2. MARKET STRUCTURE 1: PERFECT COMPETITION AND MONOPOLY
CHAPTER 7
MARKET STRUCTURE 1: PERFECT COMPETITION AND MONOPOLY

3. DEFINITION AND OBJECTIVES OF A FIRM
Definition of a Firm
A firm is an institution that buys or hires factors of production and organizes them to produce and sell goods and services.
A firm is an independent unit of producing goods and services for sale.
Objectives of a Firm
The main goal or objective of a firm is to maximize profit and to minimize the cost.

4. ECONOMIC PROFIT AND ACCOUNTING PROFIT
Economic profit is defined
as the total revenue minus
the implicit and explicit
cost.
Consider both explicit and implicit cost
EC= TR – [Explicit Cost +
Implicit Cost]
Accounting Profit
Accounting profit is defined
as the firm’s total revenue
minus the explicit cost.
Consider only explicit cost
AC = TR – Explicit Cost

5. TOTAL APPROACH Under Perfect Market:
Total approach is the simplest way
to determine the equilibrium of a firm.
Under Perfect Market:
TR curve is straight line through origin.
The firm maximum profits at ON output
because the vertical distance between
TR and TC curve is maximum.
Quantity
TR, TC TC TR
Highest vertical differences N
Under Imperfect Market:
Total revenue (TR) curve continues to rise
from left to right at a less than proportionate
rate. A rational firm will choose the output
when the vertical distance between TR and
TC is at maximum, ON.
TR, TC
Quantity TC TR
Highest vertical differences N O

6. MARGINAL APPROACH A firm is said to be in equilibrium when marginal
MR, MC P*
Quantity MC
MR=AR Q*
A firm is said to be in equilibrium when marginal
revenue is equal to marginal cost.
MARGINAL REVENUE = MARGINAL COST
Under Perfect Market: MR curve is horizontal.
When MR is equal to MC, a firm is in equilibrium
MR, MC
Quantity MC MR P*
AR=DD Q*
Under Imperfect Market:
MR curve is downward sloping. Same as perfect market, when MR is equal to MC, a firm is in equilibrium.

7. MARKET STRUCTURE Definition of a Market
An arrangement that facilitates buying and selling of a good, service, factor of production or future commitment. OR
A market is a place where the buyers and sellers meet with one another and involves transaction.
Definition of a Market Structure
Market structure refers to the number and distribution size of buyers and sellers in the market of a good and service.
Market structure is an indication of the number of buyers and sellers; their market shares; the degree of product standardization and the ease of market entry and exit.

8. MONOPOLISTIC COMPETITION
PERFECT COMPETITION
There are large numbers of buyers and sellers,
buying and selling identical product
without any restriction on entry and exit, and
having perfect knowledge of the market at a time.
MONOPOLY
There is a single seller and a large number of buyers; selling products that has
no close substitution and has a high
entry and exit barrier.
TYPES OF MARKET
STRUCTURE
MONOPOLISTIC COMPETITION
There are large numbers of sellers, large number
of buyers; selling differentiated products due to
branding and labelling and there are no barriers
to entry and exit.
OLIGOPOLY
There are only a few firms in the industry
but a large number of buyers; products can be
either identical or differentiated, and there are
barriers to entry and exit.

9. Monopolistic Competition
MARKET STRUCTURE
Market Form
Characterictics
Perfect Competition
Monopolistic Competition
Oligopoly
Monopoly
Number of firms
Large number
Large
Few
One
Type of product
Homogenous
Differentiate
or differentiated
Unique: No close
substitutes
Conditions to entry
Very easy
Relatively easy
Significant obstacles
Blocked
Control over price
None
Some
Considerable
Price elasticity of demand
Infinite
Small
Very small
Examples
Wheat, corn
Food, clothing
Automobiles,
cigarettes
Local phone service, electricity

10. PERFECT COMPETITION Definition Characteristics
A market in which there are many buyers and sellers, the products are homogeneous and sellers can easily enter and exit from the market.
Characteristics
Large number of buyers and sellers – firms are price takers
Homogenous or standardized product – the buyers do not differentiate the products of one seller to another seller
Free of entry and exit into the market
Role of non-price competition is insignificant

11. PERFECT COMPETITION (cont.)
Perfect knowledge of the market – all the sellers and buyers in perfect competition market will have perfect knowledge of that market
Perfect mobility of factor of production – factor of production can freely move from one occupation to another and from one place to another
Absence of transport cost

