Polytechnic University of the

Philippines
College of Architecture and Fine Arts

ECON 1013: Basic Economics with Taxation &

Agrarian Reform

Market
Structure

Submitted By:
Group # 3
Genova, Geraldine
Navarro, Rachelle
Nomorosa, Rodora Marie
Vibar, Ana Renee
Vicente, Jeysalie

BS Architecture 5-3

Submitted to:
Prof Jane S. Pulma
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Abbreviation & Symbols

Abbreviation & Definition Abbreviation & Definition

Symbols Symbols

MR Marginal Revenue S Supply

MC Marginal Cost AR Average Revenue

TR Total Revenue E Equilibrium

TC Total Cost Q Output

P Price ATC Average Total Cost

R Revenue Profit

D Demand
Table 1: Abbreviation & Symbols

Market Structure

Characteristics of the market that significantly affect the behavior and

interaction of buyers and sellers. There are four types of market structure:
Pure competition, Pure Monopoly, Oligopoly and Monopolistic Competition.
There are four distinguishing features that is used as basis in deciphering the
kind of market:

Number and size of sellers and buyers

Type of the product

Conditions of entry and exit

Transparency of information

Four Types of Market Structure

1. Pure Competition

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A perfectly competitive market is rare, but the ones that do exist are very
large, such as the markets for agricultural products, stocks, foreign exchange,
and most commodities. Pure competition also offers a simplified economic
market model that yields useful insights into the nature of competition and
how it provides the greatest value to consumers.

Perfectly competitive markets have 4 essential qualities:

1. large number of firms supplying the product,

2. standardized or homogeneous products,

3. low entry and exit costs for firms entering or leaving

the industry, and

4. Suppliers are price takers in that no individual

supplier has any influence on the market price.

That a large number of firms create a highly competitive market results from
the fact that the product is standardized or homogeneous and that the costs are low
to enter or leave the industry. A high barrier to entry would otherwise limit the
number of suppliers in the market. Hence, there will be many suppliers for standard
products as long as the market price is above the average total cost of supplying
the products. The suppliers of the competitive market are price takers they have
no influence whatsoever on the market price because each supplier has only a tiny
share of the total market. If some suppliers try to raise their price by even a few
pennies, then consumers will simply buy from other suppliers. On the other hand,
for the individual seller, market demand is completely elastic, so there is no reason
for any supplier to sell even a penny less than the market price, since they can sell
all that they want for the market price.

If the products were differentiated to some degree, then the market would be
a monopolistic competition, by definition, which would allow some suppliers to

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charge a slightly higher market price if they can convince consumers, through
advertising or other methods, that their product is worth the higher price.

Economics of a Purely Competitive Seller

Few markets as a whole are perfectly elastic, where consumers would buy
whatever quantity was supplied without affecting the market price. However, sellers
in a purely competitive market see a perfectly elastic demand they can sell any
quantity of the product at the market price. This makes both the average revenue,
which is the average price of all products sold, and marginal revenue, which is equal
to the price of the last item sold, equal to the market price.

Average Revenue = Marginal Revenue = Market Price

This, in turn, makes the total revenue of the seller equal to the market price
multiplied by the number of units sold.

Revenue = Price Quantity

Short-Run Profit Maximization

Since the competitive seller cannot charge anything but the market price, it
can only maximize profits or minimize losses by minimizing costs. However, in the
short run, suppliers can only minimize variable costs, not fixed costs. There are 2
methods to determine at what output a seller would maximize his profits or
minimize losses: by comparing total revenue and total costs at each output level or
by increasing output until the marginal revenue equals marginal cost.

Under the total-revenuetotal-cost approach, maximum profits occur

when average total cost (ATC) reaches a minimum.

A firm has both fixed and variable costs. If the firm produces only a few units,
then the average total cost will be high because the fixed costs must be covered by

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the few units produced. As more units are produced, then the average fixed costs
will decline, which will also decrease the average total cost. Because a firm has
fixed resources in the short run, there will be a point where increasing the quantity
becomes more costly because of the law of diminishing marginal returns with
fixed assets. Hence, at some point average total cost will start to rise and
eventually become greater than the price of the product, which is the marginal
revenue.

