Market Structure

and Pricing
By:

Dr. Ali Fallahchay

 Objectives
1. To define and explain the meaning of markets.

2. To explain the concept of market structure and its

significance.

3. To describe the characteristics of the different types of

market.

4. To examine the relationships between structure,

conduct and performance.

5. To explain the equilibrium conditions for different types

of market in terms of price and output, both in graphical
and algebraic terms. 2
 Objectives
6. To explain the types and significance of entry and exit
barriers.

7. To give examples of different industries where different

market conditions exist, explaining their prevalence.

8. To examine some welfare implications regarding

different forms of market.

9. To emphasize the importance of oligopolistic markets,

and examine the particular problems relating to their
analysis.

3
 Market
• Market

 Group of economic agents

 Firms and individuals

 Interaction of buyer-seller relationships

4
Market Structure

5
 Characteristics of different markets
Perfect Monopolistic
Characteristic Competition Competition Oligopoly Monopoly
Number of firms A very large Many Few One
number

Type of product Standardized Differentiated Standardized or Unique; no

differentiated close subs.

Control over price None Some, but within Limited by mutual Considerable
rather narrow limits inter-dependence;
considerable with
collusion

Conditions of entry Very easy, Relatively easy Significant Blocked

no obstacles obstacles

Nonprice None Considerable Typically a great Mostly public

Competition emphasis on deal, particularly relation
advertising, brand with product advertising
names, trademarks differentiation

Examples Agriculture Retail trade, dresses, Steel, auto, farm Local utilities
shoes implements 6
 Perfect Competition
• Very large numbers of sellers
• Standardized product
• Price takers
• Easy entry and exit
• Perfectly elastic demand
– Firm produces as much or little as they want at the
price
– Demand graphs as horizontal

7
Short-run equilibrium in perfect
competition

8
 Graphical Analysis of Equilibrium
• The equilibrium for a firm and industry in perfect
competition. The equilibrium market price, P1 is
determined by the demand and supply functions in the
industry as a whole. The firms in the industry, as price-
takers, then have to determine what output they will
supply at the price.

• The output q1 is where P1 = MC, since this will

maximize profit.

Note: graphical presentation was discussed in chapter 4

 Short-run equilibrium
• If the market price is equal to average total cost (ATC),
the firm will just make normal profit. Normal profit is
defined as the profit that a firm must make in order for
it to remain in its current business.

• If the firm cannot cover all its opportunity costs,

meaning that P<ATC, then it should leave the industry
in the long-run since owners of the business can use
the resources more profitably elsewhere.

10
 Short-run equilibrium
• P<AVC then the firm should shut down in the short-run
since it cannot even cover its variables costs, let alone
make any contribution to fixed costs.

• If P>ATC, the firm is making abnormal or supernormal

profit. This means that the industry is more profitable
than average and this will in turn attract new firms into
the industry in the long-run, since it is assumed that
there are no entry or exit barriers.

11
 Long-run equilibrium
• It is possible in the long-run for firms to enter or leave

the industry;

• Existing firms and will maximize profit by producing

where P=LMC.

12
Monopoly

13
 Monopoly
• Single seller – a sole producer

• No close substitutes – unique product

• Price maker – control over price

• Blocked entry – strong barriers to entry block potential

competition

• Non-price competition – mostly PR or advertising the

product

14
 Examples of Monopoly
• Public utility companies

Natural Gas
Electric
Water
• Near monopolies

Intel
Wham-O
• Professional Sports Teams
 Barriers to Entry

• Barrier to Entry: a factor that keeps firms from entering

an industry.

Economies of Scale
Legal Barriers: Patents and Licenses
Ownership of Essential Resources
Pricing
 Economies of Scale

$20
Average total cost

15

ATC
10

0 50 100 200
Quantity
 Monopoly Demand

• The pure monopolist is the industry

• Demand curve is the market demand curve

• Downsloping demand curve

• Marginal revenue is less than price

 Monopoly Demand
Revenue and Cost Data of a Pure Monopolist
Revenue Data Cost Data
(1) (2) (3) (4) (5) (6) (7) (8)
Quantity Price Total Marginal Average Total Cost Marginal Profit (+)
of Output (Average Revenue Revenue Total Cost (1) X (5) Cost or
Revenue) (1) X (2) Loss (-)
0 $ 172 $0 $ 100 $ -100
1 162 162 $ 162 $ 190.00 190 $ 90 -28
2 152 304 142 135.00 270 80 +34
3 142 426 122 113.33 340 70 +86
4 132 528 102 100.00 400 60 +128
5 122 610 82 94.00 470 70 +140
6 112 672 62 91.67 550 80 +122
7 102 714 42 91.43 640 90 +74
8 92 736 22 93.75 750 110 -14
9 82 738 2 97.78 880 130 -142
10 72 720 -18 103.00 1030 150 -310
 Monopoly Demand
• All customers must pay the same price

