Market Structures

and Models: Perfect

and Imperfect
Competitions
Prepared and presented by
ProProf. Dr. PGM Mujinja, PhD
SPHSS. MUHAS
November, 2022
Brainstorm!
As a class, do the following:
List a company/companies
that have no real
competition:
List a company/companies
that have a few (one or two)
competitors:
WHAT IS A MARKET

In common parlance, market is assumed to be a place where goods

OR SERVICES are bought and sold.
But in economics, the term ‘market’ does not refer to a specific place.
Rather, it is a mechanism through which buyers and sellers come into
contact with each other and buy and/or sell goods at mutually
agreed prices.
 Main features of a market
include:
• (a) Buyers and Sellers: Buyers and sellers must come into
contact with each other for a market to exist. It is only after
the contact between the buyer and the seller, that a
transaction takes place.

• (b) Area: You can easily find a market place nearer to a human
settlement. But in today’s world, the market is not limited to a
particular place. Today, in the age of Internet, we have a
rapidly growing online market which is not limited to any
geographical area. A buyer can place order to buy a good
online. So modern Market exists physically and virtually.
Main features of a market include:

• (c) Commodity or Service: The transaction between

buyer and seller has to be over some good or service,
which become the integral part of a market.
• (d) Different forms of Competition: Forms of market
depends on the degree of
• competition among the sellers selling the goods,
where the degree of competition it self is
determined by the inter relationship of among the
goods and services sold by different sellers as well on
number of sellers present in
• the market.
Main features of a market include:
• (e) Money transaction: Money is the mediums of exchange in the
modern day world. Consumers pay money to the seller to buy goods
and services in the
• market. So money and market aare inseperable
List a company/companies
that have many
competitors:
Which situation is best for
consumers (buyers)?
Why?

Which situation describes most

markets?
All of the above are called
Market Structures or Models of
Competition. Each one exists
to some degree in our
economy.

They are important because

the model of competition
determines in a large degree
the availability of products or
service, choice of product and
most importantly price of
 Models of
Competition
How businesses compete and what impact it has on me.
What are Models of
Competition?
• Def. a description of the type of market that a particular business or
industry operates in.
• Also known as Market Structure.
4 Types of Models of
Competition
1. Perfect Competition
2. Monopoly
3. Monopolistic Competition
4. Oligopoly
5. Duopoly
Market forms/structures or
modelsarket structures/
 Basis of different market forms
Some distinguished characteristics are:
(a) Number of Firms: in a market indicates the degree of control of a firm
on the price of a commodity or service
(b) Ease of Entry and Exit of the Firms: leave the market without much
loss, and
profits will be just normal in the long run.
•(c) Degree of Product Differentiation: how unique the product offered
by a particular firm is. higher degree of product differentiation), the
greater is the control exercised by
Perfect Competition

•Def. a market structure in which a large

number of firms (businesses) produce
the same product.

•Only reason to choose one firm over

another is the PRICE
• Perfect and Imperfect Competition  Perfect Competition
• a) b)
Six for Perfect Competition
1. Many buyers and sellers
People have lots of options to choose
whom they buy from.
2. Identical Products: One homogeneous productThere are no
differences between what is sold by different suppliers. They
are exactly the same!
3. Rational self-interested agents  Com
Six Conditions for Perfect
Competition (cont.)
4. Informed Buyers and Sellers
Buyers know the prices and quality of product sold by all venders to make
the best decision
5. Free Market Entry and Exit
Businesses can enter the market when they can make money and exit
when they can’t.
•6. Voluntary exchange

•e) Ra
Six Conditions for Perfect

• Competition is imperfect when one or more of these features

doesn’t apply.

• Various forms/degrees of imperfect competition can be defined as 1)

to 6) are modified in different ways.
 What types of businesses are
Perfectly Competitive?
• Farm Markets (ex. Public Market)
• Many farmers selling their vegetables (Many buyers and sellers)
• A carrot from farmer Brown is equal to a carrot from farmer Jones (Identical
Products)
• Buyers can compare prices and quality by walking the market (Informed
Buyers/Sellers)
• Farmers choose to bring produce or not. Inexpensive to rent a space in the
market (Free Market Entry/Exit)
Are there many perfectly
competitive businesses?
• NO! All 4 of the conditions must be met for perfect competition.
This is very difficult in most industries.
• Often people can only buy from one supplier
• Products are rarely identical
• Buyers often do not know if a product is cheaper/better at a different
supplier
• Barriers to entry prevent free market entry
Barriers to Entry
Def. Factors that make it difficult for new
firms to enter a market.