Because the average total cost curve includes a

normal profit but not an economic profit, a
breakeven point is achieved when the total cost
curve becomes less than total revenue for the
first time (#1 in the graph). There is a 2nd
breakeven point that occurs as average total cost
increases and the total cost curve again crosses
the total revenue line (#2). Between these 2
breakpoints, the difference between total revenue and total cost yields economic
profits (#3) for any quantity of products produced between the 2 breakeven points.

Marginal-RevenueMarginal-Cost Approach

This approach compares how each additional unit of output adds to the total
revenue and total cost. The additional revenue from the unit is the marginal
revenue (MR) and the additional cost is the marginal cost (MC). A firm maximizes
output when marginal revenue equals marginal cost.

MR = MC = Market Price

This results from the fact that as long as the marginal revenue is greater than
the marginal cost, the firm is profiting from producing that unit. Once marginal

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revenue equals marginal cost, additional units will incur a marginal cost that is
greater than the marginal revenue for that unit, causing total profits to decline,
which is the result of the diminishing marginal product. This relationship is true for
all firms, whether they are purely competitive, monopolistically competitive,
oligopolistic, or monopolistic. The firm will maximize profit or minimize loss as long
as producing is better than shutting down.

Because, for purely competitive firms, marginal revenue equals price,

maximum revenue is also earned when the marginal cost of producing the last unit
is equal to the market price. This makes sense since if the marginal cost was
greater than the price, then the firm would incur losses for each additional unit.
Note that by producing until marginal cost equals the market price maximizes total
profit but not per unit profit.

If the market price is less than average total cost, then the firm cannot make
a profit, but if it is higher than the minimum average variable cost, then the firm
can at least minimizes losses.

If the price is less than the average minimum average variable cost, then the
firm has reached the shutdown point where it can minimize losses in the short run
by shutting down completely, since then the firm would lose more money if it
produced any output, thereby increasing its losses. Thus, its total loss will be equal
to its total fixed costs.

Marginal Cost And the Short Run Supply

The above discussion leads to the following conclusions regarding the

relationship between marginal cost and the short run supply. There is no production
if the market price is less than the average variable cost.

Production increases as prices increase, leading to higher economic profit in

the short run. If the cost of inputs rises, then the average variable cost will also rise.

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Hence, the market price would have to be higher for any given quantity to be
produced.

If the price of inputs declines or technology can reduce the cost of

manufacturing, then average variable costs shifts downward, allowing more product
to be supplied at any given price. The shutdown point will also be lower.

Note that the supply curve of an individual firm is different than for the
industry. For the individual firm in a competitive market, demand is completely
elastic, so the firm can sell all that it produces for the market price, so it will sell as
many units as possible until marginal cost equals marginal revenue.

However, the supply curve of the industry slopes upward as in the classical case,
wherein increased supply causes a decrease in the price.

Pure Competition: Long-Run Equilibrium

In the long run, firms can enter or exit a purely competitive market easily.
Pure competition also assumes that firms and resources can be easily reallocated in
response to demand. Hence, if economic profits are being made by the firms within
the industry, then more firms will enter the market, thereby lowering the market
price, until the equilibrium price and quantity that allows only normal profits is
obtained. If the firms are suffering losses, then some firms will leave the market,
which will reduce the market supply, thereby increasing prices, which will allow the
existing firms to make a normal profit. The long-run market price is equal to the
minimum average total cost (ATC) of producing the product. And since suppliers will
produce until the marginal cost is equal to the market price, the long-run
equilibrium in a purely competitive market can be summarized thus:

Average Total Cost = Marginal Cost = Price

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For a constant-cost industry, the supply curve is completely elastic,

because any change in the market demand will cause either an entry or an exit of
firms until the price returns to the industry's lowest average total cost. A constant-
cost industry can only exist if there are ample supplies of inputs required to produce
the product that will satisfy the entire market; otherwise, increase demand for the
product will increase demand for the inputs, which will raise the prices of both the
inputs and the product.

