Market Structures


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Market Structures

  1. 1. Unit 8 Market StructuresObjectives:After going through this unit, you will be able to explain:The concept and significance of the structure of the marketTypes of market structuresDifference between competitive and non-competitive marketsBehavior of firms in various market structuresEquilibrium conditions in various market formsStructure:1.1 Introduction1.2 Structure Conduct Performance (S-C-P) model1.3 Structure of the market1.4 Competitive and Non-competitive markets1.5 Perfect competition1.6 Firm behavior in perfect competition1.7 Monopoly1.8 Limits to monopoly power1.9 Monopoly equilibrium1.10 Sources of monopoly1.11 Monopolistic competition1.12 Features of monopolistic competitive firm1.13 Equilibrium for a monopolistically competitive firm in the short and long run1.14 Benefits of monopolistic competition1.15 Oligopoly1.16 Models of oligopoly1.17 Comparison of various market structures1.18 Summary1.19 Key words1.20 Self-assessment questions
  2. 2. 1.1 IntroductionThe concept of market form is central to economics. This is because in decision-makinganalysis, market structure has an important role through its impact on the decision-making environment. The extent and characteristics of competition in the market affectchoice behavior among the operating firms. In economics, markets are classifiedaccording to the structure of the industry serving the market. Industry structure iscategorized on the basis of market structure variables which are, further, believed todetermine the extent and characteristics of competition.1.2 Structure Conduct Performance (S-C-P) ModelThe performance of an industry or a firm is determined by the behavior of buyers andsellers in the market, which in turn is determined by the structural attributes of the marketin which it operates. This thought is propounded through the Structure ConductPerformance(S-C-P) theory which links elements or attributes defining the structure orform of the market to business policies and performance in industrial economies.The basic tenet of the S-C-P paradigm is that the economic performance of a firm is afunction of its conduct which, in turn, is a function of the industry structure to which thefirm belongs (Mason, 1939; Bain, 1956). While the structure of the market is explained atlength in the following sections, conduct and performance can be explained:Conduct refers to the activities and behavior of the sellers in the market. Sellers’activities include installation and utilization of capacity, promotional and pricing policies,research and development, and inter-firm competition or cooperation, product decisions,operational decisions, resource planning etc.Economic performance is the outcome of firm’s conduct and policies. It can bemeasured in terms of resource utilization, profit margins, growth, market share,competitiveness among rivals, turnover etc.
  3. 3. Consider the following figure which describes the relation between the structure of themarket and its impact of firm behavior and performance. Structure of the Market Number of firms Product differentiation Entry/exit conditions Mobility of resources Dissemination of information Conduct/behavior of the firm Strategic decisions Pricing policy Product decisions Operational decisions Resource planning Research and development Performance of the firm Profitability Growth Market share Competitive ability Sales turnover Equity
  4. 4. 1.3 Structure of the marketKnowing and understanding market structure has an important bearing on the firm’sconduct and performance and is, hence, vital for a business. It can be defined in terms ofthe following elements, a) Number of firms b) Product differentiation c) Entry/exit conditions d) Mobility of resources e) Dissemination of informationEach of the above elements defines the degree of competition in the market. Consider thefollowing table:S. Element of the Description Degree ofN. market structure competition in the marketa) Number of firms This defines the number of competing More the number firms in the market. of competitors higher is the competition.b) Product The differentiation of goods along key Successful differentiation features is an important strategy for firms differentiation to establish their brands as distinct from strategy reduces other brands in the same product category. competition.c) Entry/exit If the market is characterized by barriers By creating conditions then there exist obstacles on the way of barriers in the potential new entrant to enter the market market firms and compete with the existing firms. The restrict barriers can be strategic, natural, and competition. regulatory.d) Mobility of This is more in terms of access to If firms have resources resources and resource advantage that resource advantage