• Start-up Costs • Technology

Some markets require a high
The expenses that a degree of technological know-
how. As a result, new
new business must entrepreneurs cannot easily
pay before the first enter these markets.
product reaches the Ex. Software and Pharmaceutical
companies
customer.
Ex. Rent, machines,
product, labor, etc.
Types of Imperfect Competition
• Competition is imperfect when one or more of these
features doesn’t apply.
• Various forms/degrees of imperfect competition can be
defined as 1) to 6) are modified in different ways.
• Imperfect competition from a small number of sellers
or from product differences
1.Monopoly (one dominant firm)
2.Duopoly (two dominant firms) : Coke and Pepsi
3.Oligopoly p (a few firms) : Automobile market
4.Monopolistic Competition (many firms with
differentiated products): restaurants
 Imperfect Competition from
Limited Information
• Adverse Selection: bad products or bad customers
that cannot be identified.
• Moral Hazard: customers with unknown WTP buy too
much when others are paying the bill.
• Example: Used cars [adverse selection]
• Used cars often have hidden problems.
• So buyers have low WTP.
• Equilibrium prices are low.
• Owners won’t sell good cars.
• Vicious circle—market works poorly.
Imperfect Competition from Limited
Information
• Example: Health Insurance
• Buyers of health insurance tend to be less healthy than average. [adverse
selection].
• Insured people may see the doctor too often [moral hazard].
• Insurance companies respond with high prices.
• Healthy people don’t want to buy insurance.
• Vicious circle—m—market works poorly.
Imperfect competition in markets
1. Imperfect competition in markets with less-than-
voluntary exchange:
• college textbooks
• healthcare
2. Imperfect competition in markets with irrational
consumers:
• wishful thinking
• temptation
• Irrational Consumers
• Stupidity
• These imperfections can lead to high prices or
inefficiency or both.
Market Power
• A firm has market power if it can raise its prices without losing
all of its customers.
• This happens when no other firm is producing the same (or
very similar) product.
• Differences in products (real or apparent) that create market
power often come from:
• minor product characteristics
• location
• customer service
• marketing
• Most real-world firms obtain some degree of market power
through a deliberate strategy of product differentiation.
• Firms with market power can raise prices and increase profits.
Monopoly
• A firm is a monopoly when it is the only firm producing a given product
or a market dominated by a single seller.
• i.e. when no other firm produces or sells a good substitute for its
product.
• Because the monopoly is the only firm in the market,…
• …the monopoly faces the entire market demand curve.
Monopoly

• They form when barriers prevent competitors from entering the

market.
• The monopoly can create an artificial scarcity by restricting
production.
• Because of the high costs to supply a product.
• They take advantage of their monopoly power and charge high
prices.
• In most developed countries most monopolies are illegal.
What factors allow monopolies to
exist?
• Patents and Copyrights (Intellectual Property Rights)
• Product Patents: New products
• Process Patents: Production processes that lower
costs
• Copyrights: Protects the expression of an idea
• Control over important inputs
• Government Licenses and Franchises
• Decreasing Costs (Natural Monopolies)
• Network economies
Examples of Monopolies

•Tanesco
•Gas and Oil
companies
•AMicrosoft has
been accused and
convicted in court
for having
monopolistic
characteristics
Monopoly: Restricting
• The monopoly faces the market
demand curve.
• To sell quantity Q, the monopoly sets
price P on the demand curve.
• Social surplus would be maximized
producing Q* and setting price P*.
• But by restricting production, the
monopoly can sell at a higher price,
and obtain monopoly rents (taken
from CS). PS Lost CS Lost PS MC QM D,
WTP Q Price PM P* Q* Restricted
Production Monopoly Rent CS
• The monopoly loses some PS because
of reduced production, but at QM,
monopoly rents are larger than the
lost PS.
Monopoly and Social Surplus