For an increasing-cost industry, the long run supply curve slopes upward
because average total costs increase as new firms enter the market. This occurs
because there are limited quantities of inputs in relation to the market demand for
the product. Therefore, input prices rise as demand increases, so a greater quantity
will only be supplied if the market price for the product is higher, which is in
contrast to the constant-cost industry, where the market price remains horizontal at
any quantity.

For a decreasing-cost industry, the long run supply curve is downward

sloping, because the price of inputs declines with increasing quantity. This usually
occurs when the inputs themselves are manufactured and benefit from economies
of scale, where increased quantities decreases the average total cost of the inputs,
and therefore, their prices. The best example of this type of industry is the
computer industry, since an increase in demand for computers also increases the
demand for components. However, since the fixed costs of producing computer
components are substantial, the average total cost of manufacturing the
components greatly declines with increasing quantity. Therefore, the price of
personal computers declines as the quantity increases.

Productive And Allocative Efficiency Under Pure Competition

Productive efficiency requires that products be produced for the minimum

cost. When productive efficiency is achieved, price equals minimum average total
costs. Therefore, any firm that cannot produce at the minimum ATC will be forced to
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leave the industry. If a firm is more productive in producing a certain product, with
average total costs lower than the industry average, then they can increase output
continually until either other firms achieve similar efficiency or they are forced out.
Hence, firms that use the best technology and methods will achieve the lowest
average total costs, thereby providing the lowest possible price for the product.

Allocative efficiency requires that resources be apportioned among firms

and industries so as to yield the best combination of products and services most
desired by society. The greatest allocative efficiency has been achieved when there
is no other combination of goods and services that would be more desired by
society.

Allocative efficiency is achieved because suppliers supply the product at the

lowest average total cost, which allows them to supply the product at a quantity
desired by the consumers as reflected in the price that they are willing to pay. The
lowest market prices that are achieved under a purely competitive market allow the
greatest number of consumers to enjoy the product, and for those consumers that
do enjoy the product, their consumer surplus is maximized.

The Essential Characteristics of Pure Competition

Very large number of independent sellers in the industry. Single seller

is very small relative to the size of the market.
Products are homogenous of identical
Freedom of entry and exits
Product pricing is determined by the demand and supply condition
The demand curve is perfectly elastic
Agricultural products

Perfect Competition

There is knowledge about the market by all involved units, any changes in
price & quantity sold and bought are known to all in the industry

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The Demand Curve for Industry and the Firm under Pure Competition

Industry Firm
Downward slopping demand Perfectly elastic demand

If price is very low = number of sellers decrease, supply curve shifts to

the left from S1 to S2

Price and Revenue in Pure Competition

Output (O) Price (P) Total Average Marginal

Revenue Revenue Revenue
(PxO) (TR/O) (TR/O)

5 4 20 20/5 = -
4

20 4 80 80/20 = 60/15 =
4 4

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100 4 400 400/100 = 320/80 =

4 4

500 4 2000 2000/500 = 1600/400 =

4 4

1000 4 4000 4000/1000= 2000/500 =

4 4
Table 2: Price & Revenue in Pure Competition

The Change in Equilibrium Price in Pure Competition

Industry
Downward slopping demand

Firm
Perfectly elastic demand

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2. Pure Monopoly

Characteristics of Pure Monopoly

Only one seller in the industry

Product does not have close substitute

Entry is blocked by barriers like government franchises and patents

Seller is a price setter

Demand curve is relatively inelastic

Examples are utilities like electricity and water

Demand Curve in Pure Monopoly

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For a pure monopolist, its supply is the entire market supply, and, thus,
downward sloping. Since a monopoly is a price maker, it will determine what
quantity of output will yield the greatest profits.