  5. 5. some firms may over other firms in the they build market competitive abilitye) Dissemination of Flow of information among buyers and Greater ease in information sellers regarding various issues in the flow of market such as price, offers, strategy etc. information increases competition.1.4 Competitive and non-competitive marketsBased on the above attributes market forms can be classified as competitive and non-competitive as shown in the following figure, Market Forms Competitive Markets Non-competitive markets Perfect Monopoly Competition Monopolistic Competition OligopolyA firm is the smallest unit of production. The objective of a firm is to maximize profits.This it can achieve by minimizing cost of production, or maximizing total revenue. Theprospects of profit for a firm are further guided by market conditions. As shown in theabove diagram the market forms can be broadly competitive and non-competitive. Within
  6. 6. this broad categorization markets are defined in terms various attributes signifyingvarying degrees of competition. Consider the following figure, Competition decreases Perfect Monopolistic Oligopoly Monopoly Competition Competition Competition increasesThe above figure shows that as on moves from perfect competition to monopolycompetition in the market reduces. On the other hand as one moves from monopoly toperfect competition in the market increases. The following section discusses in detail thefeatures of and firm behavior in various market forms.1.5 Perfect CompetitionTraditionally perfect competition is considered as an ideal form of market. This marketstructure is a golden rule. As it is understood today, the Classical Competitive Model ishypothetical in nature; it is not based on actual market conditions. Such a competitivemarket is supposed to provide maximum justice to a maximum number of buyers andsellers. Following features characterize this market structure: a) Large number of buyers and sellers: There are large number of buyers and sellers. In that case the idea is that the individually each seller and buyer are too
  7. 7. small relative to the size of the market, so that no one of them can control price fixation. Instead they regard the price as being determined by the market and beyond their ability to influence. In other words, for buyers and sellers in this market form “price is given”. b) Product homogeneity: Firms in the market produce homogeneous products that are perfect substitutes for each other. There are no real or perceived differences between products. This leads to each firm being price takers and facing a perfectly elastic demand curve for their product. c) Entry/exit conditions: There is free entry or exit for any firm. Free entry means that new firms can set up in business to compete with established companies whenever the new competitors feel that the profits are high enough to justify the investment. Similarly, if operating firms find it commercially discouraging to continue in the perfectly competitive market they can quit as and when they want. In other words there are no barriers to entry or exit. d) Mobility of resources: All firms have access to resources. Even if there are resource advantages that some firms may enjoy over other firms in the market in the short run, in the long run the resource mobility ensures that this advantage is killed. e) Dissemination of information: In practice, this feature implies that each buyer and seller knows all about her or his opportunities to make deals, that is, knows the terms on which other market participants will buy and sell. Perfect dissemination of information would mean that all sellers and consumers know all things, about all products, at all times, and therefore always make the best decision regarding sale or purchase.These features consolidate competitive force and rule out the influencing capacity ofindividual firms. When market conditions are perfectly understood there is no chance of a
  8. 8. higher price being charged or paid. When factors of production are freely mobile, entry orexit of firms is facilitated. Proximity to the market further ensures that there is no extratransport cost, which may otherwise cause a small variation in the price.1.6 Firm behavior in perfect competitionMany economists have questioned the validity of studying perfect competition. Howeverthe theory does yield important predictions about what might happen to price and outputin the long run if competitive conditions hold good. The investigative outcome of acompetitive market, derived from the characteristics of competition, is as follows, a) Identical Prices: In a competitive market, an individual firm has no capacity to influence market conditions. Therefore it has to take market price as given, constant and uniform in nature. The price of a good is also known as the Average Revenue (AR) of the firm. Consider the following figure, Price P AR=MR =D 0 Quantity Since Average Revenue or Price and Marginal Revenue are identical, when the former is constant the latter is also constant. Moreover, the Average Revenue curve of a firm is the same as the individual demand curve. Hence, the competitive demand curve is a horizontal straight line parallel to the quantity axis. This has been shown in the above figure. The quantity of output produced and sold is shown on the x-axis and Price is measured along the y-axis. The firm cannot charge a higher or lower price than the OP. If it attempts to charge a somewhat higher price assuming competition, the firm will be able to sell nothing.
