(Solved) Market Structures - PDF

Running head: MARKET STRUCTURES
1
Market Structures
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Professor
Course
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MARKET STRUCTURES
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Question 1
a. Perfectly competitive market
Under perfect competition market, there is a freedom of entry and exit, all market players
have complete access to precise information, commodities are homogenous, and neither the
buyer nor the seller has an advantage over other (Hubbard, Garnett, Lewis, & O'Brien, 2016). On
figure one, MR = Price and also MR = MC. The allocative efficiency occurs at point A where the
price matches the marginal cost.
Figure 1: Allocative efficiency
Cost/revenue
Quantity
b.
Monopolistic competitive firms do not attain allocative efficiency because this market
does not fulfill the condition for allocative efficiency, that is, the price should equal the marginal
cost. Under this market structure, companies maximize revenue when the marginal revenue
equals the marginal costs, though; this takes place at a lower output than in perfect competition
LMC
LAC
P=MR=ARPe
Q1
A

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(Hubbard, Garnett, Lewis, & O'Brien, 2016). On figure two below, a monopolistic competitive
firm generates at point Q. At this point, the price is higher than marginal cost and thus allocative
inefficiency.
Figure 2: Monopolistic competition in long run
Revenue/
Cost
Output
Question 2
a. Collusive oligopolies and allocation of factors of production
Oligopoly firms can collude to determine the output levels or the prices with the aim of
maximizing profits (Sloman, Wride, & Garratt, 2015). As a result, the output levels are often
lower, and the prices are above market-clearing price. The colluding oligopolies behave like
monopolies, and hence there are productive and allocative inefficient.
P
MC
Q
MR
D=AR
MC=MR
Q1
MC
AC

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In collusive oligopolies, the price surpasses the minimum average total cost, and thus
firms are productive inefficient (Sloman, Wride, & Garratt, 2015). This means that in this market
structure there is underutilization of resources, that is, excess capacity. On graph three, the
collusive oligopolies maximize profits at output Q. if firms in this market were productive
efficient, then the profit maximization output would be Q1. Moreover, if the firms in this market
were allocative efficient they would operate at point U. The firms are running at a point where
the marginal cost equals the marginal revenue and thus allocative inefficient. This scenario
shows there is underallocation of resources.
Figure 3: Inefficiencies in Collusive Oligopoly
Revenue/
Cost
b.
If a firm chooses to cheat, then other businesses will retaliate through price wars. Price
wars will reduce the revenues of these firms and in worse cases other companies are likely to
P
MC
Q
MR
D=AR
MC=MR
OutputQ1
MC
AC
Excess
capacity
U

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incur losses. A company in collusive oligopoly will accept to operate under losses as long as its
variable costs are fully covered (McTaggart, Findlay, & Parkin, 2015). On graph four below,
such firm will function at point A where the marginal costs match the marginal revenue
generating output Q. The cost the firm incurs in producing Q is OQms while the price received Q
is Qt, and total revenue is OQnt. Hence, the loss suffered is depicted by area msnt.
Figure 4: Loss when a firm cheats
Revenue/
Cost
Output
Question 3.
a. Monopoly and Inefficient allocation of resources
Allocative Inefficiency
Allocative efficient occurs when the marginal cost matches the prices, that is, when MC =
P (McTaggart, Findlay, & Parkin, 2015). However, the price of a monopoly exceeds the
m
n
p
s
t
u
O Q
D
MR
SMC SATC
AV
A

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marginal costs. Since a monopoly does not fulfill the condition of MC = P, then it is allocative
inefficient. On graph five below, a single seller in the market operates at point G where the price
equals the marginal cost producing a revenue-maximizing quantity Q. If a single seller was
allocative efficient, then the seller would operate at point D producing allocative efficient
quantity Qd. As a result, the resources used in production are under-allocated when there is a
single seller in the market.
Figure 5: Allocative inefficiency when there is a single seller in the market
Price and
Cost
Productive Inefficiency
A single seller in the market is perpetually productive inefficient (McTaggart, Findlay, &
Parkin, 2015). Such firm is productive inefficient because the generation of products does not
occur at the minimum average cost. On figure six below, a monopoly maximizes profits at output
LMC
LAC
U V
W
G
D=AR
MR
QdQO
D
Z
Quantity

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Q. However, the efficient, productive quantity is Qc which is not attained when there is a single
seller in the market. Therefore, less output is generated and priced highly leading to a reduction
in the welfare of the consumers. The variation between Q and Qc depicts the excess capacity.
The factors of production are therefore underutilized.
Figure 6: Productive Inefficiency for a monopoly
Price and
Cost
Quantity
b. Advantages and disadvantages of monopoly
A monopoly can make use of the supernormal profits to undertake meaningful research to
enhance the quality of the products. Moreover, research can also result in innovation that can
significantly reduce the production costs. Economies of scale enjoyed by a monopoly can also
O
c
t
r
LMC LAC
Qc
s
p
Q
D=AR
MR

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lower costs (McTaggart, Findlay, & Parkin, 2015). Such benefits can be passed to consumers
through reduced prices.
Despite these benefits, a monopoly has some drawbacks. Foremost, since there is no
close substitute and rivals, a monopoly often hike the prices of commodities. Also, a monopoly
can produce goods of low quality knowing well that consumers will buy due to lack of
alternative sellers (McTaggart, Findlay, & Parkin, 2015).
Question 5
Subsidies
Figure 7: Subsidies to promote consumption of clean energy
Price
The government can provide subsidies to increase the intake of clean energy like the solar
power. On graph seven above, equilibrium in the free market is achieved at point U where
demand matches the supply. Though, at this point, the marginal social benefits of cleaner energy
SMB
P=PMB
Capacity
S2
S=PMC=SMC
P
P2
Q Q1
P1 u
h

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surpass the private marginal benefit. Therefore, subsidies will shift the supply curve of clean
energy to S2 and consumption will also increase since it is more affordable. Now the optimal
social point is h where marginal social benefit matches the social marginal costs.
Corrective Taxation
On graph eight below, the use of tax will make the supply curve to change from S1 to S2. As a
result, production reduces from Q1 to social optimal level Q.
Figure 8: Corrective Taxation
Price
Output
Question 8
a. a 10% rise in income will increase the demand for prerecorded music compact disks by 70%
whereas the demand for cabinet makers work will rise by 7%.
D=PMB=SMB
T
R
S=PMC1
S2=SMC2
P
P1
Q Q1

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b. Through substitution effect. If the price of prerecorded music compact disks player hikes the
buyers will shift to an MP3 player.
c. YED = 0.6. It is a normal good. A 10% growth in income will result in a 6% surge in demand.
YED = -2.6. It is an inferior good. A 10% growth in income will lead to a 26% drop in demand
d. XED = +0.64. Depicts products are substitutes. A 1% hike in the price of good A will cause
0.64% surge in demand for a good B.
e. XED = -2.6. Products are complements. A 1% hike in the price of good A will result in 2.6%
decline in demand for good B.

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References
Hubbard, R. G., Garnett, A., Lewis, P. E., & O'Brien, A. P. (2016). Essentials of economics (3 ed.).
Melbourne, Victoria: Pearson Australia.
McTaggart, D., Findlay, C. C., & Parkin, M. (2015). Economics. Frenchs Forest, N.S.W: Pearson.
Sloman, J., Wride, A., & Garratt, D. (2015). Economics (9th ed.). Harlow : Pearson.