Price and Revenue Schedule for Pure Monopoly

Output (O) Price (P) Total Marginal Average

Revenue Revenue Revenue
(OxP) (TR/O)
0 22 0 - -
1 20 20 20 20
2 18 36 16 18
3 16 48 12 16
4 14 56 8 14
5 12 60 4 12
6 10 60 0 10
7 8 56 (4) 8
8 6 48 (8) 6
Table 3: Price and Revenue Schedule for Pure Monopoly

MR < AR for Pure Monopoly, Demand = P = AR, but MR Is lower

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In trying to maximize revenue, the monopolist has a dilemma: the monopolist

can only sell more product if it lowers its prices, because it's demand curve
slopes downward as demand curves generally do. Demand only increases
with decreasing prices, but the marginal revenue gained by selling one
additional unit will always be less than the price of that unit because the
monopolist will have to sell all of its units at the lower price.

Revenue and Cost Schedule for Pure Monopoly

Output Price (P) Total Total Economi Marginal Marginal

(O) revenue Cost c Profit Cost Revenue
(OXP)
0 22 0 10 (10) - -
1 20 20 15 5 5 20
2 18 36 19 17 4 16
3 16 48 22 26 3 12
4 14 56 25 31 3 8
5 12 60 29 31 4 4
6 10 60 35 25 6 0
7 8 56 43 13 8 (4)
8 6 48 53 (5) 10 (8)
Table 4: Revenue and Cost Schedule for Pure MOnopoly

Equilibrium condition for the firm is where MR = MC.

MR = MC = 4is where 5 units with profit of P31. As shown in the table4 , P31 is the
maximum profits

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As long as marginal revenue is greater the marginal cost, then producing an

additional unit will increase profits. When marginal revenue equals marginal
cost, then the monopolist looks to the demand curve to see what price that
corresponds to. At that point, profit is maximized. If the monopolist increases
production beyond MR = MC, then the marginal cost will be greater for each
additional unit than marginal revenue, which will decrease profits, since costs
continue to increase.

Output Determination in Pure Monopoly

Equilibrium is Point
C where MR = MC
at Q = 5

TR = PxQ = 12x5
= 60

TC = ATCxQ =
5.80x5 = 29

Profit = TR TC =
P60 P29 = P31,
represented by
the shaded area

Reasons for Monopoly

A single firm may control the entire supply of a basic input

Average cost of product is minimum at an output rate that is big enough to

satisfy the entire market at a price that is profitable

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Having a patent that gives investor exclusive right

Firm is awarded a market franchise by a government agency

3. Oligopoly
This market structure is characterized by an industry which is dominated by a
few firms. Oligopoly lies between pure monopoly and monopolistic
competition in which there are few sellers that dominate the market and have
control over the price of the product.

An Oligopoly firm may either produce:

Homogeneous product- also called Pure or Perfect Oligopoly. It is often

found in the producers of industrial products like aluminum, copper, steel and
other related products.
Heterogenous product- also called Imperfect or Differentiated Oligopoly. It
is often found in consumer goods like automobiles, soaps, detergents,
television and other related products.

Features of Oligopoly Market

1. Few Sellers- under this kind of market, there are few sellers. Few firms are
dominating the market and has a control over the price of the product.
2. Interdependence- the firm should be cautious to any action taken by the
competing firms. Since there few firms in the market, the other firms must
comply to stay in the competition.

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3. Advertising- every firm advertises their products on frequent basis to reach

customers and increase the customer base.
4. Competition- there will be an intense competition with the other sellers.
This makes every seller to keep an eye over the rival and be ready with the
counterattack.
5. Entry and Exit Barriers- the firms can easily exit the industry whenever it
wants however, it must face certain barriers to enter. It could be government
license, patenting, large firms economies of scale, high capital requirement,
complex technology. Sometimes, the government regulations favor the
existing large firms making it as a barrier for new entrants.
6. Lack of Uniformity- lack of uniformity exists among the firms whether the
size of the firm is big or small.

Kinded Demand Curve Model

This model states that prices will be stable and there is a little incentive to price
change. This suggests that firms compete through a non-price competition
methods.

This assumes that firms seek to maximize profits

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If firms increase the price, they will lose a large share of the market because
they will become uncompetitive making the demand elastic for price
increases.
If firms cut price, they will gain a big increase in the market share. However,
firms will unlikely allow this. Therefore, other firms will cut price as well.
Demand will only increase by a small amount, making the demand inelastic
for a price cut.
Therefore, this suggests that prices will be rigid in oligopoly.