  9. 9. On the other hand, if it charges a somewhat lower price the firm will unnecessarily suffer losses. Because of the large number of competing firms, individual firm faces highly elastic demand curve and any rise in price will lead to a large fall in demand and total revenue. b) Competitive equilibrium in the short run: In the short run, it is possible for an individual firm to make more than the normal profit. This situation is shown in the following diagram; the firm gets the price P from the equilibrium in the market. P is above the average cost denoted by C. The volume of economic profit is shown by the arrow. Market FirmPrice Price D S MR Economic Profit AR e P C AR=MR =D 0 Qe Quantity Quantity c) Competitive equilibrium in the long run: In the long run, economic profit cannot be sustained. Freedom of entry causes the arrival of new firms in the market which further causes the demand curve of each individual firm to shift downward, bringing down at the same time the price, the average revenue and marginal revenue curve. The final outcome is that, in the long run, the firm will make only normal profit (or zero economic profit). Its horizontal demand curve will touch its average total cost curve at its lowest point, as shown in the following figure.
  10. 10. In a competitive market, a firm will be in equilibrium at a point where all the four variables are equal. d) MR = MC = AR = AC. A firm in such equilibrium earns only normal profit.d) Economic efficiency due to competition: Competition will ensure that firms attempt to minimize their costs and move towards productive efficiency. The threat of competition should lead to a faster rate of technological development and process efficiency, as firms have to be responsive to the needs of consumer.1.7 MonopolyMonopoly is the market condition in which there is only one provider of a particularcommodity. Such a situation is beneficial for the firm as it enjoys lack of marketcompetitors. The customer has no alternatives for the available goods and services andhas to buy them at given facilities for the dictated price.The primary characteristics of monopoly market form include the following: a) Single Seller: For a pure monopoly to take place, only one firm can be selling the good. A company can have a monopoly on certain goods and not on other goods.
  11. 11. b) No close substitutes: A monopolist’s product is perceived as non-substitutable in the market. c) Price maker: Monopolist exercises market power and is hence called a price maker. This market power is reflected by the firm’s control in the market through, (i) Product differentiation, and (ii) Supply d) Very high barriers to entry: In a monopoly market structure, because there is a single seller selling a product with no close substitutes, there exist very high barriers to entry making it difficult for other firms o enter the market. These barriers can be of three types: (i) Strategic barriers such as control on source of the raw material (ii) Legal barriers such as patents, government granted permits and licenses (iii) Economies of scale and natural monopolists1.8 Limits to the Monopoly PowerFrom the above features it would seem that monopolists enjoy unlimited power in themarket. This may not be true however. A monopolist may have complete freedom indetermining his own price, yet there are some limits to his power. These are: (i) The demand curve of a monopolist slopes downwards, as shown in the following figure:
  12. 12. Price AR=D Quantity A downward sloping demand curve faced by a monopolist implies that a monopolist cannot choose both price and quantity of output to be sold. He has to determine one of these. If he chooses to exercise monopoly power by charging a higher price he will be able to sell lower quantity and if prefers to sell larger quantities he can do so only for lower prices.(ii) Another constraint on monopoly power arises out of the income and willingness of consumers. Even though a monopolist has complete freedom to charge any price this freedom is restricted by the consumer’s ability to purchase goods which is further limited by his income..(iii) Finally, monopoly power also depends upon elasticity of the demand curve. If the demand curve is rigid or less elastic the monopolist has a greater degree of control. As the demand curve becomes more flexible or flatter the monopolist’s control starts declining as shown in the following diagram,
  13. 13. Price D2 D1 Quantity This is explained with the help of above figure. In the figure there are two demand curves. D1 is rigid or less flexible showing greater monopoly control. D2 is flatter or more flexible and depicts a lower degree of monopoly control. In case of a flexible demand curve there is a danger that even at a higher price, the total revenue of a monopolist may be smaller.1.9 Monopoly Equilibrium: In order to study equilibrium under monopoly let us drawthe demand and supply or cost curves of a monopolist. Price MC AC R P C AR S MR O Q Quantity
