. Or alternatively,
existence of excess loss would cause some firms to exit the industry.
As new firms enter the industry, supply also increases. Due to the increased supply, the price in the
market will fall and hence the price charged by the firm will also fall. The higher profits that were
being enjoyed by the firms will start to drop.
In the long run, the firm will be at equilibrium when the excess profits have been exhausted and no
new firms are attracted to enter the industry and when there are no loses to force the firm will be in
the long run equilibrium when it is only enjoying normal profits.
LMC
Cost & Revenue
LAC
p MR
e
0 Q Le 2Output
On completing this lecture, students should be able to:
• Discuss characteristics of perfect competition and explain why individual firms are
price takers.
• Analyze short and long run profit maximization.
• Describe a monopolist’s demand curve
• Analyze short term and long term profit maximization for a monopolist
• Discuss inefficiency and price discrimination of the monopoly.
MARKET STRUCTURES
Business organizations operate in two types of markets, one for factors of production such as labor,
and one for output. This chapter deals with the output markets. The structures of the markets in
which firms operate may vary. The implications of these variations are vital for an understanding of
the environment in which business operates. These different forms of market structures are
characterized as:
Perfect competition
Monopoly
Monopolistic competition
Oligopoly
PERFECT COMPETITION
The following are the characteristics of perfect competition.
(a) Large numbers of sellers and buyers: each seller supplies only a small part of the total quantity
offered in the market. Neither the buyer nor the seller can affect the price in the market. Price is
determined by market forces of demand and supply, and each individual firm consider price as
given.
(b) Product homogeneity: - the product of any one seller (i.e. firm) is identical to the product of every
other firm in the market. There is no way in which a buyer could differentiate among the products
of different firms.
(c) Free entry and exit of firms: - there is no barrier to entry or exit from industry seller and buyers
are free to join or leave the market whenever they want.
(d) Profit maximization: - all firms in the industry aim to maximize profit. No other goals are pursued.
(e) No government regulation: - government does not interfere with the market through imposing
tariffs, subsidies etc. the forces of demand and supply are the ones which are left to bring the
market back to equilibrium.
(f) Free mobility of factors of production: - factors of production are free to move from one firm to
another throughout the economy. Labour is not unionized.
(g) Perfect knowledge. All sellers and buyers have complete knowledge of the conditions of the
market. Information is free and costless. Under these conditions uncertainty about future
development in the market is ruled out.
SHORT-RUN EQUILIBRIUM OF FIRM UNDER PERFECT COMPETITION
The term equilibrium of the firm can be defined as a situation where the firm does not wish to
change the size of its output (i.e.) it is satisfied with the amount it is producing and therefore
there is no need to vary the size of its plant. It follows therefore that the point of equilibrium of a
firm is where the firm is making the highest profit and this is at a point where marginal
cost equals marginal revenue MC MR
1
, Cost & Revenue SMC
SAC
v e
P MR AR P
C n
0 Q1 Qe Output
From the figure, we note two points at which MC MR , these are point v and point e. even though
point v fulfills the condition MC MR , it cannot be the equilibrium point of the firm. Since
MC MR implying that additional output adds more cost than revenue and therefore loss.
Therefore it is at point e that the producer would be at equilibrium. The sufficient condition therefore
is for the MC to cut the MR curve from below. That is, slope of MC must be greater than slope of MR.
In the short-run, depending on the position of the average cost curve, the firm can make excess profit
or loss. In this example the firm makes excess profits represented by shaded region PCne.
LONGRUN EQUILIBRIUM OF THE FIRM
Since entry into the industry is free in case of perfect competition, the existence of excess profits
(sometimes called super normal profits) attract other firms to enter the industry. Or alternatively,
existence of excess loss would cause some firms to exit the industry.
As new firms enter the industry, supply also increases. Due to the increased supply, the price in the
market will fall and hence the price charged by the firm will also fall. The higher profits that were
being enjoyed by the firms will start to drop.
In the long run, the firm will be at equilibrium when the excess profits have been exhausted and no
new firms are attracted to enter the industry and when there are no loses to force the firm will be in
the long run equilibrium when it is only enjoying normal profits.
LMC
Cost & Revenue
LAC
p MR
e
0 Q Le 2Output
