1. RUNNING HEAD: MARKET STRUCTURES 1
Market Structures and its Composition of Individual Firms
Aaron Showers
Colorado Technical University
Professor Deborah McCafferty
ECON212-1404B-06: Principles of Microeconomics
December 19, 2014

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Market Structures and its Composition of Individual Firms
Introduction
The economics of an online business can be analyzed and seen as profitable or not when
all aspects of its production, cost, and revenue and profit have been identified. Some of the
intricacies that go into production are cost, revenue, and profit. Each of these facets will work
differently when analyzing a business operation and its short run and long run affects. An
individual firm’s main purpose can be looked at as getting results from production. According to
the Editorial Board (2014), the production function is the relationship between the product and
service which is the output, relative to the cost or the amount of inputs required to generate it
(p.72). This is the baseline for explaining the components of business production: product, cost,
revenue and profit.
Understanding Cost, Revenue, and Production
The Editorial Board (2014) defines the total product as the output known as the good that
is generated based on the amount of input contributed to its development (p.72). These inputs
can be various factors such as materials used, labor contributed, and/or manufacturing overhead
associated with the overall input (Nobles, Mattison, & Matsumura, 2014, p.1201). Cost can be
classified into 2 categories fixed and variable. Fixed cost can be defined as expenses that do not
change as the level of output changes while variable cost does change and is measured by the
amount of input used within production, total cost would be the sum of both variable and fixed
cost (Editorial Board, 2014, p.76). As noted in the Editorial Board (2014), total revenue is
defined as the total of all monies received from sales made of a good or service created (p.78).
Profit is the difference between the revenues received and the cost that has been incurred from

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the production process. When the cost and the revenue is understood a firm may maximize its
profit potential to the highest level of efficiency (Editorial Board, 2014, p.75).
Overview of the Distinct Market Models and Their Functions
The Short Run vs. the Long Run
Before understanding the different market models, there similarities, differences, and
unique features one must understand the time frames that an individual firm will operate in
which is the short run and the long run. According to Beggs (2014), the short run and the long
run can be looked at as not “a specific period of time but the time horizon needed for a producer
to have flexibility over all relevant production decisions.” In other words the short run would be
associated with the variable cost within that time horizon in which fixed cost such as
manufacturing overhead (property, plant, and equipment) and the overall production process is
already established. The short run time horizon entails variable cost that affects the output of the
production process such as labor or materials used at that particular level. In the long run time
horizon there are no fixed and sunk cost as the overall outlook of a firms operation is subject to
change as needed. This would include scaling up or down on property, plant, and equipment that
would determine at what level fixed cost is fixed as well as making changes with direct labor and
direct labor used (Beggs, 2014). Overall, the long run effects would be outside of the realm of
the fixed and sunk cost incurred (Beggs, 2014).
The 4 Distinct Market Structures
The main market structures known as perfect competition, monopoly, monopolistic
competition, and an oligopoly are the 4 different structures that a business is classified under
with 2 being more theoretical (perfect competition and monopoly) and 2 being more actual
(monopolistic competition and oligopoly).

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Perfect Competition
A perfect competition model is mainly a theoretical construct but markets that move
towards this model are embraced with many benefits, it is also known as the standard that is used
to evaluate all other models (Editorial Board, 2014, p.86). This is because consumers would
tend to pay lower prices on products than markets with power over price which means high
demands and in the long run a firms average total cost is at minimum amounts (Editorial Board,
2014, p.86). In perfect competition, production and allocative efficiency is also achieved.
Allocative efficiency is when market supply is equal to market demand where no other deviation
can result in the betterment of social welfare. This is the point where the marginal cost is equal
to the marginal benefit, the equilibrium point of price and quantity (Editorial Board, 2014, p.92).
Production efficiency is utilizing the most efficient technology available, this has a low cost
effect in the long run (Editorial Board, 2014, p.92).
Some features found in a perfection market construct are the involvement of many buyers
and sellers, free entry and exit of market as desired, utilizing products that are exactly similar in
nature, availability of perfect information, sellers being price takers which is accepting the
market equilibrium price because of standardized product and building size and in the long run
tend to have a normal profit outcome (Bized, 2010). In a perfect competition market consumers
have the option to buy from another firm if the price is raised above the equilibrium price
because of this ability consumers have, producers will accept the market price of their product as
there is no benefit in raising or lowering it. Furthermore large amounts of positive profits are
eliminated in the long run because of non-existing barriers for other firms to enter the market.
This is because as more firms enter the market the supply will increase having an effect on the
supply curve shifting it to the right which will in turn cause the equilibrium price to drop; as a