  14. 14. In the above figure AR and MR are the demand and marginal revenue curves of amonopolist. AC and MC are the respective cost or supply curves. The usual equilibriumof MR=MC is equally applicable to the monopolist. At equilibrium, the monopolistproduces and supplies output quantity Q. This is the only profit-maximizing condition forthe monopolist. Under the given demand-cost structure no other level of output can helpto enhance his profit.At equilibrium the monopolist charges price P which is determined by a correspondingpoint R on the average revenue curve. The total revenue of the monopolist is then, TR = OQ X P = OQRPSimilarly the total cost of the monopolist is governed by a point on the average costcurve. S or C is the average cost of producing output Q in which the total cost will be, TC = OQ XAC = OQSCThe profits of the monopolist as the difference between TR and TC are, Profits = TR - TC = OQRP - OQSC = CSRPHence CSRP are the monopoly profits. These profits look similar to economic profitsunder competition.Monopoly profits differ in two respects: (i) Monopoly profits are permanent and enjoyed in the short as well as long run. There is no fear of monopoly profits being competed away. (ii) Monopoly profits arise out of control over conditions in the market. The monopolist follows restrictive policies and charges a higher price. This is the source of his profits
  15. 15. 1.10 Sources of MonopolyTraditionally monopoly is considered as an evil form of market. Restrictive practices ofthe monopolist cause prices to be higher and supply of goods to be smaller than whatwould normally be available. But sometimes monopoly is unavoidable. Thesecircumstances are called sources of monopoly. They are: (i) There are some natural resources such as land with specific properties, mines, oil deposits, fields, etc. the supply of each of which is absolutely limited. When such products are essential and not available anywhere else the owners of the resources automatically acquire natural monopoly powers. (ii) In some enterprises, large amount of capital is required to be invested right from the beginning. Steel production, railway construction etc. are examples of such enterprises. Those who possess such capital resources enjoy monopoly powers. Other small investors cannot compete with them and the monopoly survives unrivaled. (iii) In certain enterprises, specialized technical resources are required to be employed. Ship building, aeronautics, space research are examples of these enterprises. Those who possess such technical resources will have monopoly power. (iv) In modern times certain legal provisions create monopoly rights. These are in the form of intellectual property rights (IPR) leading to monopoly power. (v) Finally there are monopolies in the form of public utilities. Road construction, postal services, water supply, telecommunications, etc. are some of the examples. In the case of such services it is necessary to maintain a high quality and a uniformity of products or services. This results in monopoly power.In all such cases monopoly form of the market becomes unavoidable. Though there arecertain evils of the monopoly market form these have to be suffered and tolerated. Inabsence of monopoly production and supply of these goods and services the society willbe totally deprived of certain benefits.
  16. 16. 1.11 Monopolistic competitionMonopolistic competition refers to a market structure that is a traverse between the twoextremes of perfect competition and monopoly. The model retains many features ofperfect competition but depicts a market form having competition which is imperfect. Asa result, the model offers a somewhat more realistic depiction of many commoneconomic markets. The model best describes markets in which numerous firms supplyproducts which are each slightly different from that supplied by its competitors.Examples include automobiles, toothpaste, furnaces, restaurant meals, motion pictures,romance novels, wine, beer, cheese, shaving cream and many more.1.12 Features of Monopolistic CompetitionMonopolistic competition is a modern form of the market. A large variety of goods aresold in such a market. Its main features can be stated as follows: a) Many sellers: The number of firms operating under monopolistic competition is sufficiently large implying a great degree of competition. b) Product Differentiation: Under monopolistic competition products are differentiated. This is one of the most important features of this form of market. Product differentiation may be real or perceived. (i) Real differentiation implies an evident distinctiveness about the product one that can be maintained in some physical or chemical composition of the product or in the taste and appearance of that product. (ii) Perceived differences refer to the product distinctiveness that is created in the consumers mind primarily through advertising or promotion, although the product itself may not be “really” different. When products are differentiated more buyers are likely to be attracted. Thereby t he firm gains extra control over demand and market conditions.
