Chapter 5: Market Structure

Overview

Market Structures

Definition & Context

A market is any arrangement that brings buyers and sellers together. It can be a Physical Market (geographic location, personal contact) or a Digital Market (internet, mobile, faster value transmission).

The 4 Major Market Models:

Perfect Competition (Pure Competition)
Monopolistic Competition
Oligopoly
Pure Monopoly

Perfectly Competitive Market

Complete absence of rivalry.

Core Assumptions

1. Large Number of Sellers/Buyers

Share of each is insignificant. No single entity can influence price.

2. Homogeneous Product

Products are identical (perfect substitutes). No preference for one firm over another.

3. Price Taker

Firms must accept the market price determined by supply and demand.

4. Free Entry/Exit

No barriers. Resources are perfectly mobile.

The Demand Curve: Industry vs. Firm

The Market (Industry)

Market price is set where D = S.

→

The Individual Firm

Firm takes Price (Pm) as given. Demand is perfectly elastic.

Profit Maximization

Determining the optimal output level.

1. Total Approach (TR - TC)

Profit $\Pi = TR - TC$. Maximize the vertical distance where TR > TC.

2. Marginal Approach (MR = MC)

Produce where additional revenue equals additional cost.

Condition 1: $ MR = MC $

Condition 2: MC slope > MR slope (MC rising)

Profit & Loss Scenarios

Depends on where Price (AR) is relative to Average Cost (AC).

1. Economic Profit ($P > AC$)

2. Shutdown Point ($P = \min AVC$)

Firm shuts down if Price < minimum AVC.

Mathematical Application

Given: $ P = \$10 $ and $ TC = 2 + 10q - 4q^2 + q^3 $

Step 1: Find Equilibrium Output

Condition: $ MR = MC $ and Slope MC > 0

$ MR = P = 10 $

$ MC = \frac{dTC}{dq} = 10 - 8q + 3q^2 $

Set $ 10 = 10 - 8q + 3q^2 \Rightarrow 3q^2 - 8q = 0 $

$ q(3q - 8) = 0 \Rightarrow q=0 $ or $ q = 8/3 $

Since MC must be rising (2nd order condition), $ q = 8/3 \approx 2.67 $

Step 2: Calculate Profit

$\Pi = TR - TC$

$ TR = 10(8/3) = 80/3 \approx 26.67 $

$ TC(8/3) \approx 19.18 $

$\Pi = 26.67 - 19.18 = \$7.49 $

Step 3: Shutdown Price

Find min AVC ($dAVC/dq = 0$)

$ TVC = 10q - 4q^2 + q^3 $

$ AVC = 10 - 4q + q^2 $

$ \frac{dAVC}{dq} = -4 + 2q = 0 \Rightarrow q = 2 $

Min AVC = $ 10 - 4(2) + (2)^2 = 6 $

Shutdown Price = $6

Imperfect Competition

Structure	Firms	Product	Entry	Curve Shape
Perfect Comp	Many	Homogeneous	Easy	Horizontal
Monopoly	One	Unique	Blocked	Steep Downward
Monopolistic	Many	Differentiated	Easy	Flatter Downward
Oligopoly	Few	Mixed	Hard	Kinked (Often)

Ch.5 Summary