$142
132
122
112 Loss = $30 D
102
Gain = $132
92
82

0 1 2 3 4 5 6
 Monopoly Demand
• All customers must pay the same price

$142
132
122
112 Loss = $30 D
102
Gain = $132
92
82

MR

0 1 2 3 4 5 6
 Monopoly Demand

• Marginal Revenue < Price

• Monopolist is a price maker
• Monopolist sets prices in elastic
region of demand curve
Output and Price Determination
Demand and Marginal-Revenue Curves
$200 Elastic Inelastic

150
Price

100

50
D
MR
0 2 4 6 8 10 12 14 16 18
Total-Revenue Curve
$750
Total Revenue

500

250
TR

0 2 4 6 8 10 12 14 16 18
 Output and Price Determination
Steps for Graphically Determining the Profit-Maximizing Output, Profit-
Maximizing Price, and Economic Profits (if Any) in Pure Monopoly
Step 1 Determine the profit-maximizing output by finding where MR=MC.
Determine the profit-maximizing price by extending a vertical line
Step 2 upward from the output determined in step 1 to the pure monopolist’s
demand curve.

Determine the pure monopolist’s economic profit by using one of two

Step 3 methods:
Method 1. Find profit per unit by subtracting the average total cost of
the profit-maximizing output from the profit-maximizing price. Then
multiply the difference by the profit-maximizing output to determine
economic profit (if any).

Method 2. Find total cost by multiplying the average total cost of the
profit-maximizing output by that output. Find total revenue by
multiplying the profit-maximizing output by the profit-maximizing
price. Then subtract total cost from total revenue to determine the
economic profit (if any).
Output and Price Determination

$200
Price, Costs, and Revenue

175
Pm=$122 MC
150

125
Economic
Profit ATC
100

75 D
A=$94
MR=MC
50

25
MR
0
1 2 3 4 5 6 7 8 9 10
Quantity
Misconceptions of Monopoly Pricing

• Not highest price

• Total profit
• Possibility of losses
Misconceptions of Monopoly Pricing
Price, Costs, and Revenue

MC

ATC
A Loss
Pm
AVC

V
D
MR=MC

MR
0 Qm
Quantity
 Economic Effects of Monopoly
Pure competition is efficient
Monopoly is inefficient

S=MC MC
Pm b
P=MC= d
Pc Pc c
Minimum
ATC a

D D
MR
Qc Qm Qc

(a) (b)
Purely Competitive Market Pure Monopoly
 Economic Effects of Monopoly

• Income transfer
• Cost complications
• Economies of scale
• X-Inefficiency
• Rent seeking expenditures
• Technological advance
 X-Inefficiency

ATCx X
Average total costs

ATC1

X'
ATCx' Average
ATC2 total cost

0 Q1 Q2
Quantity
Assessment and Policy Options
• Antitrust laws
• Break up the firm
• Regulate it
• Government determines price and
quantity
• Ignore it
• Let time and markets get rid of
monopoly
 Global Perspective
Competition from Foreign Multinational Corporations
 Price Discrimination
• Price discrimination
• Charging different buyers different
prices
• Price differences are not based on
cost differences
• Conditions for success:
• Monopoly power
• Market segregation
• No resale
Examples of Price Discrimination
• Business travel
• Electric utilities
• Movie theaters
• Golf courses
• Railroad companies
• Coupons
• International trade
 Graphical Analysis

P P
Economic
profit Economic
Pb
profit

Ps
MC = ATC MC = ATC
Ds
Qb Qs
MRb Db MRs

(a) Small businesses (b) Students

 Regulated Monopoly
• Natural monopolies
• Socially optimal price
• Set price = marginal cost
• Fair return price
• Set price = ATC
 Regulated Monopoly

Monopoly
Price
Price and Costs (Dollars)

Pm Fair-Return
Price
Socially
a f Optimal
Pf Price
ATC

Pr r MC
MR D
b
0
Qm Qf Qr
Quantity
 De Beers’s Diamonds
• De Beers once controlled about 80%
of the world’s diamond market
• Monopoly position eroded over time
• New diamond discoveries
• Nearly perfect artificial diamonds
• Unfavorable media attention
• Now focus on increasing demand for
diamonds rather than controlling
supply