Basic Microeconomics Chpater 10

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5/19/12 Prepared by Mr. Festus

Market Structures

Chapter 10

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Perfect Competition

Perfection is something that wecan just imagine. But althoughperfection doesnt exist, that

doesnt stop us from imaginingwhat something perfect lookslike because it is a benchmark to

compare something else to. The same holds true for market

forms. Economists would like

markets to strive for



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Perfect Competition

The assumptions economistsmake about perfectlycompetitive markets are:

1. There are large numbers of buyersand sellers but no one buyer orseller can influence market price.

2. All market participants are pricetakers.

3. No collusive behaviour between

firms. They act independently.5/19/12 Prepared by Mr. Festus 33


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revenue (AR), andmarginal revenue (MR)

curves One of the assumptions of aperfectly competitive market isthat no buyer or seller can

influence market prices.

Because no single firm caninfluence the market price, the

price determined by the marketforces is a given for all the firmsin the industry.

Note that the demand curve in5/19/12 Prepared by Mr. Festus 44


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The total revenue (TR)curve

Total revenue is equal to the price of a product,times the number or products traded in the market.

For any firm the price of all goods sold is the same,so there is a linear relationship between the number

of products sold and total revenue. The TR curve is a straight line from the origin, and

the slope will be determined by the price of theproduct.

Marginal revenue (MR) is the slope of the TR curve. Average revenue is the slope of the line from the

origin through the TR curve. This is equal to theslope of the TR curve itself.

Marginal revenue is also equal to the derivative ofthe total revenue function.5/19/12 Prepared by Mr. Festus 55


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Profit in the short runwith TR and TC curves

One way to calculate profit is tosubtract total cost from totalrevenue.



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Short-run profit withMarginal Calculations

There is another way ofdetermining maximum profit.This is achieved by calculating

marginal revenue and marginalcost, and then comparing thetwo.

If marginal revenue is higherthan marginal cost, then therevenue gained from the last

unit sold is more than the5/19/12 Prepared by Mr. Festus 77


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Short-run profit withMarginal Calculations

If marginal revenue is lessthan marginal cost, an

increase in production willdecrease profit i.e. profitis maximised when

marginal revenue equalsmarginal cost.

This is the point at which5/19/12 Prepared by Mr. Festus 88


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The supply curve of anIndividual Firm

The supply curve of a firm isnothing more than the quantitiesof a product that the firm is

willing to sell at different prices. Pprice is determined by the

industry as a whole and the

individual firm has no choice butto sell at this price or leave theindustry.

Over the short run it makes5/19/12 Prepared by Mr. Festus 99


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The supply curve of anIndividual Firm

This part of the MC curve alsoforms part of the supply curve ofthe firm.

However, no firm can exist overthe long run if it makes losses.

So this only holds true for theshort run and if the firm canforesee an improvement in theprofitability of their activities

over long run, otherwise it will5/19/12 Prepared by Mr. Festus 1010


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Short-run adjustment inMarket Prices

A firm will operate in the short runwhere marginal costs equalmarginal revenue at the positively

sloped part of the MC curve. For the firm to stay in business, the

price must be equal to or higherthan average variable costs.

The point at which price equalsaverage variable costs, is known asthe shut-down point.

If the rice dro s below avera e5/19/12 Prepared by Mr. Festus 1111


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Long-run Equilibrium ofthe Firm

How do firms react to changes inmarket prices over the long run?To see this, suppose there is an

increase in the market price.Then, two situations are likely tohappen:

On the one hand, if the existingfirms are making above normalprofits because prices are high,

it will attract new firms to the5/19/12 Prepared by Mr. Festus 1212


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Imperfect Competition

While in perfect markets firmsdo not collude, in imperfectmarkets they do collude by

having formal or informally. While in perfectly competitive

markets all products are

identical in imperfect marketsproduct are heterogeneous. Inimperfect markets brand names

are important and consumers5/19/12 Prepared by Mr. Festus 1414


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Barriers to Entry

The fact that firms cannot freelyenter and/or exit and industrygives rise to imperfect

competition. The existence of economies of

scale gives rise to greater

concentrations of firms in certainindustries.



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Barriers to Entry

Some of the factors that preventfree entry of new firms are thefollowing:

There may be legal restrictionssuch as the number of licences thatthe government allows in an

industry. There may be restrictions on

imports. This can be achieved viaimport tariffs and quotas.

A certain firm ma be the holder of5/19/12 Prepared by Mr. Festus 1616


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Different MarketStructures

With a monopoly there is onlyone seller in an industry, butwith an oligopoly, a few firms

dominate business activities in aspecific industry.

An oligopoly is a market

structure where a few firmsdominate business activities in aspecific industry.

Monopolistic competition is5/19/12 Prepared by Mr. Festus 1717


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MonopolisticCompetition

This market is similar to aperfectly competitive market inthree ways:

There are many buyers and sellers.

Firms can enter and exit theindustry easily.

There are no barriers to entry.

The most important difference isthat products in this marketstructure are differentiated.5/19/12 Prepared by Mr. Festus 2020


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Oligopoly

An oligopoly is a market structure where a few firmsdominate an industry.

This may be the result of the cost structure of theindustry.

Legal restrictions such as patent rights, licensingpolicy of the government, tariffs, and economies ofscale create barriers to entry and make oligopoly thenorm in manufacturing.

This is the reason why there is less rivalry in thismarket structure.

Because there are only few firms in such industrythey are mutually interdependent.

If firms in an oligopoly collude, they decrease the

risks for all the firms involved.5/19/12 Prepared by Mr. Festus 2121


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How do these MarketStructures Compare?



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Competition policy inNamibia

Perfect competition is the idealmarket structure becauseconsumers benefit from low

prices created by thecompetition among firms.

Monopolies or market dominance

is strongly discouraged bygovernments since it can lead toinefficiencies and higher prices.

Namibia is no exception and The5/19/12 Prepared by Mr. Festus 2323

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Basic Microeconomics Chpater 10