Session Objectives

Understand the Structure of Various Markets

Pure/Perfect Competition Monopolistic Oligopoly Duopoly Monopoly Oligopsony Duopsony Monopsony
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MARKET
Means by which buyers and sellers are brought into contact with each other and goods and services are exchanged
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Market Structure
Determinants of market structure
Freedom of entry and exit Nature of the product homogenous (identical), differentiated? Control over supply/output Control over price Barriers to entry

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Very Many Some

Fair amount

Agric. products Fishery

Extensive

Fair Amount

with
differentiated

Extensive

oligopolies

Cable TV Water
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Monopoly
Pure monopoly where only one producer exists in the industry. In reality, rarely exists always some form of substitute available! No substitutes for the good There are barriers to entry into the market Monopoly exists therefore where one firm dominates the market Firms may be investigated for examples of monopoly power when market share exceeds 25%
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Can you remember the industrys on a monopoly board?

Trains Water Electricity Taxman Bank Jail Car Parking
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Which of these industries do you think are MONOPOLIES?

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Monopoly power
Monopoly power refers to cases where firms influence the market in some way through their behaviour determined by the degree of concentration in the industry
Influencing prices Influencing output Erecting barriers to entry Pricing strategies to prevent or stifle competition May not pursue profit maximisation encourages unwanted entrants to the market April 29, 2012 Session Sometimes seen as a 13 case of market failure

Monopoly
Origins of monopoly: Natural monopoly usually on a network or grid wasteful to duplicate! Geographical factors where a country or climate is the only source of supply of a raw materialquite rare. However, consider a single grocery store in a isolated village Through growth of the firm Through amalgamation, merger or takeover Through acquiring patent or license Through legal means Royal charter, nationalisation, wholly owned plc

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Monopoly characteristics
Price could be deemed too high, may be set to destroy competition (destroyer or predatory pricing), price discrimination possible. Efficiency could be inefficient due to lack of competition (X- inefficiency) or could be higher due to availability of high profits Innovation - could be high because of the promise of high profits, Possibly encourages high investment in research and development (R&D). Could be low as there is no incentive to reduce costs. Collusion possible to maintain monopoly power of key firms in industry
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Revenue in Monopoly
Single seller situation So Demand Curve of Industry and the Monopolist is the same AR and MR curves are downward sloping Position of MR Curve If TR = PQ and P = a bQ MR and DD curve start from same point i.e. a MR has ve slope and is twice as steep as DD curve
Price

Industry Demand Curve

Qty Demanded A

Price / MR

C AR

Q MR

B Quantity

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Equilibrium of a Monopoly
Conditions
MC = MR Slope of MC > Slope of MR
Cost / Revenue

Objective Profit Maximization

ATC

C B

D A E

AVC

In the fig.
MC intersects MR from below at E At this Point OQ is the equilibrium Output OC is the equilibrium Price TR = OCDQ TC = OBAQ Profits = TR TC = ABCD
O MC Output Q

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Price discrimination
Refers to the practice by the seller of charging different prices in different markets or to different buyers for the same commodity. Mr. John Robinson it is the act of selling the same product produced under a single control, at different prices to different buyers.
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Different forms of price discrimination

Personal price discrimination Regional price discrimination Trade price discrimination Price discrimination on the basis of Age and Sex Price discrimination on the basis of quantity of the product purchased
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Conditions essential for the success of price discrimination

Monopoly No resale Differences in the elasticity of demand Immobility of buyers Personal service - ignorance - indifferent attitude Existence of more than one market Boundaries and tariff

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Degrees of price discrimination

First degree price discrimination Second degree price discrimination Third degree price discrimination
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First-degree price discrimination 1

Monopolist charges consumers their reservation value for each unit consumed. Extracts all consumer surplus Since profit is now total surplus, find that first-degree price discrimination is efficient.

