Chapter Five: Market structure

5.1. The concept of market in physical and digital space

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 but also
including mobile phones, display advertising, and any
other digital media.
Physical market is a set up where buyers can physically meet
their sellers and purchase the desired merchandise from
them in exchange of money.
 Four major types of markets
• perfectly competitive market,
• monopolistically competitive market,
• oligopolistic market, and
• pure monopoly market.
 Types of markets
Characteristics Market models
Pure competition Monopolistic oligopoly Pure monopoly
competition
Number of firms Large Many Few One or single
Type of product Homogeneous Differentiated Homogeneous or Unique, no
differentiated close
substitutes
Control over price None Some, but within Limited by mutual Significant
rather narrow interdependence
limits and collusion
Condition of entry Very easy Relatively easy Considerable Blocked
barriers/obstacles
Examples Agricultural Clothes , shoes Steel, Local utilities
products Automobiles
 5.2. Perfectly competitive market
Assumptions
1. Large number of sellers and buyers
• the share of each seller in the total supply of a product is very small.
• no single seller can influence the market price by changing the
quantity supply.
• the share of each buyer in the total demand is very small
• no single buyer or a group of buyers can influence the market price
by changing their individual or group demand for a product
• sellers and buyers are not price makers rather they are price takers
• the price is determined by the interaction of the market supply and
demand forces.
 Assumptions of perfectly competitive
market…
2. Homogeneous product:
• buyers do not distinguish between products supplied by the various firms of an
industry
• Product of each firm is regarded as a perfect substitute for the products of other
firms
• no firm can gain any competitive advantage over the other firm.
3. Perfect mobility of factors of production:
• labor can move from one job to another and from one region to another
• Capital, raw materials, and other factors are not monopolized.
4. Free entry into and exit out of the market
5. buyers and sellers have Perfect knowledge about market conditions
6. No government interference:
• no discriminator taxes or subsidies,
• no allocation of inputs by the procurement, or any kind of direct or indirect control.
• the government follows the free enterprise policy.
Individual and market demand curve
 Short run equilibrium of the firm

Total Revenue (TR):

• TR=P X Q, where P = price of the product Q =
quantity of the product sold
• Average revenue (AR)
AR = TR/Q = P.Q/Q =>AR = P
Marginal Revenue:
MR= TR/ Q = (PxQ)/Q = P.Q /Q (because P
is constant) => MR =P
Therefore, AR = MR = P =Df
 Short run Profit of a firm
• Since the purely competitive firm is a price
taker, it will maximize its economic profit only
by adjusting its output.
• It adjusts its variable resources to achieve the
output level that maximizes its profit.
• There are two ways to determine the level of
output
a) Total Approach (TR-TC approach)
b) Marginal Approach (MR-MC)
a) Total Approach (TR-TC approach) of
profit maximization
 b) Marginal Approach (MR-MC) of profit
maximization.
∏ =TR- TC
1.MR = MC ……………… First order condition (FOC)
2. Slope of MC > slope of MR ------- Second order
condition (SOC)
Proof:
MR=MC
The relationship between price and ATC to
determine profit or loss.
loss
 Normal Profit
iii) Normal Profit (zero profit) or break- even point - If the AC is equal to the
market price at equilibrium, the firm gets zero profit or normal profit.
Shutdown point
 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-4q 2 +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?
 Short run equilibrium of the industry

Short run supply

- 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
 Monopoly market
Characteristics:
1. Single seller- is a one firm industry
2. No close substitutes- the monopolist‘s product
is unique
3. Price maker: can change product price by
changing the quantity of the product supplied
- down ward sloping demand curve
4. Blocked entry - because there are barriers
 Sources of monopoly
i) Legal restriction: postal service, telegraph, telephone
services, radio and TV services, generation and
distribution of electricity, rail ways, airlines etc…are
examples
ii) Control over key raw materials/ raw material
monopolies.
iii) Efficiency/ natural monopolies- economies of scale-
produces at minimum cost, can eliminate the
competitors by curbing down its price for a short period
.
iv) Patent rights/patent monopolies
 Monopolistically competitive market
This market is characterized by:
(i) Differentiated product: similar but not identical in the eyes of
the buyers
-The difference could be in style, brand name, in quality, or others.
-the differentiation of the product could be real (eg. quality) or
fancied (e.g. difference in packing).
(ii) Many sellers and buyers:
(iii) Easy entry and exit:
(iv) Existence of non-price competition: like product quality,
advertisement, brand name, service to customers, etc.
-Many retail trade activities such as clothing, shoes, soap, etc are in
this type of market structure.
 Oligopoly market
• This is a market structure characterized by:
i. Few dominant firms: small firms that each firm recognizes the
actions of other firms, implying that firms are mutually
interdependent.
ii. Entry barrier: The barriers may include economies of scale,
legal, control of strategic inputs, etc.
iii. 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
 Exercise
Review questions
1. Discuss the main assumptions of perfectly competitive market
2. Describe the feature of monopolistic competition that resembles perfect
competitive and the monopolistic market structure.
3. What is the difference between real and fancied differentiation. Explain
using practical examples.
4. What are the similarities and differences between oligopoly and
monopolistically competitive market structure?
5. A firm operates in a perfectly competitive market. The market price of its
product is 4 birr and the total cost function is given by TC= 1/3Q 3 -5Q2
+20Q +50, where TC is the total cost and Q is the level of output.
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?