Lecture 9 Market Structure

1. Lecture 9Market Structure

2. Market and Competition • Market is the transaction between two parties where goods or services are transferred from seller to buyer in exchange of money. • We can classify different markets depending on the degree of competition. To determine structure of any particular market, we begin by asking • How many buyers and sellers are there in the market? • Is each seller offering a standardized product, more or less indistinguishable from that offered by other sellers -Or are there significant differences between the products of different firms? • Are there any barriers to entry or exit, or can outsiders easily enter and leave this market? • Answers to these questions help us to classify two types of competition A) Perfect competition A market that has perfect competition is called perfectly competitive market. B) Imperfect competition There can be three types of markets based on the degree of imperfection. • Monopoly • Oligopoly • Monopolistic

3. Number of Firms? Many firms Type of Products? One Few Differentiated Identical Firm firms products products Monopolistic Perfect Monopoly Oligopoly Competition Competition • Wasa Mobile Company • Soap • Rice Market Structure

4. Various Forms of Imperfect Competition Monopoly(most inefficient and most extreme imperfection) • The only supplier of a unique product with no close substitutes in the market. Oligopoly (more efficient than a monopoly) • If there are few firms in the market and each firm is producing close substitute product then we have oligopoly. Monopolistic Competition(closest to perfect competition) • A large number of firms that produce differentiated products that are reasonably close substitutes for one another.

5. Characteristics of Monopoly • A monopoly has the following characteristics: • A monopoly is the only seller in the market. • It is price maker that means it has full control over how much price it will charge for a product. • There is barrier to entry and exit in the market it is operating. Example of legal barrier is licensing. Example: WASA

6. Characteristics of Oligopoly • Oligopoly has the following characteristics: • There will be few firms in the market. • Each firm will have some control over the price • There is intense rivalry among the firms that are operating in the market to increase there market share. Example : Mobile phone operators in BD.

7. Characteristics of Monopolistic Competition • Monopolistic Competition has the following characteristics: • There are many firms in the market. • There will be product differentiation. Example: Soap producing companies.

8. Perfect Competition • In a perfectly competitive market there will be no seller who has a large stake in the market and that’s why a single seller does not have the market power to control the price of the product. • A perfectly competitive market must have the following properties: • Large number of buyers and sellers • The firms' products are identical • Both buyers and sellers are price takers • Free entry and exit from the market for the firm

9. Characteristics of Perfect Competition in details 1) A Large Number of Buyers and Sellers • In perfect competition, there must be many buyers and sellers • How many? • Number must be so large that no individual decision maker can significantly affect price of the product by changing quantity it buys or sells

10. 2) The firms' products are identical • Buyers do not perceive significant differences between products of two different sellers • For instance, buyers of rice do not prefer one farmer’s rice over another

11. 3) Both buyers and sellers are price takers • A price taker is a firm or individual who takes the market price as given. That means he cannot influence or change the price. • A price maker is a firm or individual who can influence or change the market price. • In perfect competition both buyers and sellers are price takers. • A seller is a price taker in perfect competition because there is a large number of seller in the market and so a single seller cannot influence the market price for example by increasing or decreasing the amount it is selling. • A buyer is a price taker in perfect competition because there is a large number of buyer in the market and so his decision about buying or not buying a product do not affect the market price.

12. 4) Free entry and exit from the market for the firm • In perfect competition there will be no barrier to entry for a new firm. Entry into a market by a new firm is rarely free—a new seller must always incur some costs to set up shop and begin production • But perfectly competitive market has no significant barriers (for example start up cost is low) to discourage new entrants • Any firm wishing to enter can do business on the same terms as firms that are already there • Perfect competition is also characterized by easy exit • A firm suffering a long-run loss must be able to sell off its plant and equipment and leave the industry for good.

13. 3. The typical firm can sell output as much as it wants at the market price… 1. The intersection of the market supply and the market demand curve… Price Price Quantity Quantity 4. so it faces a horizontal demand curve 2. determine the equilibrium market price The Competitive Industry and Firm Market Firm S $400 $400 Demand Curve Facing the Firm D 100

14. The Demand Curve Facing by a Perfectly Competitive Firm is Horizontal • We can see that the demand curve of a industry or market is downward sloping ( left graph). But the demand curve facing by a firm is horizontal, or perfectly elastic ( right graph). • Why is the demand curve faced by a firm horizontal ? • In perfect competition products sold by different firms are identical • As there are many firms so a single firm is producing a tiny fraction of the total market supply. So a single firm cannot affect market price by increasing or decreasing production. So a firm can sell as much as it wants at the given market price. That is it faces an infinite demand of its product and that’s why the demand curve faced by a firm is horizontal.

15. For a competitive firm, marginal revenue at each quantity is the same as the market price. • Example: • So we can write • P=MR • For this reason, marginal revenue (MR) curve and demand curve facing firm are the same • So the demand curve/ MR curve is a horizontal line at the market price

16. Profit and Loss in the Short Run and Long run • A competitive firm can make either profit or loss in the short run. • But in the long run a firm can only make zero profit that means no profit, no loss. • Why? • As there is free exit and entry in perfect competition that’s why the firms make zero profit in the long run. • In the short run if a firm make a loss it might still continue to operate because it cannot sell off its plant and equipment in short period of time . But in the long run if the firm keep making a loss then it will exit the market/ industry eventually. So the total number of firms that remains in the industry decreases and those firms that remains in the industry will make zero profit. • In the short run if firms make a profit then new firms will enter the industry. As the number of firms increases the profit of each firm will go down and become zero in the long run.

17. Profit in the Short Run • In the short run if firms make a profit then it will attract new firms to enter the industry.

18. Loss in the Short Run • If the firm keep making a loss then it will exit the market/ industry eventually.

19. Zero Profit in the Long Run • In the long run, price equals the minimum of average cost. That’s why in the long run a firm can make zero profit that means no profit, no loss.

20. Entry and Exit in the Long Run • If firms are making profit then new firms will enter the industry. As the number of firms increases the profit of each firm will go down and become zero in the long run. • If firms are making loss then some firms will exit the industry. So the total number of firms that remains in the industry decreases and those firms that remains in the industry will make zero profit in the long run. • So due to the entry and exit of firms in the long run, firms that remain in the industry will make zero economic profit.