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result, having an effect on long term positive profits (Editorial Board, 2014, p.91). On the other
hand firms will exit the market if price is lower than the average total cost. This is when
business will no longer be profitable if in the market. They will stay out of the market until price
is above the minimum average total cost (p.91). Even though this is a theoretical construct many
market will move in this direction, however the actual occurrence is rare.
Monopoly
A monopoly can be looked at as a market that has on producer. An example of a
monopoly would be a local gas company or a regional ground cable company like Comcast in
New Jersey. This is seen as the direct opposite of a perfect competition market model as one
company is used to service the entire market. This model in itself is also a theoretical construct
with markets mirroring this model to be very rare. In perfect competition markets there are
many firms known as price takers; however, in monopolies there is only one firm and that
producer has the ability to influence price by choosing the level of output that would result in the
most amount of profit for the company, in this regard the company would be looked at as a price
maker. The monopolist essentially is able to choose the quantity and price that would guarantee
the highest level of profit available for success.
Some of the features of monopolies include high barriers to entry, having control over
price and/or output, price discrimination, the firm being equal to the industry, consumer choice,
over 25% market share, natural monopolies and abnormal profits (Bized, 2010). Price
discrimination occurs when a firm charges different prices to different customers for the same
products and services. Consumers can be grouped in categories such as age, employment and
other characteristics (Editorial Board, 2014, 74). A natural monopoly is large economies being
achieved only by the event of having one producer. In a pure monopoly model a firm may

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restrict output to a particular quantity, they would produce less than the competitive market
equilibrium quantity while charging a higher price. Doing this would have a negative effect on
the social welfare as quantity is restricted to the amount where marginal revenue is equal to the
firms marginal cost (Editorial Board, 2014, 74). Because monopolies are large economies of
scale, there are natural barriers with new firms wishing to enter being placed at a cost
disadvantage (Editorial Board, 2014, p.98). Other types of barriers that prevent for new firms
are legal and strategic barriers. The products used in a monopoly don’t have any close
substitutes, this is what keeps the market strong being that substituted products would take away
from the high demand and diminish a firm’s power over the market. In this sense a monopoly
can be considered to be highly inelastic. Some examples of products that cannot be substituted is
gas, water, or electricity.
Monopolistic Competition
Monopolistic competition is looked at as a more intermediate market that shows a more
realistic case that most markets will correspond to. Some of the features of this market includes
many buyers and sellers, differentiated products, relatively free entry and exit, some control over
price and a small minor monopoly over their products (Bized, 2010). These features show
commonalities with both perfect competition and monopoly markets. Like perfect competition
there are many small companies in this market, there are also low barriers to entry that makes
entry and exit easy and convenient. However, unlike perfect competition the products are similar
but differentiated and not standardized (Editorial Board, 2014, p.119). This enables producers of
monopolistic competition to have some control over its price with a downward sloping demand
curve.

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Monopolistic competition companies can be seen as having products that are similar but
slightly different as this would enable them to have some control over price regulations. Unlike
a monopoly, these firms have many competitors that would use close substitutes as advantage.
They use the ability to offer a difference in products or services as a way of competing against
each other. These businesses offer products diverse in quality, design, store location, brand, or
even customer perception (Editorial Board, 2014, 120). Demand is not perfectly elastic but
products can be changed if the price is raised too much over its competitors (Editorial Board,
2014, 120). There can be minor cost that are incurred for entry and exit into these markets but
for the most part, entry and exit is free. Some examples of products that use a monopolistic
competitive model are restaurants, sneakers, health vitamin products etc.
Oligopoly
An oligopoly can be defined as a concentrated market structure with a few firms that
control a substantial share of the market, there are high barriers of entry and a differentiated set
of products with firms having a significant amount of power. Usually the top four firms control
at least 40% or more when it is considered to be an oligopoly market (Editorial Board, 2014,
122). The action that one firm takes in an oligopoly usually has an effect on its competitor’s
profits as each company is interdependent on each other. Some main features of an oligopoly are
competition amongst the given few, high barriers to entry, product differentiation,
interdependence between firms, abnormal profits, contraction ratio and collusion (Bized, 2010).
With price leadership, a firm will raise its price to match that of the price leader. Like in a
monopoly, barrier to entry are reasons for contributing oligopolistic firms market power, free
entry and exit is more restricted as huge amounts of capital is required for startup prohibiting
entrepreneurs from taking advantage of positive market trends. Some examples of oligopolies are

