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Market Structure: Perfect Competition,

Monopoly, Oligopoly and Monopolistic


Competition

Instructor: Maharouf Oyolola


Introduction
• In this chapter we are mostly interested in
how price and output are determined
under different market structure. Thus, we
will study how price and output are
determined under perfect competition,
Monopoly, Oligopoly and Monopolistic
Competition.
The Market concept
• A market is a group of economic agents
(individuals and/or firms) that interact with
each other in a buyer-seller relationship.
• This interaction results in transactions
between the demand (buyer) side and the
supply (seller) side of the market.
Market structure and Degree of
competition
• The process by which price and output
depends heavily the structure of the
market.
• Four types of market structure are usually
identified: Perfect Competition, Monopoly,
Oligopoly and Monopolistic Competition.
Characteristics of a Perfectly
Competitive market
1 ) A very large number of buyers and sellers →
each of them buys or sells such a small
proportion of the total industry output that a
single buyer’s or seller’s actions cannot have
an impact on the market price.
2 ) A homogenous product produced by each
firm, that is, no product differentiation.
3 )Free entry and exit from the market, that is
minimal barrier to entry and exit
Characteristics of a Perfectly
Competitive market
• 4) No collusion among firms in the industry
• 5) Complete knowledge of all relevant
market information by each firm.

• Note: A firm operating within a perfectly


competitive industry is a price-taker.
Characteristics of a monopolistic
market
• 1) only one firm produces the product
• 2) Low cross elasticity of demand between
the monopolist’s product and any other
product; that is no close substitute
products.
• 3) Substantial barriers to entry that
prevents competition from entering the
industry.
Characteristics of a monopolistic
market
• These barriers include the following:
• - large capital requirements, exceeding the
financial resources of potential entrants.
• - Legal exclusion of potential competitors
• - Absolute cost advantages of the
established firm
Characteristics of a monopolistic
competitive market
• 1) Large number of firms
• 2) Product differentiation. Each firm is selling a
product that is differentiated in some manner.
• 3) No collusion among firms in the industry
• 4) Free entry and Exit
• Note: By far the most distinguishing
characteristic of monopolistic competition is that
the outputs of each firm are differentiated in
some way from those of every other firm. In
other words, the cross-elasticity of demand
between the products of individual firms is high.
• Product Differentiation may be based on
certain characteristics of the product itself,
such as trade names; quality, design,
color or style.
Characteristics of an oligopolistic
market
• 1) Small number of firms
• 2) Interdependence of firms
• 3) The products that are produced by
oligopolists may be homogenous – as in
the cases of basic steel, aluminum, and
cement – or differentiated- as in the cases
of automobiles, cigarettes, home
appliances, soaps, detergents, and air
travel.
Price determination under perfect
competition
P QD QS

55 350 450

45 400 400

35 450 350

25 500 300

15 550 250
Determine the equilibrium price and
quantity algebraically
• QD=625-25P
• QS=175+15P
• Setting QD=QS
• P=$45
• QD=400

