UNIT 7 MARKET STRUCTURE

MARKET STRUCTURE Market structure is best defined as the organizational and other characteristics of a market. Traditionally, the most important features of market structure are: The number of firms The market share of the largest firms The nature of costs

The degree to which the industry is vertically integrated The extent of product differentiation The turnover of customers

TYPES OF MARKET STRUCTURE PERFECT COMPETITION MONOPOLISTIC COMPETITION MONOPOLY OLIGOPOLY THESE MARKET STRUCTURES ARE DIFFERENT IN TERMS OF THEIR CHARACTERISTICS.

CHARACTERISTICS OF PERFECT COMPETITION MANY PARTICIPANTS HOMOGENOUS PRODUCTS NO BARRIERS TO ENTRY EACH FIRM IS A PRICE TAKER {Passive} HIGH ECONOMIC EFFICIENCY

WEAK INNOVATIVE BEHAVIOUR

PERFECT COMPETITIVE FIRMS MAKING PROFITS IN THE SR & LOSSES IN THE LR A higher price creates a profit opportunity in sector Y. Simultaneously, lower prices result in losses in industry X.

MONOPOLY This is a market in which there is only one supplier of the goods or services, many purchasers and there are no close substitutes. Example NWC is a monopoly where pipe water is concern.

CHARACTERISTICS OF A MONOPOLY FIRM One supplier and many buyers Firm is a price maker A monopoly firm faced a known demand curve Large barriers to entry and exit

The Monopolist’s Profit-Maximizing Price and Output The profit-maximizing level of output (Qm) occurs where MR = MC. Notice that the outcome is different from that of perfect competition. Here, the price ($4.00) is less than the marginal cost ($1.50), and the monopolist earns positive economic profit.

Monopoly in the Long and Short-Run It is possible for a profit-maximizing monopolist to suffer short-run losses and go out of business in the long-run.

Marginal Revenue and Market Demand At every level of output except one unit, a monopolist’s marginal revenue is below price.

Marginal Revenue and Total Revenue The marginal revenue curve shows the change in total revenue that results as a firm moves along the segment of the demand curve that lies exactly above it. Total revenue is maximum when marginal revenue equals zero.

TYPES OF BARRIERS TO ENTRY 1. Government franchises, or firms that become monopolies by virtue of a government directive. 2. Patents or barriers that grant the exclusive use of the patented product or process to the inventor. 3. Economies of scale and other cost advantages enjoyed by industries that have large capital requirements. A large initial investment, or the need to embark in an expensive advertising campaign, deter would-be entrants to the industry. .

Ownership of a scarce factor of production: If production requires a particular input, and one firm owns the entire supply of that input, that firm will control the industry.

The Social Costs of Monopoly Monopoly leads to an inefficient mix of output. Price is above marginal cost, which means that the firm is under producing from society’s point of view.

The Social Costs of Monopoly The triangle ABC measures the net social gain of moving from 2,000 units to 4,000 units (or welfare loss from monopoly).

Rent-Seeking Behavior Rent-seeking behavior refers to actions taken to preserve positive profits. A rational owner would be willing to pay any amount less than the entire green rectangle to prevent those positive profits from being eliminated as a result of entry.

Monopolistic Competition Monopolistic competition is a common form of industry (market) structure characterized by: large number of firms, none of which can influence market price by virtue of size alone. Large number of purchasers firms producing differentiated products

Some degree of market power is achieved by firms producing differentiated products d. New firms can enter and established firms can exit such an industry with ease e.

Price/Output Determination in the Short Run In the short-run, a monopolistically competitive firm will produce up to the point where MR = MC. This firm is earning positive profits in the short-run.

Price/Output Determination in the Long Run As new firms enter a monopolistically competitive industry, the demand curves of existing firms shift to the left, pushing MR with them. In the long run, profits are eliminated. This occurs for a firm when its demand curve is just tangent to its average cost curve. As new firms enter a monopolistically competitive industry in search of profits, the demand curves of profit-making existing firms begin to shift to the left, pushing marginal revenue with them as consumers switch to the new close substitutes. This process continues until profits are eliminated, which occurs for a firm when its demand curve is just tangent to its average cost curve.

Oligopoly An oligopoly is a form of industry (market) structure characterized by: 1. a few dominant firms 2. many purchasers 3. products may be homogeneous or differentiated. 4. Firms are interdependent ie. the behavior of one firm depends on the behavior of the other

The Kinked Demand Curve Model Above P*, an increase in price, which is not followed by competitors, results in a large decrease in the firm’s quantity demanded (demand is elastic). Below P*, price decreases are followed by competitors so the firm does not gain as much quantity demanded (demand is inelastic).