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Chapter 5 updated-1

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Mintesnot Geta
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CHAPTER 5

MARKET STRUCTURE

1
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:
I. Perfectly competitive market,
II. Monopolistically competitive market,
III.Oligopolistic market, and
IV.Pure monopoly market.
2
The concept of market in physical and
digital space
 Market might be defined as 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 (American Marketing Association,1985).
 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, mainly on the
internet including mobile phones, display advertising,
and any other digital media.
3
…cont’d
 Digital marketing channels are systems on the
internet that can create, accelerate and transmit
product value from producer to consumers by
digital networks.
 Physical market is a set up where buyers can
physically meet their sellers and purchase the
desired merchandise from them in exchange of
money.
 The choice of the marketing mainly depends on the
nature of the products and services.
 Market is also defined as an institution that governs
the relationship between buyers and sellers.
4
1. Perfectly competitive market
Characteristics ( Assumptions)
1. Free entry and exit,
2. Large number of sellers and buyers,
3. Homogeneous product,
4. Perfect mobility of factors of production,
5. Perfect knowledge about market conditions,
6. No government interference

5
5.2. Perfectly competitive market
 From the assumptions, a single producer under
perfectly competitive market is a price-taker.

6
TR and MR of a Competitive firm
 Total Revenue (TR): it is the total amount of
money a firm receives from a given quantity of
its product sold.
 It is obtained by multiplying the unit price of the
commodity and the quantity of that product sold.
𝑻𝑹 = 𝑷 . 𝑸
where P = price of the product
Q = quantity of the product sold.
 Average revenue (AR):- it is the revenue per unit
of item sold. It is calculated by dividing the total
revenue by the amount of the product sold.
𝑻𝑹 𝑷𝑸
𝑨𝑹 = = =𝑷
𝑸 𝑸 7
Marginal Revenue
 Thechange in total revenue due to the change in
output sold.
∆𝑇𝑅 𝜕𝑇𝑅
𝑀𝑅 = or 𝑀𝑅 = = 𝑃 = 𝐴𝑅 = 𝐷𝑓
∆𝑄 𝜕𝑄

=>
8
Short run equilibrium of the firm
 Since the purely competitive firm is a price taker, it
will maximize its economic profit only by adjusting
its output.
 Two approaches
Total Approach (TR-TC approach)
Marginal Approach (MR-MC)
 Total Approach
According to this approach a firm is recommended
to produce the quantity of output at which the
difference between total revenue and total cost is
maximum.
That is Q at which 𝑻𝑹 − 𝑻𝑪 = 𝒎𝒂𝒙
9
Graphically,

10
Marginal Approach (MR-MC)
 In the short run, the firm will maximize profit or
minimize loss by producing the output at which
marginal revenue equals marginal cost.

 Thatis, produce Q at which


𝑀𝑅 = 𝑀𝐶 … … … … … … … … … … … … . 𝑓𝑜𝑐
𝑀𝐶 𝑟𝑖𝑠𝑒𝑠 𝑜𝑟 𝑖𝑡𝑠 𝑠𝑙𝑜𝑝𝑒 𝑖𝑠 𝑝𝑜𝑠𝑖𝑡𝑖𝑣𝑒 … . . 𝑠𝑜𝑐

Mathematically
𝑚𝑎𝑥П(𝑞) = 𝑇𝑅(𝑞) − 𝑇𝐶(𝑞)

11
Marginal Approach (MR-MC)

 The profit maximizing output is 𝑄𝑒 , where MC=MR


and MC curve is increasing. At Q*, MC=MR, but
since MC is falling at this output level, it is not
equilibrium output. 12
Graphically

13
Short Run Profit of a firm
 Depending on the relationship between price and AC
of a perfectly competitive firm Profit might be;
Positive ( above normal)
Zero ( normal)
Negative ( loss)