4. Monopolistic Competition
Monopolistic competition describes a common market structure in which
firms have many competitors, but each one sells a slightly different product.
Monopolistic competition as a market structure was first identified in the
1930s by American economist Edward Chamberlin, and English
economist Joan Robinson.

Characteristics

There are many sellers in the industry.

Firms compete by selling differentiated products that are highly substitutable
for one another but not perfect substitutes. Products may differ in brand
name, image making, advertising and so forth.
It is relatively easy for new firms to enter the market with their own brands
and for existing firms to leave if their products become unprofitable.
The firms demand curve is relatively elastic because the product of
monopolistic competition has a lot of substitute.
Relatively elastic demand.
Soap, shampoo, deodorants and shoes are some of the items sold in
monopolistically competitive market.

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Four Main Types of Differentiation of the Products in Monopolistic

Competition

Physical product differentiation

o Firms use size, design, colour, shape, performance, and features to

make their products different. For example, consumer electronics can
easily be physically differentiated.

Marketing differentiation

o Firms try to differentiate their product by distinctive packaging and

other promotional techniques. For example, breakfast cereals can
easily be differentiated through packaging.

Human capital differentiation

o The firm creates differences through the skill of its employees, the
level of training received, distinctive uniforms, and so on.

Differentiation through distribution

o Including distribution via mail order or through internet shopping, such

as Amazon.com, which differentiates itself from traditional bookstores
by selling online.

Monopolistic Competition in the Short Run

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At profit maximization, MC = MR, and output is Q and price P. Given that price (AR)
is above ATC at Q, supernormal profits are possible (area PABC).

As new firms enter the market,

demand for the existing firms
products becomes more elastic and
the demand curve shifts to the left,
driving down price. Eventually, all
super-normal profits are eroded
away.

Short Run

Monopolistic Competition in the Long Run

Super-normal profits attract in new entrants, which shifts the demand curve for
existing firm to the left. New entrants continue until only normal profit is available.
At this point, firms have reached their long run equilibrium.

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Long Run
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Clearly, the firm benefits most

when it is in its short run and
will try to stay in the short run
by innovating, and further
product differentiation.

Advantages of Monopolistic Competition

There are no significant barriers to entry; therefore markets are

relatively contestable.

Differentiation creates diversity, choice and utility. For example, a typical high
street in any town will have a number of different restaurants from which to
choose.

The market is more efficient than monopoly but less efficient than perfect
competition - less allocatively and less productively efficient. However, they
may be dynamically efficient, innovative in terms of new production
processes or new products. For example, retailers often constantly have to
develop new ways to attract and retain local custom.

Disadvantages of Monopolistic Competition

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Some differentiation does not create utility but generates unnecessary waste,
such as excess packaging. Advertising may also be considered wasteful,
though most is informative rather than persuasive.
As the diagram illustrates, assuming profit maximization, there is allocative
inefficiency in both the long and short run. This is because price is above
marginal cost in both cases. In the long run the firm is less allocatively
inefficient, but it is still inefficient.

Summary

Comparative Characteristics of Four Market Structure

Features Pure Pure Oligopoly Monopolistic

Competition Monopoly Competition

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Demand Perfectly Relatively Kinked curve Relatively

Curve elastic inelastic elastic

Non-price Not necessary To enlarge the Relatively Very important

Competition market important

Example of Fruits and Water and Gasoline, Soaps, shoes,

products vegetable electricity, steel, cars, dresses,
trains like the sugar, cement candies and
PNR, LRT and and airlines services of
MRT parlors and
restaurants
etc.

Demand Perfectly Relatively Kinked curve Relatively

Curve elastic inelastic elastic

Non-price Not necessary To enlarge the Relatively Very important

Competition market important

Example of Fruits and Water and Gasoline, Soaps, shoes,

products vegetable electricity, steel, cars, dresses,
trains like the sugar, cement candies and
PNR, LRT and and airlines services of
MRT parlors and
restaurants
etc.
Table 5: Comparative Characteristics of Four Market Structure

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