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MARKET STRUCTURES:PERFECT COMPETITION, Allocative efficiency

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Introduction to Economics ­ECO401
VU
UNIT - 6
Lesson 6.1
MARKET STRUCTURES
Market structure refers to how an industry (broadly called market) that a firm is operating in is
structured or organized.
The key ingredients of any market structure are:
·  Number of firms in the market/industry
·  Extent of barriers to entry
·  Nature of product
·  Degree of control over price.
Knowledge about market structure can help answer four questions:
i.  How much profit a firm will make (normal or supernormal)
ii. How much quantity it will produce at its profit-maximisation point (i.e. whether it will
be a large level of output or a small one relative to the market)
iii. Whether or not a higher level of output would increase the cost or productive
efficiency of the firm or allocative efficiency for society (see the summary on
monopoly for details)
iv. Are the prices set too high, too low, or just right?
Four broad market structures have been identified by economists:
·  Perfect competition
·  Monopoly
·  Monopolistic competition
·  Oligopoly.
Implication for
Type of
Number Freedom of
Nature of
Examples
demand curve of
market
of firms
entry
product
firm
Perfect
Very
Homogenous
Grains (wheat) or Horizontal; firm is a
Unrestricted
competition
many
(undifferentiated) vegetables
price taker
Downward sloping but
Monopolistic Many /
Plumbers,
relatively elastic; firm
Unrestricted Differentiated
competition  Several
restaurants
has some control over
prices.
Downward sloping
1.
relatively inelastic but
Cement, cars,
Oligopoly or
Undifferentiated
depends on reactions
electrical
Few
Restricted
or 2.
Cartel
of rivals to a price
appliance, oil.
Differentiated
change
Downward sloping
Restricted or
more inelastic than
WAPDA, or
Monopoly
One
completely  Unique
oligopoly; firm has
KESC
blocked
considerable control
over price
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Introduction to Economics ­ECO401
VU
PERFECT COMPETITION
The main assumptions of perfect competition are:
i.  Large number of buyers and sellers, therefore firms price-takers.
ii. No barriers to entry (also implies free mobility of factors of production).
iii. Identical/homogeneous products.
iv. Perfect information/knowledge.
The word perfect in perfect competition is not used its normative sense. Rather it means that
competition in the industry is of an extreme nature. It is used as a benchmark with which to
compare other types of market structures.
Perfect competition can be thought of as an extreme form of capitalism, i.e. all the firms are
fully subject to the market forces of demand and supply.
Concentration ratio is used to assess the level of competition in an industry. It is simply the
percentage of total industry output that is produced by the 5 largest firms in the industry.
The Short Run and Long Run under Perfect Competition:
The short run is the period where at least one factor of production is fixed. In perfect competition,
it also means that no new firms can enter the market. In the long run, all the factors of production
are variable.
Equilibrium analysis can help us answer questions about the market-clearing price and quantity;
where the profits are maximized and how much are these profits; how individual firms make their
short run supply decisions and how these translate into the long-run industry supply curve.
In the short run, a perfectly competitive firm can settle at an equilibrium where it is making super
normal profits, normal profits, loss, or where it decides to shut down.
In the short run, the firm's supply curve is identical to the positive part of MC. The short run
industry supply curve is simply the horizontal summation of the supply curves of individual firms.
The demand (or AR) curve for the industry is downward sloping but for any individual perfectly
competitive firm, is horizontal. Thus the firm can sell as much at the given market price. For this
reason, the AR and MR curves align under perfect competition.
In the long run, any firm can enter or leave the industry. If there are supernormal profits in the
short run, more firms will be attracted to the market and the increase in supply will push prices
down to eliminate supernormal profit possibilities in the long run. By contrast, if firms are making
losses in the short run, they will leave the industry in the long run causing supply to fall, prices to
rise and normal profitability to be restored. In the long run, therefore, perfectly competitive firms
can only earn normal profits.
Allocative Efficiency and Productive Efficiency:
Public interest is concerned with both allocative efficiency and productive efficiency.
a. Allocative efficiency: The optimal point of production for any individual firm is where
MR=MC. The optimal point of production for any society is where price is equal to
marginal cost. This is called the point of maximum allocative efficiency and is achieved
in perfect competition (because MR=MC, and MR=AR=P for a perfectly competitive price
taking firm, therefore P=MC).
b. Productive efficiency: This is attained when firms produce at the bottom of their AC
curves, that is, goods are produced in the most cost efficient manner. Perfectly
competitive firms also achieve this in the long run because they produce at P=MC and
this intersection point also happens to be the point of tangency with the lowest part of the
AC curve. Thus P= ACminimum.