12. PERFECT COMPETITION (cont.)
The price is determined by the intersection of the market supply curve and the market demand curve.
Since the firms are price takers, they face a horizontal demand curve Demand curve in perfect competition is horizontal or perfectly elastic. Therefore:
Price = MR = AR
Price
Price SS
RM10
P = MR = AR
RM10 DD Q*
Quantity
Quantity
Market
Firm

13. TOTAL REVENUE – TOTAL COST APPROACH
PROFIT MAXIMIZATION
Using Table:
The profit maximization is
determined by scanning through
the profit at each level, and the
level which gives the highest profit
is the profit maximizing output.
Quantity
Total Revenue
Total Cost
Profit/Loss 60
−60 1
100
140
−40 2
200
210
−10 3
300
290 10 4
400
390 5
500 6
600
630
−30 7
700
800
−100
Using Graph:
TR curve is a straight line through
the origin. The maximum profit is
where the vertical difference is
the highest.
TR, TC TC TR
Highest vertical differences
Quantity 40

14. PROFIT MAXIMIZATION (cont.)
MARGINAL REVENUE – MARGINAL COST APPROACH
PROFIT MAXIMIZATION (cont.)
Using Table:
The profit maximizing output
level is obtained following
the MR = MC rule.
Quantity
Total Revenue
Marginal Revenue
Total Cost
Marginal Cost
Profit/Loss - 60
−60 1
100 10
140 8
−40 2
200
210 7
−10 3
300
290 4
400
390 5
500 11 6
600
630 13
−30
700
800 17
−100
Using Graph:
MR curve is perfectly elastic
or horizontal to the price.
The profit maximization rule,
MR = MC, where the MC curve
intersects with the MR curve.
MR, MC MC
RM10 MR
Quantity 40

15. PROFIT MAXIMIZATION IN SHORT RUN
A competitive firm earns economic profit
At this output, the firm earns economic profit or supernormal profit equal to the shaded area.
The firm’s demand curve is horizontal at the price of RM20 and AR = MR.
The profit maximizing price and output is P* and Q*.
Price (RM) MC
ATC
The marginal cost curve intersects the demand curve at point B.
A competitive firm maximizes its profit when MR = MC.
PROFIT 20 B P*
P = MR = AR
Economic profit or supernormal profit is the profit earned by a competitive firm when TR > TC.
Quantity Q*

16. PROFIT MAXIMIZATION IN SHORT RUN (cont.)
A competitive firm at breakeven
At this output, the firm is at the breakeven or earns normal profit.
The profit maximizing price and output is P* and Q*.
The firm’s demand curve is horizontal at the price of RM20 and AR = MR.
Price (RM) MC
Normal profit or breakeven profit is necessary for a firm to stay in business TR = TC
The marginal cost curve intersects the demand curve at point B.
A competitive firm maximizes its profit when MR = MC.
ATC B
P* 20
P = MR = AR
Quantity Q*

17. PROFIT MAXIMIZATION IN SHORT RUN (cont.)
A competitive firm suffers economic losses
At this output, the firm suffers economic losses or subnormal profit equal to the shaded area.
The profit maximizing price and output is P* and Q*.
The firm’s demand curve is horizontal at the price of RM20 and AR = MR. MC
Price (RM)
The marginal cost curve intersects the demand curve at point B.
A competitive firm maximizes its profit when MR = MC.
Economic losses or subnormal profit is the losses incurred by a competitive firm when TR < TC.
ATC B
P* 20
P = MR = AR
LOSSES
Quantity Q*

18. PROFIT MAXIMIZATION IN SHORT RUN (cont.)
SHUT DOWN PRICE
If price falls below than RM5, operating the firm will incur more losses than the fixed cost and the firm must shut down.
At the price of RM5 per kg, the loss incurred by the firm is equal to the fixed cost.
Price (RM) MC
A firm will continue operation even it suffers losses.
Shut down point is the point where the price is equal to minimum AVC.
A firm can continue with the production as far as the price is equal to minimum average variable cost (AVC).
ATC B
P = MR = AR 20
TOTAL FIXED COST
LOSSES
AVC 5
Quantity Q*

