Chapter 8: Market Structure

The Market Structure

Basically, when we hear the word market, we think of a place

where goods are being bought and sold. Today, we consider

the Philippine Stock Exchange where title of ownership of the
largest

firms

in

the

Philippines

are

being

traded

as

commodities. Nevertheless, there is no exact size for a

location to be considered as market. In economics, market is
a place where buyers and sellers are exchanging goods and
services with type following consideration:
1.

Types of goods and services are being traded

2.

The number and size of buyers and sellers in the market

3.

The degree to which information can flow freely

 There are two types of market structures:

perfecert market and imperfect

market
Perfect Market is a market situation which

consists of a very large number of buyers and

sellers offering a homogeneous product.
Perfect Competition is built on two critical
assumptions: the behavior of an individual
firm and the nature of the industry in which it
operates.

Perfect Competition cannot be found in the real

world. For such to exist, the following conditions
must be observed and required:
1. A large number of sellers, each acting
independently and not colliding with any other.
2. Selling a homogenous product, that is, the
output of one firm is indistinguishable from the
output of any other firm in the industry. The
product is standardized and differentiated
among firms. The buyer is not concerned with
where he/she purchases. This is ensured by
the model's requirement that all the services
associated with a purchase, such as delivery
conditions and credit terms, are absolutely the
same for every seller.

3. No artificial restrictions placed upon price or

quantity. Any artificial restrictions placed upon
the movement of prices and/or the quantity of
the output prevent a pure competition market
situation. Pure competition cannot exist under
government price setting or producer's price,
and quantity setting results from agreements
among competitors.
4. Easy entry and exit. Sellers are free to enter
and leave a purely competitive industry. A firm
must be able to sell its product as easily as longestablished firm can. There are no legal barriers,
and financial and technical requirements.

5.

All buyers and sellers have perfect

knowledge of market conditions and any
changes that occurs.
6. Terms are "price takers" that have no
control on the price of the product. The only
thing they can decide is the level of output
they can produce.

Short-run Analysis of perfect Competitions

The principle aim of a firm is to maximize

profits. In the short-run, some inputs are
variable and, therefore, fixed costs arise
regardless whether the firm is operating or not.
Thus, it pays for the firm to continue operating
even though losses are incurred in the short-run
as long as these losses are smaller than fixed
costs. We can draw the demand curve faced by
firms horizontally when the price of the product
is constant, the change in total revenue or
marginal revenue is equal to price. That is,
P=MR Eq.8

To determine the profit-maximizing output of

the firm, it must expand output as long as

marginal revenue exceeds marginal cost
(MR>MC) and stop producing before reaching
a point where MR>MC. If the MR from
producing additional unit of output is greater
than MC, the extra unit of production will
increase profit. On the other hand, if the extra
production will raise MC instead of MR, the
firm should stop producing. The firm will
maximize profits by producing at the level of
output where MR=MC.

Figure 8 illustrates a short-run equilibrium

under a perfect competition market. Panel B
represents the industry demand and supply
curve. The market price is 10 pesos and
industry output is 1,000,000 units (lets us
assume that there are 1,000 firms in the
market). Panel A shows the "cost-situations" of
each firm in the market, we can notice that
the demand curve is horizontal at 10 pesos
which is also the market, there will be 800,000
units of total output seen on panel B. The
output that would maximize profit for an
individual firm is at point b where MR=MC,
wherein the maximizing units of output is
1,000 and price at 10 pesos.

Long-run Analysis of Perfect

Competition
In the long-run, all inputs and costs of production
are variable, and the firm can build the most
appropriate scale of plant to produce the optimum
level of output. In Figure 8.1, point A is the most
appropriate level of output. At this point, price is
equal to the long-run marginal cost (LMC) of the
firm; it is also at this point that the optimum scale of
plant represented by the tangency of the short-run
average total cost (SATC) to the long-run average
cost (LAC) of the firm gives the best level of output.
Of firms that are already operating in the market
earn profit. If firms that are already operating in the
market earn profits, others will try to enter the
market that will results.

Imperfect Market
Imperfect market, on the other hand, is a
market situation wherein the conditions
necessary for perfect competitions are not
satisfied. Under this situation, there are few
sellers which are enough to affect the market
price.

Imperfect competition only happens when

the firm becomes relatively larger in
connection with market size. The essential and
distinguishing feature of this type is the power
the individual firm has to determine prices by
adjusting its sales, without having a complete
power of a monopolist.

Form of Imperfect Market

Imperfect market includes:

Monopoly
The term monopoly comes from the Greek

words "monos" which means "one" and

"polein" which means to sell. Under this
situation, there is only one seller of goods or
services. Monopoly is characterized by only
one producer in the industry, hence, there is
lack of economic competition and viable
substitute for the goods and services that
they provide. The monopolist can influence
and has considerable control over the price (a
monopolist is considered as a price maker).