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Table of Contents:
  1. INTRODUCTION TO ECONOMICS:Economic Systems
  2. INTRODUCTION TO ECONOMICS (CONTINUED………):Opportunity Cost
  3. DEMAND, SUPPLY AND EQUILIBRIUM:Goods Market and Factors Market
  4. DEMAND, SUPPLY AND EQUILIBRIUM (CONTINUED……..)
  5. DEMAND, SUPPLY AND EQUILIBRIUM (CONTINUED……..):Equilibrium
  6. ELASTICITIES:Price Elasticity of Demand, Point Elasticity, Arc Elasticity
  7. ELASTICITIES (CONTINUED………….):Total revenue and Elasticity
  8. ELASTICITIES (CONTINUED………….):Short Run and Long Run, Incidence of Taxation
  9. BACKGROUND TO DEMAND/CONSUMPTION:CONSUMER BEHAVIOR
  10. BACKGROUND TO DEMAND/CONSUMPTION (CONTINUED…………….)
  11. BACKGROUND TO DEMAND/CONSUMPTION (CONTINUED…………….)The Indifference Curve Approach
  12. BACKGROUND TO DEMAND/CONSUMPTION (CONTINUED…………….):Normal Goods and Giffen Good
  13. BACKGROUND TO SUPPLY/COSTS:PRODUCTIVE THEORY
  14. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):The Scale of Production
  15. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):Isoquant
  16. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):COSTS
  17. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):REVENUES
  18. BACKGROUND TO SUPPLY/COSTS (CONTINUED…………..):PROFIT MAXIMISATION
  19. MARKET STRUCTURES:PERFECT COMPETITION, Allocative efficiency
  20. MARKET STRUCTURES (CONTINUED………..):MONOPOLY
  21. MARKET STRUCTURES (CONTINUED………..):PRICE DISCRIMINATION
  22. MARKET STRUCTURES (CONTINUED………..):OLIGOPOLY
  23. SELECTED ISSUES IN MICROECONOMICS:WELFARE ECONOMICS
  24. SELECTED ISSUES IN MICROECONOMICS (CONTINUED……………)
  25. INTRODUCTION TO MACROECONOMICS:Price Level and its Effects:
  26. INTRODUCTION TO MACROECONOMICS (CONTINUED………..)
  27. INTRODUCTION TO MACROECONOMICS (CONTINUED………..):The Monetarist School
  28. THE USE OF MACROECONOMIC DATA, AND THE DEFINITION AND ACCOUNTING OF NATIONAL INCOME
  29. THE USE OF MACROECONOMIC DATA, AND THE DEFINITION AND ACCOUNTING OF NATIONAL INCOME (CONTINUED……………..)
  30. MACROECONOMIC EQUILIBRIUM & VARIABLES; THE DETERMINATION OF EQUILIBRIUM INCOME
  31. MACROECONOMIC EQUILIBRIUM & VARIABLES; THE DETERMINATION OF EQUILIBRIUM INCOME (CONTINUED………..)
  32. MACROECONOMIC EQUILIBRIUM & VARIABLES; THE DETERMINATION OF EQUILIBRIUM INCOME (CONTINUED………..):The Accelerator
  33. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS
  34. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….)
  35. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):Causes of Inflation
  36. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):BALANCE OF PAYMENTS
  37. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):GROWTH
  38. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):Land
  39. THE FOUR BIG MACROECONOMIC ISSUES AND THEIR INTER-RELATIONSHIPS (CONTINUED…….):Growth-inflation
  40. FISCAL POLICY AND TAXATION:Budget Deficit, Budget Surplus and Balanced Budget
  41. MONEY, CENTRAL BANKING AND MONETARY POLICY
  42. MONEY, CENTRAL BANKING AND MONETARY POLICY (CONTINUED…….)
  43. JOINT EQUILIBRIUM IN THE MONEY AND GOODS MARKETS: THE IS-LM FRAMEWORK
  44. AN INTRODUCTION TO INTERNATIONAL TRADE AND FINANCE
  45. PROBLEMS OF LOWER INCOME COUNTRIES:Poverty trap theories: