Unit III
Market structure Methods of pricing
Characteristics Differential pricing
Pricing and output Government
decision intervention &pricing
Market classification
Area wise Time wise Trade wise
• Local • Market • Competition
• National period • Monopoly
• International • Short period
• Long period
Types of Competition
Perfect • Demand=Supply
Competition
• Monopolistic
Imperfect competition
competition • Oligopoly
• Duopoly
• Simple
Monopoly • Discriminating
Different Types of Market Structures
Perfect Competition
Features of perfect competition
◦ Free entry and exit to industry
◦ Homogenous product – identical so no consumer
preference
◦ Large number of buyers and sellers – no individual
seller can influence price
◦ Sellers are price takers – have to accept the market
price
◦ Perfect information available to buyers and sellers
The Perfectly Competitive Firm and
Industry in Short-Run Equilibrium
Draw economic loss
The Long Run adjustments in Perfect
Competition
D1 MC
P D P
S S1
ATC
P1
P P=MR
Q Q1
The Individual firm 7
Advantages of Perfect
Competition
High degree of competition helps allocate
resources to most efficient use
Price = marginal costs
Normal profit made in the long run
Firms operate at maximum efficiency
Consumers benefit
What happens in a competitive
environment?
◦ New idea? – firm makes short term abnormal
profit
◦ Other firms enter the industry to take
advantage of abnormal profit
◦ Supply increases – price falls
◦ Long run – normal profit made
◦ Choice for consumer
◦ Price sufficient for normal profit to be made
but no more!
Imperfect or Monopolistic
Competition
Imperfect or Monopolistic Competition
◦ Many buyers and sellers
◦ Products differentiated
◦ Relatively free entry and exit
◦ Each firm may have a tiny ‘monopoly’ because of the
differentiation of their product
◦ Firm has some control over price
◦ Examples – restaurants, professions – solicitors, etc.,
building firms – plasterers, plumbers, etc.
Short-Run and Long-Run Equilibrium
for a Monopolistic Competitor
Short-Run Profits Short-Run Losses
Long-Run Equilibrium
Visual 3.13
[Link]
t
What happens to the demand
curve with more competition?
The demand curve for an
existing firm will become more
elastic and shift to the left as
entry occurs
Oligopoly
Competition between the few
May be a large number of firms in the industry but the industry is
dominated by a small number of very large producers
Concentration Ratio – the proportion of total
market sales (share) held by the top 3,4,5, etc
firms:
A 4 firm concentration ratio of 75% means the top 4 firms account
for 75% of all
the sales in the industry
Features of an oligopolistic market
structure:
Price may be relatively stable across the industry –
kinked demand curve?
Potential for collusion
Behaviour of firms affected by what they believe their rivals
might do – interdependence of firms
Goods could be homogenous or highly differentiated
Branding and brand loyalty may be a potent source of competitive
advantage
Non-price competition may be prevalent
Game theory can be used to explain some behaviour
AC curve may be saucer shaped – minimum efficient scale
could occur over large range of output
High barriers to entry
oligopoly
The
Assume
IfThe
thefirm
principle
firmthe
therefore,
seeks
firm
ofto
is
thelower
charging
effectively
kinked
its price
demand
a faces
price to of
£5‘kinked
a
gain and
a curvedemand
competitive
producing
rests on curve’
an forcing
advantage,
the
output itsit rivals
principle
of 100. to
will follow
maintain that:
asuit.
stableAnyorgains
rigid pricing
it makes will
If it chose to raise price above £5, its
quickly beOligopolistic
structure. lost and the firms
% changemay in
rivals
a. would
If a firm
not raises
followitssuit
price,
anditsthe firm
demand will
overcome this
beby smaller
engagingthaninthenon-%
effectively
rivalsfaces
will not
an follow
elasticsuitdemand
reduction
price in price – total revenue
competition.
curve for its product (consumers would
would
b. Ifagaina firmfall
lowers
as theitsfirm
price,
nowitsfaces
buy from the cheaper rivals). The %
£5 a relatively
rivalsinelastic
will all dodemand
the same
change in demand would be greater
curve.
than the % change in price and TR
Total would fall.