• When monopolies raise price and restrict production,…

• consumer surplus is transferred to the monopoly in the form of
monopoly rents,… but the output reduction decreases total social
surplus.
• Monopoly behavior also affects surplus in other more important ways.
 Marginal Revenue and Market
Power
• Total Revenue (TR) is the money a firm obtains by selling its output.
• Marginal revenue (MR) is the additional revenue obtained from selling
another unit of output.
• In a perfectly competitive market,
• a firm’s output does not affect the price,…
• so a competitive firm obtains the same added revenue (the price) for
each additional unit sold.
• Therefore, MR = P.
 Marginal Revenue and Market
Power
• But any firm with market power (including a
monopoly), faces a downward-sloping demand curve.
• Suppose the firm cannot price-discriminate [charge
different prices to different consumers].
• Then, if it lowers the price of an additional unit in
order to sell it,
• it must lower its price for ALL units that it sells.
• To find the marginal revenue, you start with the price
it receives for the additional unit… and then subtract
the revenue loss on its other units caused by the price
drop. Therefore, MR < P.
Marginal Revenue 
• Suppose a firm facing
demand D produces q − 1
units. If the firm produces
one more unit…
• it cannot sell it for more than
price p,…
• so revenue increases by p×1
= p. But the price on the
other q−1 units drops by ∆p,
• so revenue drops back by
(q−1)∆p . Therefore, MR = p
− (q−1)∆p .
Monopolist
• Monopoly earns profits (MR −
MC) on every unit up to and
including 5,…  but he would
lose profits on units 6, 7, 8, etc.
• So he will sell 5 units.
• But society would have
benefited from units 6 to 9,…
because WTP > MC. Social
surplus would have been
positive on tho
Monopolist
• In our example, the
monopolist sells 5 units for
$600 each.
• Cost of each unit
• (MC = ATC) is
• $150. 5(600 – 150) = $2250 .
• In this example, we have so
far assumed that the
• monopolist cannot price-
discriminate [sell to
• different consumers at
different prices].
• What if he could?
Natural Monopolies

• Some monopolies are allowed by the government to exist. Natural

Monopolies are markets that run best when one firm provides all of
the supply.
• Ex. DAWASA Water Authority
• some natural monopoly has open to competition by sharing some
business lines of the company
Government Monopolies

• Patents: Licenses that give inventors the exclusive right to sell their
product for a certain period of time.
• Industrial Monopolies: Rare cases where the government allows an
industry to restrict the number of firms in the market. Ex. M
Monopolistic Competition

• Def. Many companies compete in an open market to sell products

that are similar, but not identical.
 Four conditions of
Monopolistic
Competition
1. Many Firms
Mono. Comp. do not have high start-up costs and so have more firms.

Few Artificial Barriers to Entry

Barriers to entry are relatively low.

2.
Four conditions of
Monopolistic
Competition
3. Slight Control over Price
Firms have some freedom to raise prices because each firm’s goods are a
little different from everyone else’s
4. Differentiated Products
Firms have some control over selling price because they can differentiate, or
distinguish, their products from other products in the market.
What types of businesses are
Monopolistically Competitive?
• Lots! Most markets exist in this model.
• Ex. Soft Drinks
• Coke, Pepsi, Sayona, Mocola, Azam, etc. (many firms)
• Relatively inexpensive to produce, don’t need huge factories, chemicals,
etc. (Few artificial barriers to entry)
• Coke is a little more expensive than Mocola (Slight control over price)
• Some people like Coke more than Pepsi, etc. (Differentiated Products)
So, how do Firms in
Monopolistic Competition get
customers?
• Through Nonprice Competition: a way to attract customers through
style, service or location, but not a lower price.
4 types of Nonprice Competition