• Page327 and 328


Competition in the global economy
• In this section we examine how
international competition affects prices in
the nation, how the value of the nation’s
currency affects the nation’s international
competitiveness, and how a competitive
firm in the nation adjusts to international
competition.
Domestic Demand and Supply,
Imports, and Prices
• Domestic firms in most industries face a
great deal of competition from abroad.
Most Us-made goods today compete with
similar goods from abroad and vice-versa.
• Examples of industries in which domestic
firms compete with foreign firms: Steel,
automobile, television sets, cameras,
wines, computers and aircrafts.
See figure 8-4 page 335
• In figure 8-4, DX and SX refer to domestic
market demand and supply curves of
commodity X.
• In the absence of trade, the equilibrium
price is given by the intersection of DX and
SX at point E, so that domestic consumers
purchase 400X (all of which are produced
domestically) at PX=$5
See figure 8-4 page 335
• With free trade at the world price of PX=$3, the
price of commodity X to domestic consumers will
fall to the world price.
• The foreign supply curve of this nation’s imports,
SF, is horizontal at PX=$3 on the assumption that
this nation’s demand for imports is very small in
relation to the foreign supply. From the figure,
we can see that domestic consumers will
purchase AC or 600X at PX=$3 with free trade
(no transportation costs), as compared with
400X at PX=$5 in the absence of trade (given by
point E.
See figure 8-4 page 335
• Figure 8-4 also shows that with free trade,
domestic firms produce only AB or 200X,
so that BC or 400X is imported at PX=$3.
Resources in the nation will then shift from
the production of commodity X to the
production of other commodities in which
the nation is relatively more efficient or
has a comparative advantage.
See figure 8-4 page 335
• With tariffs or other trade restrictions, the price of
commodity X in the nation will be higher than the
free-trade price of $3, and the nation’s imports
will be smaller than 400X.
• However, tariffs and other restrictions to the flow
of international trade have been reduced sharply
over the past decades and have been all
eliminated for trade among 15-nation European
Union (EU) and in North America ( NAFTA)
The Dollar Exchange Rate and the
International Competitiveness of U.S. Firms
• The Foreign Exchange market is the market
where one currency is exchanged for another.
• The foreign exchange market for any currency,
say the US dollar, is formed by all the locations
(such as London, Tokyo, and Frankfurt, as well
as New York) where dollars are bought and sold
for other currencies.
• These international monetary centers are
connected by a telephone and telex network and
are in constant contact with one another.
• The exchange rate is the rate at which one
currency is exchanged for another.
• This is the price of a unit of the foreign currency
in terms of the domestic currency. For example,
the exchange rate (R) between the US dollar
and the euro (€) , the currency of 12 nations of
the European Monetary Union (Austria, Belgium,
Finland, France, Germany, Greece, Ireland,
Italy, Luxembourg, Netherlands, Portugal, and
Spain) is the number of dollars required to
purchase one euro.
Example
• If R =$/€=1, the means that one dollar is
required to purchase one euro.

• Under a flexible exchange rate system of


the type we have today, the dollar price of
the euro (R) is determined (just like the
price of other commodity in a competitive
market) by the intersection of the market
demand and supply curves of euros.
See figure 8-5 page 337
• The vertical axis measures the dollar price of
euros, or the exchange rate ( R=$/€) , and the
horizontal axis measures the quantity of euros.
• The market demand and supply curves for euros
intersect at point E, defining the equilibrium
exchange of R=1, at which the quantity of euros
demanded and the quantity of euros supplied
are equal at €300 million per day.
See figure 8-5 page 337
• At a higher exchange rate, the quantity of
euros supplied exceeds the quantity
demanded, and the exchange rate will fall
toward the equilibrium rate of R=1.
• At an exchange rate lower than R=1, the
quantity of euros demanded exceeds the
quantity supplied, and the exchange rate
will bid up toward the equilibrium rate of
R=1.
See figure 8-5 page 337
• The lower is the exchange rate (R) , the
greater is the quantity of euros demanded
by the United States.→ the lower the
exchange rate, the cheaper it is for the
United States to import from and invest in
the European Monetary Union (EMU), and
thus the greater is the quantity of euros
demanded by US residents.
• If the US demand curve for euros shifted
up as (e.g., as a result of increased US
tastes for EMU’s goods) and intersected
the US supply curve for euros at point A,
the equilibrium exchange rate would be
R=1.10, and the equilibrium quantity
would be €400 million per day. The dollar
is then said to have depreciated, since it
now requires $1.10 (instead of the
previous $1.00) to purchase one euro.
• Depreciation refers to an increase in the
domestic price of the foreign currency.

• Appreciation refers to a decline in the domestic


price of the foreign currency.
• In the absence of interferences by national
monetary authorities, the foreign exchange
market operates just like any other competitive
market, with the equilibrium price and quantity of
the foreign determined at the intersection of the
market demand and supply curves for the
foreign currency.