  17. 17. c) Selling Cost: Selling Cost is another important feature of a monopolistically competitive market. This is primarily in the form of advertisement expenditure. Whenever a product is differentiated it is necessary to inform buyers; and advertisement is a medium through which buyers can be told about superiority of that product. Selling Cost is inevitable if products are differentiated. Infact, many a times, advertising itself is used a strategy to create product differentiation. For example using celebrities in product endorsements etc. d) Entry/exit conditions: There is freedom of entry. There are no quantitative restrictions or differences in market conditions. However qualitative differences may create some barriers in the short run. In the long run, all such barriers may not exist. e) Resource Mobility: There is a great degree of resource mobility allowing firms to have access and minimizing resource advantages. f) Dissemination of information: In monopolistic competition, buyers do not know everything, but they have relatively complete information about alternative prices. They also have relatively complete information about product differences, brand names, etc. Each seller also has relatively complete information about production techniques and the prices charged by their competitors.1.13 Equilibrium for a monopolistically competitive firm in the short and long runThe equilibrium for a monopolistically competitive firm in the short run is shown thefollowing diagram:
  18. 18. Price MC AC R P C AR S MR O Q QuantityA monopolistically competitive firm acts like a monopolist in that the firm is able toinfluence the market price of its product by altering the rate of production of the product.In the short-run, the monopolistically competitive firm can exploit the heterogeneity of itsbrand so as to reap positive economic profit. As shown in the above diagram the firmearns economic profit equal to CPRS. In the long run, however, freedom of entry,mobility of resources, and ease of flow of information may nullify the short run economicprofit.The equilibrium for a monopolistically competitive firm in the long run is shown thefollowing diagram.
  19. 19. As shown in the above figure, in the long run, whatever distinguishing characteristic thatenables one firm to reap monopoly profits will be duplicated by competing firms. Thiscompetition will drive the price of the product down and, in the long run, themonopolistically competitive firm will make zero economic profit.1.14 Benefits of monopolistic competitionMonopolistic competition has several advantages which are: (i) Monopolistic competition creates more variety for the consumer. (ii) The price of every variety sold in the market will be lower. This is because of competition. Competition in the industry, forces each firm towards efficiency improvements whose benefits are passed along to the consumers in the form of lower prices. (iii) The improvement in productive efficiency for each firm may lead to a reduction in the use of resources in the industry as well as efficient utilization of the existing resource base.1.15 OligopolyOligopoly denotes a market situation where there are few sellers for a product or service.It exhibits the following features: a) Few interdependent firms: Interdependence means that firms must take into account likely reactions of their rivals to any change in price, output or forms of non-price competition. b) Product branding: Each firm in the market is selling a branded or differentiated product. c) Entry barriers: Significant entry barriers into the market prevent the dilution of competition in the long run which maintains economic profits for the dominant firms.
  20. 20. d) Non-price competition: Non-price competition is a consistent feature of the competitive strategies of oligopolistic firms. Examples of non-price competition include: (i) Free deliveries and installation (ii) Extended warranties for consumers and credit facilities (iii) Longer opening hours (e.g. supermarkets and petrol stations) (iv) Branding of products and heavy spending on advertising and marketing (v) Extensive after-sales service (vi) Expanding into new markets + diversification of the product range1.16 Models of OligopolyThere is no single theory of how firms determine price and output under conditions ofoligopoly. Some models of oligopoly describing firm behavior and pricing and outputdecisions are: a) Collusions and cartels b) Price leadership c) Game theory d) Kinked demand curve a) Collusions and cartels It is often observed that when a market is dominated by a few large firms, there is always the potential for businesses to seek to reduce market uncertainty and engage in some form of friendly behavior. When this happens the existing firms decide to engage in price fixing agreements or cartels. The aim of this is to maximize profits mutually and act as if the market is a pure monopoly. This behavior is deemed illegal by the competition authorities of many countries. But it is hard to prove that a group of firms have deliberately joined together to raise prices.
