MARKET STRUCTURE

This section introduces the benchmark market

structures: perfect competition, monopoly and
oligopoly.
Market structure is important as:
In decision-making analysis, market structure has an
important role through its impact on the decision-
making environment.
In economics, markets are classified according to
the structure of the industry.
The variables which have received the most
attention in the market structure are:
Number of buyers and sellers, extent of product
substitutability, costs, simplicity in entry and exit, and
the extent of mutual interdependence. 1
Determinants of market structure
 Freedom of entry and exit
 Nature of the product – homogenous (identical), differentiated?
 Control over supply/output
 Control over price
 Barriers to entry

In the traditional framework, these structural variables are

distilled into the following taxonomy of market
structures:
(1) Perfect Competition--many sellers of a standardized
product,

(2) Monopolistic Competition--many sellers of a

differentiated product,

(3) Oligopoly--few sellers of a standardized or a

differentiated product, and
(4) Monopoly--a single seller of a product for which there is no
2
close substitute.
Perfect Competition:
 Perfect competition is a market situation where there
are many firms selling identical products with no firm
large enough in relation to the entire market to be
able to influence the market price.
 When no individual firm is in a position to influence
the market price because of the smallness of its own
size compared to the industry, it will have to sell its
output at a price given to it by the market.
 Thus, under perfect competition every firm is a
“price taker” i.e. it sells at a price determined by
the forces of demand and supply for the entire
industry rather than fixing its own price for the
product. 3
Example:
 A farmer cultivating wheat and sells it not at a price
set by him but at the price obtainable by the market.
 This is so because he is just one of the many
farmers cultivating wheat crop.
 If all the farmers sell wheat only at the price
determined by the total demand for and the supply
of wheat in the entire market, they are going to sell
at the same price.
 This is the most distinguishing feature of perfect
competition.
 In this market situation, the price in the entire market
for a product is exactly the same.
4
Assumptions of Perfect Competition:
 Free entry and exit of firms to industry.
 Homogenous product – identical, so no
consumer preference are there.
 Large number of buyers and sellers – no
individual seller can influence the market
price.
 Sellers are price takers – they have to
accept the market price.
 Perfect information available to buyers and
sellers.
 Absence of transaction cost.
5
Pure Competition and Perfect Competition:
 Pure competition exists when only some of the
conditions mentioned above are satisfied such as
large number of buyers and sellers, homogeneous
product and free entry.
 On the other hand, Perfect competition prevails
when certain additional conditions such as perfect
knowledge, perfect mobility and absence of
transport cost, are also satisfied.
 Thus, basically the two terms refer to the same kind
of market situation. While the concept of pure
competition is more practical that of perfect
competition is more comprehensive.
6
Revenue Curves of the Firm under Perfect Competition:
 Two important features of perfect competition which
determine the revenue curves of the firm are (1)
large number of sellers and buyers and (2) the
homogeneous product.
 The number of firms being very large, no
individual firm can influence the market price by its
own action.
 In fact, the firm is so insignificant unit in the whole
industry that even if it expands its output and sells
more in the market, it will not make any difference to
the price.
 Thus the firm can sell as much as it likes at the price
determined in the market by the operation of
demand and supply forces.
7
 On the other hand, the homogeneous
production implies that each firm is producing
exactly same product.
 There are no natural of artificial differences in the
production of different firms.
 And no firm would charge lower than the market
price, because why should it charge less, if it can
sell as much as it likes at the given price.
 Thus, under competitive condition, the price of
commodity is given as fixed by the market
demand and supply for the industry as a whole, it
would remain same whether one firm sells more
or less. 8
 Therefore, under perfect competition,
average revenue and marginal revenue are
constant and equal.
 Since, price is fixed and given, each
additional unit sold would add to the total
revenue the same amount of money which
was added by the previous one and the one
before that.
 Thus, the marginal revenue is constant and
also equal to the average revenue.
 The AR and MR curve can be shown as
follows: 9
AR & MR

P AR=MR

O Quantity

10
 From the diagram above, it is clear that the
average revenue curve of the firm operating
under competitive condition is shown by the
curve AR, which runs parallel to the x-axis at
a distance which is equal to the price of the
commodity.
 The marginal revenue curve MR also lies at
the same place at which AR is lying.
 Since AR is equal to MR under perfect
competition, the same curve shows revenues,
average as well as the marginal revenue.
11
Equilibrium of the Firm under Perfect Competition:
 A firm is said to be in equilibrium when it does
not intend to change the volume of output which
it is producing.
 The equilibrium of the industry is a situation
where:
 (a) all the individual firms are in equilibrium and
hence do not change the level of their output
and
 (b) where there is no incentive for out side firms
to enter and join the industry or when there is
no tendency for the existing firms to leave the
industry.
12
Short-run Equilibrium:
 Short run can be defined as the period of time
which is not sufficient to allow the firm to
make an adjustment in the scale of operations
by changing the quantity of fixed factors
engaged in production.
 Further, the short period is a time during
which the new firms can not enter into the
industry, and similarly the existing firms can
not leave it.
 Thus the number of firms in an industry is
given and fixed in the short period of time. 13
 Under perfect competition, since the price of the
commodity is determined by the forces of demand
and supply, for the industry as a whole, each one of
the firm has to sell at that price.
 If it charges a higher price, no one would purchase
from it.
 Since, firm can sell as much as it likes on the given
price, there is no need for it to charge lower price.
 Hence, the price at which the firm is selling its output
is given and fixed.
 In other words, a firm under perfect competition is a
‘price taker’, i.e. it has to sell at the given market
price.
14
Therefore, the average revenue of the firm
would take the form of a strait line parallel to
the x-axis at a distance which is equal to the
price of the commodity.
When average revenue is constant, marginal
revenue would also constant and equal to it.
Therefore the marginal revenue curve will be
lying at the same place at which the average
revenue curve is lying.
The Short-run equilibrium of firm under
perfect competition can be shown as follows:
15
 Y MC
ATC
Revenue and Costs

E
AR=MR=P

O X
Q Output/Quantity

16
 In the above figure, the price which is determined by the
forces of demand and supply for the industry as a whole
is OP.
 The firm has to sell at this price. Therefore, the AR is
parallel to the x-axis at a distance of OP.
 MR is also equal to the AR and hence, represented by
the same line.
 ATC is average total cost curve, which has a usual U
shape. MC is the marginal cost curve.
 MR and MC are equal at point E.
 After drawing a perpendicular from point E to the x-axis
at Q we get OQ as the level of output which gives
normal profit.
 For the output OQ, the per unit price being EQ, the total
revenue and the total cost of the firm is OQEP.
 Under the given conditions, this is the normal profit,
because it is this OQ level of output where MR=MC.
17