MARKET STRUCTURES NOTES
5.1 Perfect Markets
Perfect market is a market with many buyers and sellers where nobody can
determine the price of goods or services.
Characteristics
- Large number of buyer and sells where each individual firm supplies
part of total quality supplied. Buyers are many such that no
monopolistic powers can affect the working of the markets Under this condition no
individual firm or buyer can affect the market - Free entry and free exist there are no barriers to entry or exit to
the industries. Entry and exit from the industries may take time but
firms have the freedom of movement in and out of the industry. - Product homogeneity The industry is defined as group of firms
producing homogenous product i.e. the technical characteristic as
well as the service associated with product sold are identical.
There is no why is which buyer can differentiate among the products
of different firms.
N/B: Under perfect competition firms
are price takers. Meaning the demand curve of an individual firm will be perfectly elastic showing that the firm can sell any quantity of output at a given or prevailing market price. The concept of price taking is illustrated in
Figure 5.1
- Profit maximization The goal of the firm is profit maximization both
is the short run and in the long run. No other goal is pursued. - No government regulation. There is no government intervention in the
operation of this market. - Perfect mobility of factors of production. Factors are free to move
from one firm to another throughout the economy. It is assumed that
there is perfect competition on the factor market. - Perfect knowledge All sellers and buyers are assumed to have complete
knowledge about the conditions in the market. This knowledge refers not
only to prevailing condition in current but also for future periods. The
revenue position of a perfectly competitive firm In perfect competition
since each unit of out is sold at the same price both the average and
marginal revenue are constant. This is illustrated in Table 5.1
The short run Recall that the short run is the context the theory of the
firm is the period in which the quality of at least one factor of
production is fixed. The level of output during this period of time can
alter the utilization of variable factors. In the short run is the
perfect competition can make normal profit, abnormal profits or losses
Normal profit This refers to the minimum level of profit which a firm
must make in order to induce it to remain in operation. The level of
normal profit varies from one industry to the other. This because of
different level of risk and nature of the production process
involved in different industries. Normal profits may be considered be
just past cost of production line since production will not continue
unless at least this level of profit is attained.
From Figure 5.3 when the level of output is Q2 the cost for unit is EQ2
and the price DQ2 supernormal profit is equal to CPDE which is
represented by the scheduled area.
5.2 Monopoly
Monopolies are usually associated with economies of scale because of the
large size of the market controlled by the firm. Economies of scale
imply lower unit’s costs of production. It is likely that the consumer
will benefit from this cost effectiveness through lower prices from a
monopoly supplier. A monopolist like any other firm finds profit
maximizing level of output where the marginal revenue is equal to
marginal cost as shown in Figure 5.4. Monopoly firm maximizes profit at
the level of output Q where the necessary and sufficient conditions of
profit maximization are satisfied. The super normal profits earned by
the monopolist are represented by the shaded area PCBX. This monopolist
profit will persist in the long run since the are barriers to the entry
in the industry. In the long run the monopoly can expand or use the
existing plants at any level that will maximize profit. Owing to the
existence of barriers it is unnecessary for the monopolist to reach the
optimum scale of production which corresponds to the minimum point of
the long run average curve.
Sources of Monopoly Power
Legal barriers This takes the form of statutory monopolies or patents
i.e. monopolies established by an Act of parliament and patent meaning
that a firm is protected from competition of new firms. Products
differentiation barrier This may be in form of product uniqueness,
advertisements and branding where an existing monopolist may exploit his
position as a supplier of an established products which the customer is
persuaded to believe that it is the best.
Economies of scale barriers could arise where existing firms are already
operating on a vast scale production and enjoying technical economies of
sale. Transport cost and tariff barriers Some firms may enjoy local
monopoly position arising from the ability to sell more cheaply in their
own localities than other firm. Such firms can therefore rise prices in
their local markets above the production cost by an amount that does not
exceed transport cost close of firm in other localities with similar
production cost
Advantages of monopolies
- Economies scale
- No wastage of resources
- Price stability since monopolists are price makers
- Ability to carry out research and development to improve on their
product
Disadvantages
- Diseconomies of scale arises in case the firm grows in a very large
size, exploits the economies of scale and fails to achieve the
targeted economies of scale. - Inefficiency since there is no competition
- Lack of motivation though the firm is in a better financial position
to research and develop there product the monopoly may fail to do so
since there is no competition or a challenging firm. - Consumers‟ exploitation .This is the most notorious practice of
monopoly. This is done through overpricing and price discrimination
of their products.
What is Price Discrimination ?
This exists where the same product is sold at different prices to
different buyers. This depends on the tastes and preferences of the
consumers, different periods of the firm, consumers‟ income etc. These
factors will give rise to a demand curve with different elasticities in
different areas in the markets for the firms. Price discriminates is
easily implemental by a monopolists since he controls the whole supply
of a given good. There are two necessary conduction for price
discrimination to take place:
- The monopolist must effectively separate markets. If he has not
separated the market the customers in the low price market will buy and
sell the commodities those consumers in the higher price market. - The price elasticity of demand for the two markets must be different
so that profitability will be realized. At every price the demand in any
market must be elastic than the other where the low priced market have a
more elastic demand than the high priced market. By selling the quality
dined by the equation MC and MR at different price the monopolist
realizes a higher total revenue and profits, the monopolists realizes a
higher total revenue and profits as compound to charging uniform prices.