1. Characteristics of Goods
Firms distinguish products through size, color, shape, texture or taste
Ex. Coke vs. Pepsi, Lemon Pepsi, Vanilla Coke
2. Location of Sale
A convenience store in the middle of the rural area differentiates by selling
it miles from competitors
4 types of Nonprice
Competition (cont.)
3. Service Level
Some sellers can charge higher prices because they offer customers a higher
level of service
Ex. Fancy sit-down restaurant vs. Mama Ntilie
4. Advertising Image
Advertising creates apparent differences
between products in the marketplace.
Ex. Coca vs. Mocola
Monopolistic vs. Perfect
Competition
`tPerfect Monopolistic
Competition
Prices Lower, firms Higher, firms have
have no control some control
Profit Lower Higher in short term,
s but must work hard
to keep ahead of
rivals
Cost Low costs, no Higher costs for
and variety (identical differentiation, wide
Variet products) variety
Oligopoly

• Def. A market dominated by a few, large profitable firms

IG Derivation of firm A reaction
curve
• Oligopoly is a market structure with few sellers;
• If there are just two firms, the market is called a duopoly
• Firms operating in an oligopolistic market situation may either
collude or act independently.
• As illustrated in given there are two firms operating in the market
and that the B firm produces qB0 units of goods, the A firm’s
optimal output choice must determine the optimal output
combination on the dashed horizontal line generated by point
qB0. Since the A firm maximizes profits, this dashed line must be
tangent to one of its Misoprofit curves, some of which are also
drawn in the Figure. firm increases its output level from qB0 to
qB1,
• The optimal production level for the A firm, given that the B firm
produces qB0, is therefore equal to qA0. Second, if the B
• This reduces the price level in the market and the A firm’s
profitability.
• Consequently, the A firm’s optimal response is then a
reduction in output, from qA0 to qA1.
• Third, similar reactions by the A firm to changes in the output
level of the B firm are given by the dots in Figure
• Connecting all such dots gives the reaction curve of the A firm.
• Fourth, note that if the output level of the B firm is equal to
zero, the A firm’s problem reduces to that of a monopolist.
• Clearly this leads to the maximum attainable profits for the A
firm, at point qmon. The isoprofit curves of the A firm increase
as they approach qmon.
 How do Oligopolies work?
• Collusion: • Cartels:An association by producers
An agreement among members of an established to coordinate prices and
oligopoly to set prices and production.
production levels. Ex. OPEC: Organization of Petroleum
• Price Fixing: Exporting Countries controls the oil supply
An agreement among firms to sell at and manipulates prices of gasoline.
the same or similar prices. Ex. DeBeers controls 80% of world’s
diamonds, keeps prices high by limiting
• Both are Illegal actions supply.
Market Power

Def. The ability of a company to control prices and output

Markets dominated by one or a few firms (monopoly or oligopoly)

have higher prices and lower output. (great market power)
Markets with many sellers (monopolistic and perfect competition)
have lower prices and higher output. (little or no market power)
 Predatory Pricing
• Def. Setting the market price below cost levels for short term to drive
out competitors. Firms in Monopolistic and perfect competition do this
to gain market power.
• Ex. My Bakery shop sells a bread for $0.50 each, even though it costs
me $0.75 to make. I am losing money ($-0.25), but it drives the
competition out of business, so I can raise the price later.
Government and Competition

• The Government keeps firms from controlling prices and supply of

important goods. Antitrust laws are laws that encourage
competition and break up monopolies/oligopolies in the
marketplace
4 forms of Anti-trust Laws

1. Regulating Business Practices

Government can intervene if a firm has too much market power
2. Breaking Up Monopolies
Antitrust laws have been used to break up monopolies (Microsoft)
Antitrust Laws (cont)

3. Blocking Mergers
A merger is a combination of two or more companies into one firm. The
government can block this if it decreases competition
4. Preserving Incentives
Guidelines on mergers are introduced allowing companies to merge if they
show benefits to consumers.
 Deregulation
• Def. The removal of some government controls over
a market. It is used to promote competition.
• Deregulation allows more competition in a market,
lowers prices and increases variety (benefits), but
often can lead to layoffs and business closings
(negatives) in the short term because of the change.
• Ex. Airline Deregulation in the early 1980s. New,
smaller, cheaper airlines emerged, but the older,
larger airlines are having trouble competing and
have had to cut back on flights, employees, and
benefits (in-flight meals etc.)