 Positive
profit (above normal) – also known as
economic profit.
𝑇𝑅 − 𝑇𝐶 > 0 or 𝑇𝑅
𝑄
>
𝑇𝐶
𝑄
⇒ 𝑇𝑅 > 𝑇𝐶 ⇒ 𝐴𝑅 = 𝑃 > 𝐴𝐶
⇒ Gross profit>0 ⇒ 𝑢𝑛𝑖𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 > 0
14
Positive profit

15
Zero (normal) profit or Break-even point
𝑇𝑅 − 𝑇𝐶 = 0 or 𝑇𝑅
𝑄
=
𝑇𝐶
𝑄
⇒ 𝑇𝑅 = 𝑇𝐶 ⇒ 𝐴𝑅 = 𝑃 = 𝐴𝐶
⇒ 𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 = 0 ⇒ 𝑢𝑛𝑖𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 = 0

16
Loss ( Below normal) profit
𝑇𝑅 − 𝑇𝐶 < 0 or 𝑇𝑅
𝑄
<
𝑇𝐶
𝑄
⇒ 𝑇𝑅 < 𝑇𝐶 ⇒ 𝐴𝑅 = 𝑃 < 𝐴𝐶
⇒ 𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 < 0 ⇒ 𝑢𝑛𝑖𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 < 0

17
Shutdown point
 The firm will not stop production simply because it
incurs loss ( 𝐴𝐶 > 𝑃).
 The firm will continue to produce irrespective of
the existing loss as far as the price is sufficient to
cover the average variable costs.

 This means, if 𝑃 > 𝐴𝑉𝐶 but 𝑃 < 𝐴𝐶 , the firm


minimizes total losses.
 But if 𝑃 < 𝐴𝑉𝐶, the firm minimizes total losses by
shutting down.
 Thus, 𝑃 = 𝐴𝑉𝐶 is the shutdown point for the firm.
18
Shutdown point

19
Numerical example
Example: Suppose that the firm operates in a
perfectly competitive market. The market price of
its product is $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?
20
Short run equilibrium of the industry
 An industry is in equilibrium in the short-run when
market is cleared at a given price i.e. when
the total supply of the industry equals the total
demand for its product, the prices at which
market is cleared is equilibrium price.
Graphically,

Q
21
2. Monopoly Market
 Definition and characteristics
 A monopoly is a market with a single firm that
produces a good or service for which no close
substitute exists and that is protected by a barrier
that prevents other firms from selling that good or
service.

Examples of monopolists in Ethiopia includes,


•The Ethiopian Electric Power Corporation
•Ethiopian Airlines (Domestic flight)
•Urban water supply service
The market in which we buy services provided by
these monopolists is called monopoly market. 22
Characteristics (Assumptions)
 The main characteristics of this market structure
include:
 Blocked entry ( entry barrier) =>economic, legal,
technological etc.

 There is only one (single) seller, the monopolist,

 The product is unique: product is said to be unique


when it has no close substitutes.

 A monopolist is Price maker => downward


demand curve => MR ≠ 𝑃 = 𝐴𝑅.
23
Sources of monopoly power
 Sources of monopoly power are sources of
barriers to entry and includes;
 Legal restriction: Some monopolies are created
by law in public interest. Most of the state
monopolies in the public utility sector including
postal service, telegraph, telephone services, radio
and TV services, generation and distribution of
electricity, rail ways, airlines etc… are usually public
monopolies.
 Control over key raw materials,
 Efficiency
 Patent rights:
24
3. Monopolistically competitive Mkt

 A market structure in which large number of


sellers and buyers make transaction over
heterogeneous or differentiated products.

 There is free entry and exit sellers

 Many sellers and buyers,

 Products are differentiated (heterogeneous)

 Existence of non-price competition.


25
4. Oligopoly
 Its an imperfect market in which only few firms sell
either homogenous or heterogeneous products .

Characteristics (Assumptions)
 There is/are entry barrier/s,
 Existence of few dominant firms,
 Interdependence among firms,
 Products may be either homogenous or
differentiated.
 Non-price competition:

 Duopoly: a special type of oligopoly in which there


are only two firms in the market. 26
Summery

27

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