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)