Revenue B
Total Revenue A
D = elastic
Total Revenue B Kinked D Curve
D = Inelastic
100 Quantity
Duopoly
There are only 2 sellers
Limiting case of oligopoly
Each firms knows that whatever it does will
affect its rival’s policies.
There are two extremes in a duopolistic :
i) Each firm engages in cut throat
competition and
ii) the firms realise the evils of competition
and agree to corporate
Characteristics
Only two firms
Two firms may either resort to
compete or collusion
Only non price competition exists
Producers are homogenous
Same price will exist in the long run
Action of one firm will have reations
by the other.
Models of duopoly
Cournot’s Chamberlin’s
model model
Cournot’s model
Assumptions
Two independent sellers sells homogenous
product
The cost of production is identical ( water spring
– zero cost of production)
Each seller aims maximum profit
The number of buyer is large
They face straight line demand curve
Each firm decides their output assuming rival will
not change his output.
The model
Two firms A & B
Owning spring of mineral water
It is nature’s gift – zero cost of
production
The duopolists face a straight line dd
curve, their output is given
Explained with diagram
Price and output in monopoly
Monopoly, single firm, no c
lose substitutes, barriers to entry
According to Chamberlin, “ the
essence of monopoly is control
over supply”
In monopoly, firm is a price maker
Market Structure
Monopoly:
◦ High barriers to entry
◦ Firm controls price OR output/supply
◦ Abnormal profits in long run
◦ Possibility of price discrimination
◦ Consumer choice limited
◦ Prices in excess of MC
What is a Price Maker?
A firm that has the ability
to choose among
combinations of price
and output, attempting to
find the profit maximizing
combination
How does a Monopoly determine
Price & Output to maximize profits?
MR = MC
©1999 South-Western College Publishing
Why are profits maximized
MR = MC?
MR > MC (keep producing)
MR < MC (stop producing)
MR = MC (no $ gained or lost on the last unit)
©1999 South-Western College Publishing
Monopoly: Positive Profit
ATC
$ P
MC
P
Profit
ATC
D
MR
Q
Q 27
Monopoly: Loss Case
ATC ATC
$ MC
Loss
P
P
D
MR
Q 28
Q
Advantages and disadvantages of
monopoly
Advantages:
◦ May be appropriate if natural monopoly
◦ Encourages R&D
◦ Encourages innovation
◦ Development of some products not likely without
some guarantee of monopoly in production
◦ Economies of scale can be gained – consumer may
benefit
Disadvantages:
◦ Exploitation of consumer – higher
prices
◦ Potential for supply to be limited -
less choice
◦ Potential for inefficiency –
X-inefficiency – complacency
over controls on costs
What does the Demand Curve
look like for a Monopoly?
It is the same as the market demand
curve
Demand curve in Monopoly, same as the
market demand
D
32
Q
What is Marginal Revenue?
TR
MR = Q
©1999 South-Western College Publishing
MR < P for all but the first unit of output
P Demand
Marginal Revenue
34
Q
Profit maximization in monopoly
Put in the marginal cost
curve, best output is where
MR=MC, best price for that
output is found by going up
to the demand curve
Best price and output for
monopoly
$
MC
P
D
MR
Q
Q 36
Short run profit possibilities
As always in the short run,
can make positive profits,
losses, or zero economic
profits-to show profit, must
add in the average total cost
curve.
Monopoly: Positive Profit
ATC
$ P
MC
P
Profit
ATC
D
MR
Q
Q 38
Monopoly: Loss Case
ATC ATC
$ MC
Loss
P
P
D
MR
Q 39
Q
Monopoly: Zero Profits Case
ATC
$ MC
ATC
P
P
D
MR
Q 40
Q
When will a firm continue to
operate even when making a loss?
When its losses are less than its fixed
costs: in other words, as long as Price
exceeds AVC, can stay in business in
the short run
When will a firm shut down when
making a loss?
When its losses are greater than its fixed
costs
How does Monopoly compare to
Perfect Competition ?
Higher prices & less output
under monopoly
Long run profits possible in
monopoly due to barriers to
entry
Why are demand curves
downward sloping in
Monopolistic Competition?