  21. 21. Collusion is often explained by a desire to achieve mutual profit maximizationwithin a market or prevent price and revenue instability in an industry. Pricefixing represents an attempt by suppliers to control supply and fix price at a levelclose to the level we would expect from a monopoly. To fix prices, the producersin the market must be able to exert control over market supply.The distribution of the cartel output may be allocated on the basis of an outputquota system or another process of negotiation. Although the cartel as a whole ismaximizing profits, the individual firm’s output quota is unlikely to be at theirprofit maximizing point. For any one firm, within the cartel, expanding output andselling at a price that slightly undercuts the cartel price can achieve extra profits.Unfortunately if one firm does this, it is in each firm’s interest to do exactly thesame. If all firms break the terms of their cartel agreement, the result will be anexcess supply in the market and a sharp fall in the price. Under thesecircumstances, a cartel agreement might break down. (i) Collusion in a market or industry is easier to achieve when: (ii) There are only a small number of firms in the industry and barriers to entry protect the monopoly power of existing firms in the long run. (iii) Market demand is not too variable i.e. it is reasonably predictable and not subject to violent fluctuations which may lead to excess demand or excess supply. (iv) Demand is fairly inelastic with respect to price so that a higher cartel price increases the total revenue to suppliers in the market - this is clearly easier when the product is viewed as a necessity by the majority of final consumers.
  22. 22. (v) Each firm’s output can be easily monitored - this enables the cartel, more easily, to control total supply and identify firms who are cheating on output quotasMost cartel arrangements experience difficulties and tensions and some producercartels collapse completely. Several factors can create problems within a collusiveagreement between suppliers: (i) Enforcement problems: The cartel aims to restrict total production to maximize total profits of members. But each individual member of the cartel finds it profitable to raise its own production. It may become difficult for the cartel to enforce its output quotas. There may be disputes about how to share out the profits. Other firms who may be not members of the cartel, may opt to take a free ride by producing close to but just under the cartel price. (ii) Falling market demand: An economic slowdown or recession creates excess capacity in the industry and puts pressure on individual firms to cut prices to maintain their revenue. (iii) The successful entry of non-cartel firms into the industry: This undermines a cartel’s control of the market. (iv) The exposure of illegal price fixing by market regulators: Such legal pressures may also cause the cartel to breakdown.b) Price leadership Another type of oligopoly behavior is explained by Price Leadership. This is when one firm has a clear dominant position in the market and the firms with lower market shares follow the pricing changes prompted by the dominant firm. If most of the leading firms in a market are moving prices
  23. 23. in the same direction, it can take some time for relative price differences to emerge which might cause consumers to switch their demand. c) Game theory A game is a situation in which the fate of a player in a game depends not only on the actions of that player but also on the other players involved in the game. Game theory is mainly concerned with predicting the outcome of games of strategy in which the participants have incomplete information about the others’ intentions. Game theory analysis has direct relevance to the study of the conduct and behavior of firms in oligopoly market, for instance the decisions that firms must take over pricing, and how much money to invest in research and development spending. Costly research projects represent a risk for any business - but if one firm invests in R&D, can another rival firm decide not to follow? They might lose the competitive edge in the market and suffer a long term decline in market share and profitability. The dominant strategy for both firms is probably to go ahead with R&D spending. If they do not and the other firm does, then their profits fall and they lose market share. However, there are only a limited number of patents available to be won and if all of the leading firms in a market spend heavily on R&D, this may ultimately yield a lower total rate of return than if only one firm opts to proceed.d) Kinked demand curve The demand or average revenue curve used in this analysis is kinked. It has a Kink or a knot. The demand curve is not a smooth straight line but has two segments with a varying degree of flexibility or slope. Let us begin with its underlying assumptions. (i) If the firm reduces its price the producer expects other competitors to introduce a similar price cut; the market demand will increase but the share of the firm will remain unaltered.
