MBA

ECONOMICS
LECTURE
WEEK 8 &9

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 Competition
&
Market Structure

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 Market Structures
A system for grouping and analyzing
markets according to the degree and
type of competition among sellers.

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 Market Structures
The greatest influence over the price and non price
decisions of a firm and its ability to earn economic
profit over the long run is the competition it faces in
its market. All other things being equal.

The greatest influence over the

(1) Price Behavior
(2) Non price Competition
(3) Economic Profit

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 Behavior Influence
Some businesses have great control over the
prices they charge for their products, while
others have little or no control.
Some spend millions of dollars on TV and
print advertising and public relations, while
others spend nothing.

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 Behavior Influence
The greater the competition in a market, the less control
a business in that market has over the price it charges,
and the less likely the firm is to earn economic profit
on an ongoing basis.

The less the competition in a market, the greater the

control a business has over the price it charges, and the
more likely the firm is to earn economic profit over the
long run.

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 Market Structures
Economists have adopted four market structures to
represent different competitive situations:

1. Pure competition,
2. Monopolistic competition,
3. Oligopoly,
4. Monopoly.

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Industry & Market (Structure)
Industry
A group of firms producing similar
products or using similar processes.

Market
Includes firms that sell similar products
and compete for the same buyers.

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 Boundaries of a market
(1) Geographic Boundary of a Market
Defined by the geographic area in which
sellers compete for buyers.

(2) Product Boundary of a Market

Defined by product substitutability among
buyers.

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MARKET STRUCTURES STUDY
The degree of competition that a business faces
in a market influences its behavior with regard
to the prices it charges, the profit it makes, and
the non price competition it uses.

Economists have created four models of market

situations, called market structures, to represent
degrees of competition and study their effects:

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 Models of Market Situations
♦ Number of sellers.
The number of sellers in the market is important to the amount of competition.
A market may have one seller, thousands of sellers, or some number in between.

♦ Product type.
The product sold in the market can be identical from seller to seller or be
differentiated. If a firm can distinguish its product from those of its competitors
through size, color, or any other attribute, then non price competition can arise.

♦ Entry and exit.

The ease or difficulty with which firms can enter or leave the market affects
competition. It may be extremely easy for new firms to begin selling in the
market, or it may be virtually impossible.

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PURE COMPETITION
A market with a large number of
independent firms selling identical
products, and with easy entry into and
exit from the market.

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 PURE COMPETITION
The characteristics of purely competitive market is:
♦ Very large number of sellers
(Acting independently of each other.)
♦ The products offered for sale are identical:
(Buyers cannot distinguish the product of one seller from that
of another.)
♦ Entry by business firms into a purely competitive
market is easy, as is exit
from the market.
(There are no legal restrictions, fees, impossibly high capital
requirements, patents, or other barriers to entry.)

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Behavior of a Firm in Pure Competition
(1) Control over Price
A seller with no control over the price of its
product; takes the market price. (Price
Taker)
Price Set By
Competitive Force
Market Demand & Supply
Decision of Buyers & Sellers

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 Behavior of a Firm in Pure Competition

(2) Demand for an Individual Firm’s Product

Downward-sloping market demand curve

Market Demand Curve

The demand curve for all buyers in the market together.
Individual Firm’s Demand Curve
Shows the amounts of an individual firm’s product
that buyers are willing to purchase at particular prices.

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 Behavior of a Firm in Pure Competition
(3) Pricing, Profit, and Loss
Occurs when price is greater than, less than, or equal to
average total cost, respectively.

(4) Non price Competition

Have no need to engage in non price competition.
Non price Competition
Firms focus on a feature other than price to attract
buyers to their products.

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 Behavior of a Firm in Pure Competition
(5) Long-Run Costs, Profit, and Efficiency

♦ The cost of production is as low as it can possibly be

so firms are operating efficiently;
♦ The price of the product is as low as it can possibly
be; and
♦ The consumer pays no economic profit.

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Monopolistic Competition
Market structure characterized by a
large number of sellers with
differentiated outputs and

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 Monopolistic Competition
The characteristics of monopolistic competition are.

♦ A large number of sellers—not as many as in pure

competition, but a large number nonetheless;
♦ Differentiated products—buyers can distinguish
among the products of different sellers; and
♦ Fairly easy entry into and exit from the market.

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 Behavior of a Firm in Monopolistic
Competition
(1) Control over Price -----Limited Control on price

There is also a large number of sellers, but because the

sellers’ products are differentiated, buyers do not view
the product of one seller as a perfect substitute for the
product of another. For this reason, when a
monopolistically competitive firm raises its price, it
will lose some, but not all, of its buyers.

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 Behavior of a Firm in Monopolistic
Competition
(2) Demand for an Individual Firm’s Product

Because of product differentiation, the demand curve

faced by an individual monopolistic competitor is
downward sloping, This demand curve shows that if
the firm raises its price, it will lose some, but not all, of
its buyers.

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 Behavior of a Firm in Monopolistic
Competition
(3) Pricing, Profit, and Loss
Just like other firms, the profit or loss position of a seller in a
monopolistically competitive market can be determined by
comparing the demand curve and average total cost curve for its
product.