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Perfect Discrimination
The entire Consumers Surplus is appropriated The Monopolist charges different price for every successive unit sold

Cost / Revenue

First Degree Discrimination

A C D G

F MC Output Q1 Q2

Also as successive units are sold at different MC and DD curve Thus Profits are maximized when the MC intersects the Demand Curve

rates equilibrium shift to G intersection of OCDQ1 is the TR for Simple

Monopolist With Price Discrimination ACD the consumers surplus gets appropriated in TR of the Monopolist

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Second Degree Price Discrimination

Price varies according to quantity sold Though the monopolist charge different prices for the same product, he is not able to charge the maximum possible price. In other words he is not able to convert the same consumer surplus of the buyer into his profit. Mrs. John Robinson calls it the Imperfect discriminating monopoly
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1 P3 P2 P1 P 2 3

The diagram indicates the different prices OP1, OP2, OP3, charged by the seller from three different group of consumers(1, 2, 3) form each group, the seller charges price according to Kwhat they are willing to pay

Q1

Q2

Q3

x Q4 Quantity
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Explanation
The diagram indicates the different prices OP1, OP2, OP3, charged by the seller from three different group of consumers(1, 2, 3) form each group, the seller charges price according to what they are willing to pay. However, he does not charge the maximum possible price. In other words he allows the consumer to enjoy a part of their consumers surplus
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Third Degree Discrimination

A Monopolist may try to segment the market based elasticity of demand in order to capture Consumers Surplus In the fig
The Monopolist has divided his market in 2 segments AR1 is relatively inelastic demand while AR2 is relatively elastic demand MR1 and MR2 are the corresponding MR curves CMR is the combined MR curve for the Monopolist Condition for Equilibrium MR = MC E is the point of firms equilibrium with Output OQ
P1 Price / R /C P2 P F G E MC

AR2 CMR

MR1 O Q1 Q2 Q

AR1

MR2 Output

How is the Output to be distributed in the two markets ?

Such that the MR1 = MR2 = MC at equilibrium Thus F and G is such level of MR1 and MR2 respectively

Therefore OQ1 and OQ2 are corresponding quantities in the 2 markets P1 and P2 are corresponding prices Price charged is higher in market with inelastic demand
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Third degree of price discrimination

Price varies by location or by customer segment Takes place when a seller charges different prices for the same product at different markets on the basis of elasticity of demand. Normally the seller charges a lower price in a market where the demand is relatively elastic and a higher price in a
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EXAMPLES Movie Tickets Airline Prices Discount Coupons Financial Aid

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Applications of Discriminating Monopoly

Pricing of Premium and Economy segments Two part tariffs of utilities eg. Telecom, Toll-roads, etc. Dumping Different charges for foreign citizens Special discounts for women, children, senior citizens, etc.

Pre-requisites for successful discrimination Markets separated Different price elasticities in different markets
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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

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Perfect Competition
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

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Perfect Competition
What happens in a perfectly 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!

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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, building firms etc.

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Monopolistic Competition Essential characteristics

Every player tries to create product differentiation by Brand building Thus for the limited differentiated category the player enjoys limited Monopoly The degree of Monopoly enjoyed by the player can be measured by the mark-up he can charge above MC Degree of Monopoly / Monopoly Power measured by Lerner Index
L = (P MC)/P = (P MR)/P L = [P P(1 + 1/e)]/P = 1/e Higher e Lower Monopoly Power
Mark-up

Differentiated products Easily substitutable Free entry and exit

Mark-up is small when e is high

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Mark-up

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Equilibrium in Monopolistic Competition

MC P A C B AC P MC AC

MR O Q

AR O Q

MR

AR

Short-run Equilibrium TR > TC Firms are able to earn abnormal profits

Long-run Equilibrium TR = TC Because of free-entry and presence of close substitutes abnormal profits are abolished in the Long-run
As Prices fall And elasticity of demand for individual firm increases

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Oligopoly
Competition amongst the few
Industry dominated by small number of large firms Many firms may make up the industry High barriers to entry Products could be highly differentiated branding or homogenous Nonprice competition Price stability within the market - kinked demand curve? Potential for collusion? Abnormal profits High degree of interdependence between firms

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Oligopoly
Examples of oligopolistic structures:
Supermarkets Communication Chemicals Broadcasting

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Oligopoly
Price Kinked Demand Curve

Kinked D Curve D = Inelastic

100
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D = elastic

Quantity
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Duopoly
Industry dominated by two large firms Possibility of price leader emerging rival will follow price leaders pricing decisions High barriers to entry Abnormal profits likely

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Duopoly when 2 firms dominate an

Coke products have 43% of theindustry. market and Pepsi products have 32%.

6. Sprite 7. Dr. Pepper 8. Caffeine Free Diet Coke 9. Diet Dr Pepper 10. Sierra Mist
Pepsis first commercial in 1939 became so popular, it became a hit record and was played in jukeboxes. A 12-ounce bottle sold April 29, 2012 Session 13 for a nickel..
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1. Coke Classic 2. Pepsi Cola 3. Diet Coke 4. Mountain Dew 5. Diet Pepsi