A monopoly should be distinguished from a

cartel. Cartel refers to a market situation in

which firms agree to cooperate with one
another to behave as if they were a single firm
and thus eliminate competitive behavior
among them. These firms agree among
themselves to restrict their total output to the
level that maximizes their joint profit. The
most common example is the Organization of
Petroleum Exporting Countries (OPEC)

The following are sources of

monopoly:
1. There is only one producer or seller of goods
2.

3.
4.
5.
6.

and only one provider of services in the market.

New firms find extreme difficulty in entering the
market. The existing monopolist is considered
giant in its field or industry.
There is no available substitute so that a
product or service is considered unique.
It controls the total supply of raw materials in
the industry and has control over price.
It owns a patent or copyright.
Its operations are under economics of scale.

Classifications of Monopoly
Monopolies

are classified according to

circumstances they arise from, that is, cost
structure of the industry, possibly the result
of law, or by other means.

Natural Monopoly
It is a market situation where a single firm

can supply the entire market due to the

fundamental cost structure of the industry.
It arises whenever capital cost is large
enough as compared to variable cost, and
they have advantage over competitors.
This classification is common to the
providers of gas, steel and the like.

Legal Monopoly
This

is sometimes called "de jure

monopoly", a form of monopoly which the
government grants to a private individual
or firm over the product or service. Most of
the utilities granted with an franchise by
the government such as water and
electricity services enjoy legal monopolies.

Short-run Analysis of Monopoly

There is a sharp distinction between perfect
competition and monopoly in terms of price and
output
determination.
a
monopolist
is
considered a price maker, since he is the sole
seller of a product that has no close substitute in
the market. Because of this,a monopolist faces
the entire demand curve for the product, he will
reduce the supply, and to lower the price, he will
increase the supply. The effect of this is the
marginal revenue will always be lower than the
price of the product. Graphically, the marginal
revenue curve is below the demand curve.

In Figure 3.2, the best level of output in the

short-run is 1,000 units given by point a where

MR=MC. If outputs is below 1,000 units where
MR<MC, it will pay for the firm to expand
output because additional production will
increase total profits. On the other hand, if
output is produced above 1,000 units where
MC>MR, total profit will increase for the firm
reduces its output.
Although a monopolist can earn profits in the
short-run, it does not mean that is incapable
of incurring losses or to break even. The
height of the average total cost tells us the
best level of output. If the ATC=P at the best
level of output, the firm incurs losses.

Long-run Analysis of Monopoly

In the long-run, all inputs and costs are variable,

and the monopolist can make his optimal scale

of plant to make the best level of output. In
figure 8.3, the best level of output is given at
point a where Q=1,500 and price is equal to 10
pesos; notice that at this point, P=LMC and the
optimal scale of plant is given by the condition
where short-run average total cost is targent to
long-run, the monopolist is earning a profit
equal to 2 pesos (ab) per unit. As long as all
factors are unchanged, the monopolist will earn
the same amount per unit in the long-run.

Oligopoly
The word from the Greek words oligo which
means "few" and polein which means "to sell". It is a
market situation in which there is a small number of
sellers each aware of the action of the others. All
decisions depend on how the firms behave in
relation to each other. Changing output or price has
an immediate effect on the output and price of
others. Each firm knows and expects a reaction to its
own actions. a firm would not normally change the
price and quality of its product without considering
how the other firms would respond. In oligopoly,
conjectural interdependence is present, that is, the
decision of one firm influences and are influenced by
the decision of other firms in the market. Automobile
and steel industries are some examples of oligopoly.

The Characteristics of an oligopoly

include:
1. There is a small number of firms in the

market selling differentiated or identical

products.
2. the firm has control over price because of
the small number or firms providing the
supply of a certain product.

Types of Oligopoly
Oligopolies are often distinguished based

on the products they sell in the market.

Types of Organization of
Oligopoly
cartel

is a formal agreement among

oligopolists to set up a monopoly price,
allocate output and share profit among
members.
Collusionis an agreement between two or
more parties, sometimes illegal and therefore
secretive,
to
limit
opencompetitionby
deceiving, misleading, or defrauding others
of their legal rights, or to obtain an objective
forbidden bylawtypically by defrauding or
gaining an unfair market advantage.

Monopolistic

competitionis a type of
imperfect competitionsuch
that
many
producers sell products that aredifferentiated
from one another (e.g. by branding or quality)
and hence are not perfectsubstitutes.

Short-run equilibrium

of the firm under

monopolistic competition. The firm maximizes
its profits and produces a quantity where the
firm's marginal revenue (MR) is equal to its
marginal cost (MC). The firm is able to collect
a price based on the average revenue (AR)
curve. The difference between the firm's
average revenue and average cost, multiplied
by the quantity sold (Qs), gives the total
profit.

Long-run

equilibrium of the firm under

monopolistic competition. The firm still
produces where marginal cost and marginal
revenue are equal; however, the demand
curve (and AR) has shifted as other firms
entered
the
market
and
increased
competition. The firm no longer sells its goods
above average cost and can no longer claim
an economic profit

Monopsony is amarket form in which only

one buyer interfaces with would-be sellers of a

particular product.
Oligopsonyis amarket formin which the
number of buyers is small while the number of
sellers in theory could be large.