19. SHORT RUN SUPPLY CURVE Price (RM) MC AC e 20 P1 = MR1 = AR1 AVC d 10
The figure shows the AC, AVC and MC. There are five different market prices that show the horizontal demand curve at each price.
The portion of marginal cost curve which lies above the average variable cost curve is the firm’s supply curve.
Point a is not considered as supply curve since at any point below the minimum of AVC, the firm would shut down its operation and thus the quantity supplied would be zero.
Supply curve of a competitive firm is the upward portion of MC above minimum of AVC as shown by Points b, c, d and e.
Price (RM) MC AC e 20
P1 = MR1 = AR1
AVC d 10
P = MR = AR c
P2 = MR2 = AR2 b
P3 = MR3 = AR3 5 a
P4 = MR4 = AR4 40 60
Quantity

20. PROFIT MAXIMIZATION IN LONG RUN
EFFECT OF ENTRY
Firms that earn supernormal profits in the short run will only be able to earn normal or zero profits in the long run due to entry of newcomers.
The economic profit attracts newcomers to the industry. As a result, many firms will enter the market and this will lead to an increase in supply.
The price is determined by the intersection of the market supply curve and the market demand curve.
The competitive firm sells 60 kg of chicken and earns an economic profit shown by the shaded area.
Price (RM)
Supply curve will shift to the right and equilibrium market price will fall to RM15.
Price (RM) MC SS AC
SS1 20 20
P = MR = AR
PROFIT 15
P1 = MR1 = AR1 DD
Quantity
Quantity Q* 60
Market
Firm

21. PROFIT MAXIMIZATION IN LONG RUN (cont.)
EFFECT OF EXIT
The price is determined by the intersection of the market supply curve and the market demand curve.
The losses in short run forces those sellers who cannot cover their AVC or TVC to leave the market. As many firms exit the market, this will lead to a decrease in the market supply.
The competitive firm sells 60 kg of chicken and suffers losses shown by the shaded area.
Firms that suffer losses in the short run can still continue their operation as in the long run they are able to earn normal or zero profits due to exit of the firms.
Price (RM)
Price (RM)
Supply curve will shift to left and equilibrium market price will rise to RM15.
SS1 MC AC SS 15 15
P1 = MR1 = AR1
LOSSES 10 10
P = MR = AR DD
Quantity
Quantity Q* 60
Market
Firm

22. MONOPOLY Definition Characteristics
Monopoly is a market structure in which there is a single seller and large number of buyers and selling products that have no close substitution and have high entry and exit barrier.
Characteristics
One seller and large number of buyers – the monopolist is a firm as well as an industry by itself
No close substitution – monopoly firm would sell a product which has no close substitute
Price maker – monopolist is a price maker since there is one seller or producer and it has the market power to control over the price
Restriction of entry of new firms

23. MONOPOLY (cont.) Barriers to Entry
Advertising – advertising in monopoly market depends on the products sold
Barriers to Entry
Barriers to entry refer to restriction that prevents other sellers from entering into a market
Control over raw material – a monopoly status can also be maintained through control over the supply of raw material
Patent and Copyright – a patent is an exclusive right to the production of an innovative product. A copyright is an exclusive right to the author of a book or composer of a music or producer of a movie
Cost of establishing an efficient plant – natural monopoly exists when one firm can meet the entire market demand with lower price compared to two or more firms
Government Franchises – the government will give exclusive rights to a firm to sell a certain goods and services in a certain area

24. TOTAL REVENUE – TOTAL COST APPROACH
PROFIT MAXIMIZATION
(1)
Quantity
(Q)
(2)
Price
(P)
(3)
Total Revenue
(TR)
(4)
Total Cost
(TC)
(5)
Profit
(TR – TC)
340
200
−200 1
400
−60 2
330
660
560
100 3
320
960
700
260 4
310
1240
800
440 5
300
1500
900
600 6
290
1740
1040 7
280
1960
1200
760 8
270
2160
1400 9
2340
1800
540 10
240
2400
Using Table:
The profit maximization is
determined by scanning through
the profit at each level, and the
level which gives the highest
profit is the profit maximizing
output.
Using Graph:
TR curve is increasing and after the
profit maximizing output, the curve
starts to decline. Maximum profit is
where the vertical difference
between TR and TC is the highest.
TR, TC TC TR
Highest vertical differences
Quantity