  24. 24. (ii) If the firm raises the price then other competing firms will not follow the price rise. There will be a very small rise in demand but a significant reduction in the sales of the firm.The two assumptions suggest that neither a fall nor a rise in price would benefitthe firm. Oligopoly price is rigidly fixed. Moreover, such price rigidity causes akink in the demand curve with its lower segment steeper or inelastic and its uppersegment flatter and more flexible. Consequently there is no incentive to alter priceunder oligopoly. This will be clearer when explained with the help of a figure.In the above figure, there are two demand curves, DED, which is flatter and moreflexible and D1ED1, which is steeper and less flexible. The two demand curvesinterest at point E which itself is a point of kink. The upper portion of the flatterdemand curve DE and the lower portion of the steeper demand curve ED1together make up the Kinked Demand Curve. Under the above stated assumptionsthe lower portion of the flatter demand curve ED and the upper portion of thesteeper demand curve D1E are not operative. Taking into account only relevantsegments of the two demand curves a kinked demand curve DED1 has beenformed and presented in the following figure,
  25. 25. Once we locate the point of Kink there is no further problem in oligopoly analysis. The point of Kink, E, is itself an equilibrium point. At such point equilibrium output produced is Q and price charged is P. Once a kink in the demand curve is known and given, oligopoly equilibrium automatically follows. The point of kink such as E is itself an equilibrium point. Moreover, such equilibrium is rigid and stable. There is no incentive on the part of the oligopoly firm to move away from the point of kink. Any attempt on his part either to lower or raise the price will not be to his advantage. This can be explained with the help of the following figure, The lower segment ED1 of the demand curve is steeper. Even with a significant fall in price from P to P1 increase in the quantity demanded QQ1 is very small. Reduction in price will then result in smaller total revenue for the firm. On the other hand, any attempt to cause a small rise in price as PP2 on the flatter portion ED of the demand curve causes a significant fall in the quantity demanded from Q to Q2. This again will cause total revenue of the firm to be smaller at higher price. The firm is rigidly fixed at E, the point of kink with P as the price. This therefore is also called sticky price solution.1.17 Comparison of various market structuresWe have established that the structure of the market and its attributes has an importantbearing on the firm’s behavior and its pricing and output decisions. The following tablecompares and contrasts various market forms:
  26. 26. Element of Market forms Perfect Monopolistic Oligopoly Monopoly the market competition Competition structure Number of Large Many Few One firms Product Homogenous Slightly Slightly or Highlydifferentiation product differentiated highly differentiated product differentiated product with no product close substitutes Entry Complete Relative Slight or high Very high barriers conditions freedom of freedom of restrictions in to entry entry entry entry of new firms Mobility of Perfect Relative Slight or high Restriction in resources mobility of mobility of restrictions in mobility of resources resources mobility of resources resourcesDissemination Free flow of Slight Slight or high Restriction in flow of information restrictions in restrictions in of information information flow of flow of information information Profit Economic Economic Indeterminate Economic profits potential profits in the profits in the in the short run and short run but short run but long run only normal only normal profits in the profits in the long run long run Demand Perfectly Relatively Indeterminate Relatively inelastic curve elastic elastic1.18 Summary
  27. 27. In this unit we have highlighted the important bearing that the structure of the market hason a firm’s pricing and output decisions. The structure of the market can be described interms of number of buyers and sellers, product differentiation, entry conditions, mobilityof resources, and flow of information. Based on these criteria we have analyzed fourmarket forms – perfect competition, monopoly, monopolistic competition, and oligopoly.A comparison of them brings about the existence of varying degrees of competition in themarket and the consequent impact on a firm’s decisions.1.19 Key words a) Structure Conduct Performance (S-C-P) Model: Economic performance of a firm is a function of its conduct