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the cell phone industry, automobile industry, laptops (Apple & Dell), cameras (Nikon, Canon),
and digital electronic products (Sony, Panasonic, Samsung).
Example of a business functioning in Monopolistic Competition
Let’s examine a hypothetical case of an online business selling cookbooks after quitting a
job paying $50,000 a year. The average selling price being $30 and cost being $20. The
equation for demand being Q= 40,000 – 500P would illustrate a demand curve from $25-$35:
Furthermore the fixed cost are overhead ($1,000), technology ($5,000), and equipment
($4,000) are fixed cost with postage and handling ($1000), miscellaneous ($3,000) and inventory
of cookbooks ($2000) being variable cost. If I expected to sell 22,000 cookbooks my total cost
would be $450,000 with the calculations being the following:
22,000 (cookbooks) * $20 (avg. cost per cookbook) + $5000 (technology) + $1000
(overhead) + $4,000 (equipment) = $450,000 total cost. Being that the average retail selling
price is $30 per book which that month would equal 30*$22,000 = $660,000 revenue, it is
definitely worth pursuing as a profit of $210,000 would be made. This business would be
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classified under the monopolistic competition market structure as it fits the description of how a
business would operate under those circumstances.
First of all, being that it is an online business there is free entry and exit into the market
because of the ease of selling products online. Secondly, being the product is a book makes it
easy to create a business from and there are many different types of books one can sell which
gives the owner a slight monopoly with the product. Third, if this business was in a perfect
competition market all the cookbooks sold online would have the same details and recipes
offered, types of food offered ex. American, Italian etc. and meals explained breakfast lunch,
dinner, outdoor grilling etc. Fourth, it is a not a monopoly or oligopoly because of the presence
of many buyers and sellers being sold on an online website to cooks, chefs or people who enjoy
reading or learning new things. Finally, because it is a book that can offer high quality
information as opposed to other cookbooks on the market the producer would gain an edge with
some control over price, the producer would be able to price the product according to the quality
of information, and consumer perception creating a more inelastic downward sloping demand
curve. The product may even be a special edition or limited edition which would control the
quantity produced.
Explanation of the Monopolistic Competition Model
The monopolistic competition model entails control over product output that would allow
the producer to have a highly demanding product because of the differentiation between the
products. This would allow the producer to develop its own demand curve for the product
because of its exclusiveness instead of using the standard competition price of generating the
same level of revenue from that price level but having to produce more product to do so
(Editorial Boards, 2014, p.101). The marginal revenue can be defined as the change in total

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revenue by one unit divided by the change in quantity by one unit (Editorial Board, 2014, p.78).
This would create the businesses individual demand curve that would be more inelastic than the
demand of a perfect competition market. Marginal cost is defined by the change in total cost
divided by the change in output (quantity) (Editorial Board, 2014, p.78). Marginal reasoning
implies that profit is maximized when marginal revenue is equal to the marginal cost. This
occurs because of the law increasing marginal returns and diminishing marginal returns. As a
business develops, cost is usually low and profit is not made because of no specialization being
present plus the occurrence of fixed cost and fees in its operations will put the company in a
negative bracket instead of a profit. Increasing its specialization will have an effect on its output
increasing its total revenue at a rate faster than the input (initial cost). When the output level of
full specialization is realized the marginal revenue should be equal to the marginal cost and the
highest level of profit can be obtained (Editorial Board, 2014, p.74). Diminishing marginal
returns occur when more variable cost is incurred and there is too much labor or material that
surpasses the maximum efficiency in production (Editorial Board, 2014, p.74). This is the
effects in the short run as the fixed cost is established shown by the average total cost curve
being above the marginal cost curve. In order to guarantee success with cookbooks online I
would produce the amount of cookbooks where my marginal revenue equals my marginal cost
while pricing my books according to the markets demand at that quantity amount. The marginal
cost would signify a short run time horizon with profits being made because of the formula:
Profit = Total Revenue – Total Cost.
The pricing strategy I might use is keeping the books at the average market price and
creating an inelastic demand for the product. This is done by the products differentiation which
will show the uniqueness and the limited availability of that product on the market. This will

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increase revenue and develop a high profit because of its low marginal cost. However, in the
long run because of free entry for new competitors and the availability for substitutions because
of competitors taking advantage of a strong market, the demand will decrease. When the market
demand curve at the profit maximization output level becomes equal with the average total cost
there is no economic profit (editorial Board, 2014, p.121). This is because of the long run cost of
property, plant, and equipment on average is the same or more than the profit incurred. Before
this occurrence takes place I will exit the market until the demand increases again.
Conclusion
Individual firms can be seen as existing within various market structures depending on
the mechanics of it business operations. They range more intermediate markets of monopolistic
competition and oligopolies that move towards more perfect markets of theoretical constructs
demands such as perfect competition and monopoly markets. These intermediate markets are
seen as having combinations of both theoretical markets. There are many unique features of each
market structure plus the online businesses can be looked at as having a monopolistic
competition model. Its main purpose is to generate an output that can take advantage of its profit
maximization where marginal revenue equals marginal cost in the short run while keeping profits
above its average total cost in the long run.

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References
Beggs, J. (2014). The Short Run versus the Long Run. Retrieved from
http://economics.about.com/od/perfect-competition/a/The-Short-Run-Versus-The-Long-
Run.htm
Bized. (2012). Market Structures- Mind map. Retrieved from
http://www.bized.co.uk/educators/16-
19/economics/firms/presentation/structure_map.htm
Editorial Board (2014). (1st Ed.). Microeconomics. Retrieved from Colorado Technical
University Online, Virtual Campus, ECON212-1404B-06:https://campus.ctuonline.edu
Nobles, T., Mattison, B., Matsumura, M. E., (2014). Financial Statement Analysis (10th ed.).
Retrieved from http://wow.coursesmart.com/9781269366465/firstsection

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