25. PROFIT MAXIMIZATION (cont.)
MARGINAL REVENUE – MARGINAL COST APPROACH
PROFIT MAXIMIZATION (cont.)
Quantity
(Q)
Price
(P)
Marginal Revenue
(MR)
Marginal Cost
(MC)
340 1
200 2
330
320
160 3
300
140 4
310
280
100 5
260 6
290
240 7
220 8
270 9
180
400 10 60
600
Using Table:
The profit maximizing output
level is obtained following the
MR = MC rule.
Using Graph:
MR curve under imperfect market is
downward sloping as the output
increases. The profit maximization
rule, MR = MC, where the MC curve
intersect with the MR curve.
MR, MC MC P*
AR=P MR
Quantity Q*

26. PROFIT MAXIMIZATION IN SHORT RUN
Monopoly firm earns economic profit
At this output, the firm earns economic profit or supernormal profit equal to the shaded area.
The profit maximization level occurs where MR curve and MC curve intersect at Point A.
Price (RM)
Economic profit or supernormal profit is the profit earned by a monopolist when TR> TC. MC
ATC
To find the price, we use the same vertical line with output up to the demand curve. The profit maximizing price and output is P* and Q*. P*
PROFIT AC A
DD = AR MR
Quantity Q*

27. PROFIT MAXIMIZATION IN SHORT RUN (cont.)
Monopoly firm at break-even
At this output, monopolist is at the break-even or earns normal profit.
The profit maximization level occurs where MR curve and MC curve intersects at Point A.
Price (RM)
Normal profit or break-even is earned when TR = TC. MC
ATC
The profit maximizing price and output is P* and Q*.
AC/ P* A
DD = AR MR
Quantity Q*

28. PROFIT MAXIMIZATION IN SHORT RUN (cont.)
Monopoly firm suffers economic losses
At this output, monopolist suffers economic losses or subnormal profit equal to the shaded area.
Economic losses or subnormal profit is the losses incurred by a monopolist when TR < TC.
The profit maximization level occurs where MR curve and MC curve intersect at Point A.
ATC
Price (RM) MC
The profit maximizing price and output is P* and Q*. AC
LOSSES P* A
DD = AR MR
Quantity Q*

29. PROFIT MAXIMIZATION IN SHORT RUN (cont.)
Monopoly firm earns supernormal profit in long run
A monopoly firm earns economic profits or supernormal profit in the long run due to the barriers to entry of new firms.
Price (RM)
LRMC
LRATC P*
PROFIT AC A
DD = LRAR
LRMR
Quantity Q*

30. PRICE DISCRIMINATION Definition
Price discrimination refers to the selling or charging of different prices by a firm to different buyers for the same product.
Necessary Conditions
Existence of monopoly power – price discrimination can occur only if monopoly power exists and there are no competitors in the market 
Existence of different markets for the same commodity – a firm should be able to separate customers according to price elasticity of demand

31. PRICE DISCRIMINATION (cont.)
Existence of different degree of elasticity of demand – monopolist can charge higher price for inelastic market and lower price for elastic market
Cost of separating market must be low
No resale – product purchased in the low-priced market should not be resold in the high-priced market
Legal sanction – government allows the public utility firms such as electricity to charge different prices from different consumers

32. PRICE DISCRIMINATION (cont.)
First-degree Price Discrimination
Occurs when a firm charges each consumer the maximum price that he or she is willing to pay for each unit.
This price discrimination is also known as perfect price discrimination.
The best example for first-degree price discrimination is auction.
Second-degree Price Discrimination
Occurs when the products are grouped into blocks and each block is charged at a different price.
This type of price discrimination is charged by public utilities such as electricity charges, water charges, telephone charges and others.

33. PRICE DISCRIMINATION (cont.)
Third-Degree Price Discrimination
Under this price discrimination, the markets are divided into many submarkets or subgroups.
Each group is considered as a different market.
The price charged on products depends on the price elasticity of demand.
An example of third-degree price discrimination is the movie ticket where the adults are charged higher price and children are charged at lower price.
Other examples are transportation (air, railways, bus or LRT), medical, legal and entertainment.

34. COMPARISON BETWEEN PERFECT COMPETITION AND MONOPOLY
Large numbers of sellers selling homogenous products in perfect competition market
Price takers
Earns a normal profit in the long run due to free entry and exit
In the long run, perfect competitive firm produces at the lowest point on the minimum of average cost, is more efficient
Only one seller who sells products that have no close substitutes
Price maker
Earn a supernormal profit since there are barriers to entry for new entrants
Price charged is always higher than in perfect competitive market
Monopolist does not operate at the minimum point of ATC curve