Because a firm can distinguish itself from
competitors and therefore has some control
over price
What happens to the demand
curve with more competition?
The demand curve for an
existing firm will become more
elastic and shift to the left as
entry occurs
©1999 South-Western College Publishing
P
D2
D1
Q
46
©1999 South-Western College Publishing
What is Normal Profit?
The minimum profit a
business owner will
accept to continue
operating the business
( same as zero economic
profit)
What is Economic Profit?
Money made above and beyond a normal
profit
©1999 South-Western College Publishing
In Monopolistic Competition, can
Economic Profit be made in the
short run?
Yes! Positive or negative
economic profit can
be made in the short
run
Why is Normal Profit the long run
equilibrium in Monopolistic Competition?
Because when positive
economic profit is made,
firms will enter the industry
eliminating the economic
profit
In monopolistic competition, what
happens as more firms enter in search of
profits?
The demand curve of other firms shifts to
the left
©1999 South-Western College Publishing
Now move from monopolistic
competition to perfect competition
Recall the characteristics of
perfect competition: many
firms, each a tiny share of the
market, producing identical
products, free entry and
perfect information
Why does a Perfectly Competitive firm
face a horizontal demand curve?
Because it can sell all it brings to market
at the market price, therefore P always
equals MR
©1999 South-Western College Publishing
Why is a firm that is a part
of a Perfectly Competitive
Market a price taker?
Because if the firm charges higher
than the market price it will not sell
one unit
©1999 South-Western College Publishing
Why is this so?
Because consumers will buy the same
thing at a lower price from its
competitors
©1999 South-Western College Publishing
The Market and the firm in Perfect
Competition
P D P
S
P=MR
The Market Individual firm
56
Profits are maximized where
MR = MC
P MC
MR1=P1
MR1=MC
MR2=P2
MR2=MC
Q
Q2 Q1
57
Why is a firm’s MC curve above its
AVC curve its Supply Curve?
Because it always produces where
MR = MC
©1999 South-Western College Publishing
Why don’t we include the MC
curve below its AVC curve as a
part of its Supply Curve?
Because below the AVC the firm will close
down
©1999 South-Western College Publishing
What is the Market’s Supply
Curve?
It is the aggregation of the long-run MC
curves of the firm’s in the market
©1999 South-Western College Publishing
In Perfect Competition, can
Economic Profit be made in the
short run?
Yes! Positive or negative
economic profit can
be made in the short
run
Why is a Normal Profit (zero
economic profits) made in the
long run?
Because of the easy entry - easy exit
feature in a Perfectly Competitive
Market
©1999 South-Western College Publishing
Zero Profits in Perfect Competition
MC
ATC
P P = MR
P = ATC
Q1
63
What happens when a firm makes
more than a Normal Profit?
More firms enter the
industry pushing prices
down toward a normal
profit
©1999 South-Western College Publishing
Right Shift in Supply
S1
P1 S2
P2
D
Q1 Q2
©1999 South-Western College Publishing 6
5
What happens when a firm makes
less than a Normal Profit?
Some firms leave the industry pushing prices
up toward a normal profit
©1999 South-Western College Publishing
Left Shift in Supply
S2
P2 S1
P1
D
Q2 Q1
©1999 South-Western College Publishing 6
7
Explanation of long run adjustments
Start at price P, typical firm making zero
profits
Suppose demand increases to D1
Price rises to P1
Typical firm making positive profits
What happens in the long run?
Assuming perfect information and free
entry, new firms enter the market
Supply shifts right until profits eliminated
Price comes down—but how far depends
on whether costs are affected
Long Run, continued
Constant cost industry: no change in
costs as new firms enter the market, price
returns to P, original price
Increasing cost industry: all firms
experience rising costs as new firms enter
the market, final price will be higher than
original price P
Decreasing cost industry: all firms
experience lower costs as new firms enter
the market, final price will be lower than
original price
Zero Profits in Perfect Competition
MC
ATC
P P = MR
P = ATC
Q1
70
Are big firms necessarily more
innovative?
Not necessarily: some small
firms are very innovative-
this is still a controversial
area in economics.
END
