MARKET STRUCTURE 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.