12/5/2021

Ministry of Education,
ETHIOPIA
INSTRUCTOR: ERMIYAS ABEBE (JIGJIGA UNIVERSITY)

INTRODUCTION TO ECONOMICS
UNIT 5-PART 1
Market Structure

Content

Chapter 5 Part 1
Market Structure

 Perfect Competitive
 Monopoly
 Monopolistic Competition
 Oligopoly

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Introduction
 This chapter discusses how a particular firm makes a decision to achieve
its profit maximization objective.
 A firm‘s decision to achieve this goal is dependent on the type of market in
which it operates.
 To this effect we distinguish between four major types of markets:
perfectly competitive market, monopolistically competitive market,
oligopolistic market, and pure monopoly market.

The concept of market in physical and digital

 Comprehensive definition of market according to American Marketing

Association (1985) is the process of planning and executing the conception,
pricing, promotion, and distribution of goods, services and ideas to create
exchanges that satisfy individual and organizational objectives.
 So market describes place or digital space by which goods, services and ideas are
exchanged to satisfy consumer need.
 Digital marketing is the marketing of products or services using digital
technologies,
 Physical market is a set up where buyers can physically meet their sellers and
purchase the desired merchandise from them in exchange of money.

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Perfectly Competitive Market

 Perfect competition is a market structure characterized by a complete
absence of rivalry among the individual firms.
5.2.1 Characteristics of Perfectly Competitive Market
 Large number of sellers and buyers:
 Homogeneous product
 Perfect mobility of factors of production
 Free entry and exit
 Perfect knowledge about market conditions

 From these assumptions, a single producer under perfectly

competitive market is a price-taker.
 That is, at the market price, the firm can supply whatever quantity it
would like to sell.
 Once the price of the product is determined in the market, the
producer takes the price (Pm in the figure below) as given.
 Hence, the demand curve (Df) that the firm faces in this market
situation is a horizontal line drawn at the equilibrium price, Pm.

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Individual and market demand curve

P P

Ss

Pe Eq Pe Dd

Dd

Q Q1 Q2 Q3 Q4 Q5 Q
Market Demand & Supply Demand Curve of the Firm

• Monopoly Market
 Pure monopoly exists when a single firm is the only producer of a product for
which there are no close substitutes.
1. Single seller
2. No close substitutes
3. Price maker
4. Blocked entry

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5.3.2. Sources of monopoly

i) Legal restriction
ii) Control over key raw materials
iii) Efficiency
iv) Patent rights

Monopolistically Competitive Market

 This market model can be defined as the market organization in
which there are relatively many firms selling differentiated
products. It is the blend of competition and monopoly.
 Differentiated product
 Many sellers and buyers
 Easy entry and exit
 Existence of non-price competition

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Oligopoly market
 This is a market structure characterized by:
 Few dominant firms
 Entry barrier
 Products may be homogenous or differentiated. If the product is
homogeneous, we have a pure oligopoly. If the product is differentiated,
it will be a differentiated oligopoly. A special type of oligopoly in which
there are only two firms in the market is known as duopoly.

Summary
Characteristics Market Models
Perfectly Monopolistic Oligopoly Pure Monopoly
Competitive Competition
Number of Firms Large Many Few One

Types of Products Homogeneous Differentiated Homogeneous or Unique

Differentiated

Control over None Some Limited by Mutual Significant

Price interdependence
Condition of Very Easy Relatively Easy Considerable Blocked
Entry Barriers
Examples Agricultural Clothes, Shoes Steel, Automobiles Local Utilities
Products

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Ministry of Education,
ETHIOPIA
INSTRUCTOR: ERMIYAS ABEBE (JIGJIGA UNIVERSITY)

INTRODUCTION TO ECONOMICS
UNIT 5-PART 2
Perfect Competition; Short-Run Market Equilibrium

Content

Chapter 5 Part 2
Market Structure

Perfect Competition: Short run equilibrium of the firm

 Total Approach
 Marginal Approach

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Individual and market demand curve

P P

Ss

Pe Eq Pe Dd

Dd

Q Q1 Q2 Q3 Q4 Q5 Q
Market Demand & Supply Demand Curve of the Firm

Perfect Competition
Short run equilibrium of the firm
 The main objective of a firm is profit maximization.
 If the firm has to incur a loss, it aims to minimize the loss.
 Profit is the difference between total revenue and total cost.
Π = TR – TC
Π: Profit
TR: Total Revenue
TC: Total Cost

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Revenue
 Total Revenue (TR): it is the total amount of money a firm receives from
a given quantity of its product sold.
TR=P X Q
 Average revenue (AR):- it is the revenue per unit of item sold.
AR = TR/Q = (PQ)/Q = P , Hence AR curve is also firm’s demand curve
 Marginal Revenue: it is the change in total revenue resulting from the
sale of an extra unit of the product.
MR=ΔTR/ΔQ = Δ(PQ)/ΔQ = (PΔQ)/ΔQ = P, Hence MR curve is also firm’s
demand curve
 Thus, in a perfectly competitive market, a firm‘s average revenue,
marginal revenue and price of the product are equal, i.e.
AR = MR = P =Ddf

 Since the purely competitive firm is a price taker, it will maximize its
economic profit only by adjusting its output.
 In the short run, the firm has a fixed plant. Thus, it can adjust its output
only through changes in the amount of variable resources.