which, in turn, is a function of the industry structure to which the firm belongs. b) Market structure: The structure of the market can be described in terms of number of buyers and sellers, product differentiation, entry conditions, mobility of resources, and flow of information. c) Product differentiation: The differentiation of goods along key features to establish brands as distinct from other brands in the same product category. d) Barriers to entry: Obstacles on the way of potential new entrant to enter the market and compete with the existing firms. e) Perfect competition: Ideal markets form with a very high degree of competition so that a single seller or buyer is too small relative to the size of the market and no one of them can individually control market or its conditions. f) Monopoly: Market condition in which there is only one provider of a particular commodity. g) Monopolistic competition: Markets in which numerous firms supply products which are each slightly different from that supplied by its competitors. h) Oligopoly: A market situation where there are few interdependent sellers for a product or service. i) Collusions: Covert interdependence between competing oligopoly firms for pricing and output decisions.
  28. 28. j) Cartel: Overt and contractual interdependence between competing oligopoly firms for pricing and output decisions. k) Price leadership: One firm has a clear dominant position in the oligopoly market and the firms with lower market shares follow the pricing changes prompted by the dominant firm. l) Game theory: A proposition according to which the fate of a firm in the market depends not only on its own actions but also on the other firms, as in a game where the fate of a player depends on all the players involved in the game.1.20 Self-assessment questions 1) Explain the importance of the structure of the market based on the S-C-P model. 2) What are the various elements that describe the market structure? Discuss 3) Explain Perfect Competition. How does a firm arrive at equilibrium in such a market? 4) How can a monopoly be created? Discuss the advantages of a monopoly situation in the market? 5) Explain monopolistic competition. Discuss firm’s behavior in such a market. 6) Write a note on models of oligopoly. 7) Economic performance of a firm is a function of its conduct which, in turn, is a function of the a) Industry structure to which the firm belongs. b) Government policy c) Size of the firm d) Goods and services 8) The structure of the market can be described in terms of number of buyers and sellers, product differentiation, entry conditions, mobility of resources, and flow of information. a) True b) False c) Can’t say
  29. 29. d) None of the above9) Product differentiation can be a) Real b) Perceived c) Both a) and b) d) Can’t say10) Barriers to entry can be a) Natural b) Regulatory c) Strategic d) All of the above11) Fill in the blanks: a) The differentiation of goods is done along ______________features to establish______________ as distinct from other______________ in the same product category. b) ______________ are obstacles on the way of potential new entrant to enter the market and compete with the existing firms. c) ______________ is an ideal markets form with a very high degree of competition so that a single seller or buyer is too small relative to the size of the market and no one of them can individually control market or its conditions. d) ______________ is a market condition in which there is only one provider of a particular commodity. e) ______________ is a market in which numerous firms supply products which are each slightly different from that supplied by its competitors. f) Oligopoly is a market situation where there are few ______________sellers for a product or service. g) ______________ are covert interdependence between competing oligopoly firms for pricing and output decisions. h) ______________ is an overt and contractual interdependence between competing oligopoly firms for pricing and output decisions.
  30. 30. i) When one firm has a clear dominant position in the oligopoly market and the firms with lower market shares follow the pricing changes prompted by the dominant firm it is called ______________.j) ______________ is a proposition according to which the fate of a firm in the market depends not only on its own actions but also on the other firms, as in a game where the fate of a player depends on all the players involved in the game.k) A demand curve which is not a smooth straight line but has two segments with a varying degree of flexibility or slope to explain behavior of an oligopoly firm is called______________.