If the average total cost curve lies below the demand curve, or the
cost per unit of output is less than the price, an economic profit is
earned.

If the average total cost curve is above the demand curve, or the cost
per unit of output is greater than the price, a loss occurs.
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 Behavior of a Firm in Monopolistic
Competition
(4) Non price Competition
Non price competition takes all kinds of forms: packaging,
parking, facility ambiance, service, location, quality,
selection, and guarantees to name a few.

(5) Long-Run Costs, Profit, and Efficiency

Over the long run, sellers in monopolistically competitive
markets earn only normal profits, just like firms in purely
competitive markets. This occurs because, like purely
competitive markets, monopolistically competitive markets
are easy to enter and exit.
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 OLIGOPOLY
A market dominated by a few large sellers;
products are differentiated or identical;
entry into the market is difficult.

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 OLIGOPOLY
In an oligopoly
♦ The market is dominated by a few large sellers, but there
may also be small fringe sellers in the market as well;

♦ The products of the sellers may be differentiated or

identical; and

♦ Entry of firms into the market is quite difficult because

of barriers to entry such as the financing needed to enter
the market and be large enough to compete.

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 Behavior of a Firm in an Oligopolistic
Market
(1) Control over Price
With few sellers in an oligopoly, each of the dominant firms has a
large share of the market. A large market share allows the firm
some control over its price—more so than a monopolistic
competitor who also has some control because of a differentiated
product but faces a large number of rivals.
In the oligopolistic market structure, sellers are constantly watching
and weighing the actions and reactions of their competitors. This
phenomenon is called mutual interdependence.
Mutual Interdependence
So few sellers exist in the market that each seller weighs the
actions and reactions of rivals in its decision making.

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 Behavior of a Firm in an Oligopolistic
Market
(2) Price of an Individual Firm’s Product
Two of the best-known theories are leadership pricing and the kinked
demand curve model.

Leadership Pricing
One firm in a market sets a price that the other firms in the market then
adopt.

Kinked Demand Curve

Assumes that rivals will not follow price increases but will follow price
decreases; illustrates that as a seller’s price rises, the amount of its
product demanded decreases substantially, but as its price falls, the
amount demanded increases only slightly.
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 Behavior of a Firm in an Oligopolistic
Market
(3) Non price Competition
The degree of non price competition found in an oligopoly market
depends on the extent to which the products are identical or
differentiated.

Where competitors sell largely identical products, spending money on

product promotion could end up benefiting all firms in the market,
rather than just the individual firm that makes the expenditure.

On the other hand, a strong promotional campaign emphasizing a

seller’s product makes sense when the products are clearly
differentiable on the basis of quality, style, size, or some other
characteristic.
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 Behavior of a Firm in an Oligopolistic
Market
(4) Long-Run Costs, Profit, and Efficiency
With oligopoly, entry is not easy. Therefore, oligopolies can continue
to earn economic profit over the long run because new sellers
cannot readily enter the market.

The ability to earn economic profit over the long run affects the
price buyers pay for a product. The firm’s price can be greater than
its cost. Thus, over the long run, restricted entry may result in
economic profit for the firm and in higher prices for the buyer.

Restricted entry may also allow an oligopolies to operate

inefficiently over the long run.
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 MONOPOLY
A market with one seller that
maintains its position because entry
by new sellers is impossible.

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 MONOPOLY
In a monopoly market there is

♦ Only one seller—the monopolist;

♦ No need to consider the issue of product
differentiation since there is just one seller; and
♦ No possibility of entry by new sellers.

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 MONOPOLY
Natural Monopoly
It is more efficient (less costly) to have the entire
product in a market come from one large producer
rather than from several smaller producers.

Cartel
An arrangement whereby sellers formally join
together in a market to make decisions as a group on
matters such as pricing.

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 Behavior of a Monopolist
(1) Control over
Price Because it is the only seller in its market, there are two
important points to consider about a monopolist’s pricing.

First, all other things being equal, a monopolist has more control
over its price than does a firm in any other market structure. There
are no direct competitors to take buyers away when a monopolist
raises its price.

Second, because the monopolist is the only seller in its market, its
demand curve is the market demand curve: All buyers demanding
the product demand it from the monopolist.
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 Behavior of a Monopolist
(2) Demand for a Monopolist’s Product
Market demand curves are downward sloping,
Price Searcher
A firm that searches its downward-sloping demand
curve to find the price–output combination that
maximizes its profit.

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 Behavior of a Monopolist
(3) Non price Competition
Because monopolists face no direct competitors, they
use Non price competition differently from oligopolies
or monopolistic competitors, who use it to attract
buyers to a particular brand of a product

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 Behavior of a Monopolist
(4) Long-Run Costs, Profit, and Efficiency
The monopolist enjoys its position as sole seller in its market because
of barriers to entry that keep potential rivals out.

Those same barriers allow the monopolist to make an economic

profit over the long run.

The monopolist can protect its economic profit as long as its

monopoly position can be maintained.

With no competition, the monopolist can operate inefficiently, or at

higher than minimum average cost.
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