 There are two ways to determine the level of output at which a

competitive firm will realize maximum profit or minimum loss.
1. Total Approach: compare total revenue and total cost
2. Marginal Approach: Compare marginal revenue and marginal cost.

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a) Total Approach (TR-TC approach)

 In this approach, a firm maximizes total profits in the short run when the
(positive) difference between total revenue (TR) and total costs (TC) is
greatest.
TC
TR, TC
TR

Maximum
Profit

Zero
Maximum Profit
Lose

Q* Q2 Qe Q

b) Marginal Approach (MR-MC)

 The perfectly competitive firm maximizes its short-run total profits at the output
when the following two conditions are met:
1. MR = MC First Order Condition
2. The slope of MC is greater than slope of MR; or MC is rising (that is, slope of MC is
greater than zero).  Second Order Condition
Π = TR – TC
1. Profit will be at its maximum or minimum where the first derivative of Π with
respect to Q equals zero.
d Π/d Q = d (TR – TC) /d Q = (d TR /d Q) – (d TC /d Q) = MR – MC = 0
MR = MC
2. If we say slop of MC > slop MR, it means that Slop of MC > 0 because slop of MR =0

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Graphically
 Qe is profit
maximizing output
MR,
MC, MC
P

MR = P = Dd

Q* Qe Q

Profit
 Whether the firm in the short- run gets positive or zero or negative profit
depends on the level of ATC at equilibrium.
 Π = TR – TC MR, MC
 TR = PQ MC,
ATC
 TC = ATC * Q P

P MR = P = Dd
Profit
Total Revenue
Total Cost
Qe Q

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Normal Profit/Zero Profit/ Break-Even Point

MR,
MC, MC
P ATC

Total Revenue
Total Cost
Q
Qe
Qe

Lose

MR, MC
MC,
ATC
P

Lose MR = P = Dd
P
Total Cost
Total Revenue

Qe Q

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Shut-Down Point
 Supply curve of the
firm is the increasing
MR, MC portion of MC
MC,
ATC
P Ss
AVC

P Total MR = P = Dd
Total
Cost
Variable
Revenue
Cost
Qe Q

Numerical Example
 Suppose that the firm operates in a perfectly competitive market. The market
price of its product is birr 10. The firm estimates its cost of production with
the following cost function: TC=2+10Q-4Q2+Q3

A) What level of output should the firm produce to maximize its profit?
B) Determine the level of profit at equilibrium.
C) What minimum price is required by the firm to stay in the market?

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Solution
Given: TFC= 2, TVC=10Q-4Q2+Q3 TC=2+10Q-4Q2+Q3, P=MR= 10birr

A) What level of output should the firm produce to maximize its profit?
The conditions of profit maximizing; MC = MR and MC is increasing (Slop
of MC>0)
1st Order Condition
MC= d TC/ d Q = 3Q2-8Q+10
MC=MR  3Q2-8Q+10 = 10
3Q2-8Q = 0
Q(3Q-8) = 0
Hence, Q= 0 or Q= 8/3

Cont…
2nd Order Condition
Slop of MC>0
Slop of MC= d MC/ d Q = 6Q-8
CHECK, Q= 0 or Q= 8/3
Q= 0; Slop of MC= 6Q-8 = 6*0-8= -8
Q= 8/3; Slop of MC= 6Q-8 = 6*(8/3)-8= 8
Q = 8/3 satisfies both conditions.
Hence, Q= 8/3 is the equilibrium quantity

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B) Determine the level of profit at equilibrium.

Qe= 8/3 and P= 10
Π = TR – TC
Π = PQ – (2+10Q-4Q2+Q3)
Π = 10*8/3 – (2+10(8/3)-4(8/3)2+(8/3)3)
Π = 80/3 – 518/27
Π = 7.48

C) To stay in operation the firm needs the price which equals at least
the minimum AVC. Thus, to determine the minimum price required to
stay in business, we have to determine the minimum AVC.
AVC= TVC/Q=(10Q-4Q2+Q3)/Q = 10-4Q+Q2
d AVC/d Q = 2Q-4 = 0
2Q = 4
Q=2
P = AVC = 10-4Q+Q2 = 10-(4*2)+(2)2 = 6
Hence, P = 6 is the minimum price to stay functional in the market

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Short run equilibrium of the industry

 Since the perfectly competitive firm always produces where P =MR=MC (as
long as P exceeds AVC), the firm‘s short-run supply curve is given by the
rising portion of its MC curve above its AVC, or shutdown point.
 The industry/market supply curve is a horizontal summation of the supply
curves of the individual firms.
 An industry is in equilibrium in the short-run when market is cleared at a
given price.
 When an industry reaches at its equilibrium, there is no tendency to expand
or to contract the output.

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