Market structure: the way in which a market is organised in terms of the number of firms and the
barriers to the entry of new firms
Models of market structure
1. Perfect competition: an ideal market structure that has many buyers and sellers, identical or
homogeneous products, no barriers to entry. This market structure is purely theoretical, it is
used as a model which acts as a benchmark for real world competition. The characteristics of
perfect competition are:
a. There are a number of buyers and sellers who have a perfect knowledge about the
prices that are being charged.
b. Firms are the price takers not the price makers. The prices are determined by the forces
of market demand and the output of all firms.
c. The products in perfect competition are homogeneous (identical), hence all the goods
are of the same quality and are identical in the eyes of the consumer.
d. There are no barriers to enter in this market.
The demand curve of the firms is therefore perfectly elastic (a small change in price will lead
to a larger change in quantity demanded). If the firm sells an extra unit of output still the
price will remain the same as the one previously, moreover marginal revenue is equal to the
price or the average revenue. Hence D=AR=MR. Moreover, the only decision firms need to
make is to decide the level of output, assuming the firm wants to maximize profits the
output should be decided at MC=MR on the graph. If the total cost of producing output is
less than the total revenue than the firm will be making supernormal profit (abnormal
profit), however if the total cost is equal to the total revenue is equal to the total revenue,
then the firm will be considered to be making normal profit. Whereas if the total cost is
greater than the total revenue then the firm may be about to exit the industry (in the long
run) the chances of this not happening can only be created if the market price increases or
the cost of production declines. Supernormal profit can only be achieved in the short run in
perfect competition. This is because its existence will act as an incentive for the entry of new
firms. The absence of barriers to entry means that the total supply in the market will rise.
The effect of this on the existing firms is that the market price will fall and the abnormal
profit will diminish. Hence in the long run only normal profit can be made.