MARKET STRUCTURES
Kinds of Market Structure
Perfect Competition Monopoly Monopolistic Competition Duopoly Oligopoly
Perfect Competition - Features
Large number of buyers and sellers Freedom of entry or exit of firms Homogenous product No artificial restriction on exchange Profit maximisation goal Perfect mobility of goods and factors Perfect knowledge of market conditions Absence of transport cost Absence of selling cost
Equilibrium of Industry
Cost and Revenue
General Condition:
Demand = Supply
S
P D
Quantity
Industry
P= AR
Firm
Equibrium of Industry
Effect of Changes in demand and supply on
Possibilities
Price Quantity demanded/sold
Demand Demand Demand Demand Demand Demand Demand Demand
Result depends primarily on the elasticity of deman
increases, no change in supply decreases, no change in supply stagnant, increase in supply stagnant, decrease in supply and supply increase and supply decrease increases, supply decreases decreases, supply increases
Market equilibrium and supply
Market period (one/two days; no change in stock) Short period (change in output; no change in plant capacity Long period (change in plant capacity)
Cost and Revenue D P1 P2 P3 P S2 S1 S Quantity D1 S
Supply constant (S)
Supply less elastic (S1)
Supply more elastic(S2)
S1
S2 D1
Equilibrium of firm
In short run, both efficient and inefficient firms exist Production carried till MR = MC MR = AR because firms price is given
Cost/ Revenue
MC Cost/ Revenue AC
MC AC
AR=MR
AR=MR
Profit
Loss
Quantity
Quantity Firm B
Firm A
Equilibrium of firm
In short run, both efficient and inefficient firms exist Production carried till MR = MC MR = AR because firms price is given In long run only competitive firms survive. Firms will shut down if variable costs are not recovered
Equilibrium of firm
In long run only competitive firms survive. Firms will shut down if variable costs are not recovered
Cost/ Revenue
MC
AC
AR=MR
Quantity
Firm A
MONOPOLY
Features:
Only one seller : No difference between firm and industry No direct competition or substitutes Supplier is price maker Restriction on entry of other firms
Monopoly contd.
Causes for monopoly
Patent rights/Licensing Possession of scarce raw material Size of operation very large (eg. Public utility) Exclusive knowledge of technology Action by monopolist preventing new entry Ignorance and prejudice of buyers
Monopoly contd.
Monopoly is broken when
Close substitutes emerge Demand pattern changes New firms enter the industry Government intervenes
Price determination under Monopoly
Assumptions
No price discrimination Objective: Maximisation of profit Individual buyer, price taker No restriction on pricing by monopolist No entry of new firms
Price determination under Monopoly
Cost and Revenue behaviour
MC and AC, same as under perfect competition MR and AR are downward sloping; it is flat under perfect competition Since AR = Demand, the demand curve of the firm under monopoly is similar to that of industry under competition
Price determination under Monopoly
Short run pricing and output
To maximise profit or minimise loss, produce up to MR = MC
MC MC Cost/ Revenue AC
Cost/ Revenue
AC
Loss
Profit AR=D MR Quantity MR Quantity AR=D
Price determination under Monopoly
Given the same cost curves and same price level, the output under monopoly will be lower than that under competition
MC AC MC
AC
MR = AR
AR=D MR QM
QC
Monopoly
Competition
Price determination under Monopoly
Pricing in long run
Long term costs are lower than short term costs Plant capacity established depends on market: Market is small, operate at sub-optimal level Market is very large, establish larger than optimal plant and overwork it Plant size optimum Price considerations: Price elasticity of demand Potential competition from new firms State of public opinion
Evaluation of Monopoly
Disadvantages of Monopoly
Social cost of monopoly: Higher price, lower quantity, loss of consumer surplus Restriction on consumer choice No improvement in efficiency Misallocation of resources Risk to economy Resources to spend on innovation and technological progress Savings on advertisement and publicity Needed for public utility Can face foreign competition better
Advantages
Price Discrimination (Discriminating Monopoly)
Charging different prices to different buyers of same product Where possible
Difference in price elasticities in different markets Market segmentation Effective separation of sub-markets Legal sanction Status differences : Markets and buyers Ignorance and Immobility of buyers
Price Discrimination (Discriminating Monopoly)
Market segmentation bases
Income and wealth Quantity of purchase Social or professional status Geography Time of purchase Age of customer
Price Discrimination (Discriminating Monopoly)
Objectives
Maximise revenue To dispose surplus To penetrate new market To increase capacity utilisation To retain monopoly To increase future sales To enter and retain export market
Price Discrimination (Discriminating Monopoly)
Price determination
Markets have different elasticities and therefore different AR and MR curves The price curve begins at higher level in inelastic market. The combined MR curve is obtained by using the MR curve of inelastic market till it reaches the highest level of elastic market and then the market MR.
R e v e n u e
MR1
AR1
AR2v MR2
CMR
Inelastic Market
Elastic Market Quantity
Combined
Price Discrimination (Discriminating Monopoly)
The total sales is till CMR = MC. In each market the sale is done till THIS MC = ME.
MC PA PB
AR2v MR2 CMR
MR1
AR1
Q1
Q2
Monopolistic Competition
Market situation where a large number of sellers sell a differentiated product
Monopolistic Competition Contd.
Features
Many sellers : each with a different demand curve due to differentiation; otherwise, it is competition Free entry and free exit Product differentiation through: Branding Advertisement and sales promotion Pricing Each product is close substitute; though not perfect substitute
Monopolistic Competition Contd.
Price and output in short run
Similar to monopoly, but elasticity of demand is greater Firms demand affected by Its own differentiating activities Activities of competitors Overall demand for the product Firms can have normal profit, economic profit or loss Group (not industry) because products are close technological and economic substitutes Group demand and supply difficult to measure because of differentiated products
Monopolistic Competition Contd.
Price and output in long-run
Only normal profits due to exit and entry
Oligopoly
Few large firms dominating the market as sellers Features
Few sellers Increase or decrease of output of a seller affects the market Each seller knows his competitor Interdependence of decision making by firms Product may be homogenous (homogenous oligopoly) or differentiated (heterogeneous monopoly) Price rigidity Monopolistic element/Barriers to entry Advertising
Oligopoly
Sources of Oligopoly
Huge capital investment Economies of scale Patent rights Control over raw material Merger and Takeover Product differentiation Consumer loyalty
Oligopoly
Price and output
Difficult to determine Interdependent
Collaboration in price and output Price leadership
Methods
Oligopoly
Price leadership
Price leader by
The firm takes lead on fixing prices Price leader Others follow Price followers Lower cost Market share Reputation Initiative Aggressive pricing Kinked curve
Price rigidity
Price
D2
D1
D2 D1
Quantity
1. Price lowered, rivals lower (k,D1) 2. Price increased, rivals do not (D2, K)