N/B: suppose that a monopolist has two markets M1 and M2 the profit in
each market maximized by equating marginal cost to the corresponding
marginal revenue i.e.
In the first market; MR1=MC1
In the second market; MR2=MC2
That mean monopolist will maximize profit by equating the common market
cost with
the individual market revenues as MC=MR1=MR2
5.3 Monopolistic Competition
This is a form of imperfect competition which lies between the extremes
of perfect competition and monopoly and includes elements from both
markets. Examples include: restaurants, hair dressers etc
Characteristics
1 There are many buyers and sellers in the market
2 The product of the sellers is differential yet very close substitute
for each other
3 There is freedom of entry and exist of firms
4 The goal of the firms is profit maximization both in the short run and
in the long run.
5 The prices of factors of production and technology are given. Under
this competition, each producer sells a product which is to slightly
different from that of the competitor and attempts to emphasize on
differences like packaging and advertisements.
This process of creating the differences is called product
differentiation which is aimed at creating brand loyalty. The firm
demand curve will be relatively elastic since the products sold by the
competition will be relatively close substitutes. Monopolistic firm
sells differentiated products therefore have limited control over the
price. They are prices makers since they can raise their prices without
loosing their customers and have to reduce the prices in order to sell
more Short run equilibrium in monopolistic competition
In Figure 5.5 a firm operating under monopolistic competition makes
supernormal profit in the short run as shown by PCAB. The supernormal
profit will attract new firms into the industry and the surplus profit
will be reduced to normal profit in the along-run as
shown in Figure 5.6
A firm in monopolistic competition in the long run will make normal
profit since average revenue will be equal to average cost. The
existence of many brands enhances the consumer choice and ability.
However it is considered wasteful because of existence of excess
capacity shown by (Q2-Q1) which is carried (borne) by the consumer
through prices. It is also in wasteful since the resources that could
have been used in expansions and exploitation of economies of scale are
used in advertising.
5.4 Oligopoly
This refers to the market structure dominates by large few firms. The
number of sellers (firms) is small enough for other sellers to take
account of each other i.e. if one seller changes his prices or uses non-
price strategies his/her rivals would react. This is called
oligopolistic dependency.
Characteristics
- Contains few firms who produce goods that are substitute but need to
be perfect substitutes.
2 Lies somewhere between extreme of perfect competition are monopoly.
3 There are barriers to the entry.
4 Decision of the firms are strictly interdependent
5 Sellers agrees on the price or the market share
Forms of oligopoly
- Duopoly where market is dominated by two firms
- Pure oligopoly where the products of the few sellers are identical.
- Differentiated oligopoly where products are differentiated in term
of quality packaging etc. - Collusive oligopoly where the few sellers in the market come
together and make decisions to control the prices, quality and
quantity to be produced. - Non collusive oligopoly where the few sellers determine their
prices, quality and quantity without colluding.
Kinked Demand Curve
The interdependence in oligopolistic firms explains the price rigidity
among the firms. The theory of kinked demanded curve suggests that firms
in oligopoly face two sets of demand curves.
- Price increase
- Price reduction which is slightly inelastic
For price increases the firm is an elastic demand curve dd. For price
decreases it is on the inelastic demand curve DD. This means the actual
demand curve for firms is represented by dED. The demand is said to have
a kink at point E associated with the price P1 and quantity Q1. All
firms in the industry are assumed to be in a similar position which
implies that if a firm raises its prices and its competitor fails to
follow suits then, it will loss large sales of revenue. This firms is on
the elastic portion of the demand curve
If one firm reduces prices then, its competitors will have to reduce
their price by at least a much or even more to retain the market share. When the price is lower each firm has
the same market share which implies that the firms are on the inelastic
portion of the demand curve. Collusion will take the form of agreeing
the prices for each market share. This is done in order for the
oligopolistic firms to maximize their joint profits and reduce
uncertainty. A form of open collision is known as a cartel whereby firms
produce differently but act like determinants of price and output.
Figure 5.8 shows the Equilibrium of an oligopolistic firm facing kinked
demand curve.
The marginal revenue is discontinuous at the output level where there is
a kink in the demand curve. The kink in the demand curve explains the
nature of the marginal revenue curve. Where at point E and output Q the
marginal revenue curve falls vertically since at the higher price the
marginal revenue curve correspond to less elastic demand curve. The firm
maximizes its profit where the marginal cost is equal to marginal
revenue. Its is very likely that the marginal cost curve will cut the
marginal revenue curve between point X and Y which corresponds to the
discontinuous part of marginal revenue curve.
Find Other Topics On Micro-Economics Here
INTRODUCTION TO ECONOMICS
DEMAND AND SUPPLY-Micro Economics
THEORY OF CONSUMER
THEORY OF PRODUCTION
TYPES OF MARKET STRUCTURES
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