Market structure


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Market structure

  1. 1. Market Structure
  2. 2. What is a Market  The determination of Price and Output of various products depends upon the type of market structure in which the goods are sold and produced.  A Market is a whole of a region where buyer and seller interact with each other and price of the same good tends to be equity.  Essentials of a Market - Commodity which is dealt - Existence of Buyer and seller - a Place - Communication between buyer and seller that only
  3. 3. Classification of Market forms  Market structure are classified on: 1) Number of firms producing a product 2) The nature of product produced by the firm 3) The ease at which the new firms can be a part of the existing Industry. 4) Degree of control over price.
  4. 4. Classification of Market forms Market Structure No of Firms a) Perfect Large Competition Nature of Product Control over price Entry ep Condition Homogeneou None s Free entry, Infinite exit b) Imperfect Competition i) Monopolistic Competition Large Differentiated Some (close substitute) Barrier – Large product differentiat ion ii) Oligopoly Few Firms Homogeneou Some s/ Differentiated Barriers – firms dominatin g Small Unique (No Barriers Very Small iii) Monopoly One Very Large
  5. 5. Perfect Competition  Demand curve for the single firm will be infinite (perfectly elastic) The maximum output an individual firm can produce is small. Products are standardized commodities  No single firm can influence the price of the product (price taker)  Many small sellers   More sellers, more substitutes the consumer has Market power is none  Homogenous product  the substitutes are "perfect substitutes."  Sufficient knowledge  When customers know the prices offered by other sellers, they will be better able to switch – increasing elasticity further.
  6. 6. Perfect Competition  Free entry  companies may even enter the market to provide still more substitutes  Long-run economic profit (above normal) is none  No Government intervention  Example: Agricultural products, Precious metals, Financial instruments, ep = ∞ global petroleum industry D P Q
  7. 7. Imperfect Competition  Individual firm exercise control over the price  Can be caused by - Fewness of firms - Product differentiation  Sub- categories  Monopolistic Competition  Pure Oligopoly  Differentiated Oligopoly
  8. 8. i) Monopoly  Existence of a single producer  Has no close substitutes P  Large control over prices P’ ep < 1  Market power : High  Long run economic profit : High Q Q’  Kind of business Govt sanctioned regulated monopolies Public utilities, Telephones, Electricity  The expansion and contraction of output will have a effect on the prices of the product
  9. 9. i) Monopolistic Competition P P’  Large no of Firms ep > 1 D Q  Relatively easy barrier  Product differentiation which are close     substitutes Start up capital is low Market power – low to high Long run economic profit : none Kind of Business Small business- retail and services Boutiques, shoe store, restaurants, laundries Q’
  10. 10. ii) Oligopoly  Competition among few large firms producing   Homogenous – Pure Oligopoly Products differentiation – Differentiated Oligopoly  Fewness of firms / size of the firm ensures that each of them       have some control over the price Market entry: Difficult Market Power : Low to High Long run economic profit : Low to high Pricing behaviour is of mutual interdependence (Each seller is setting its price on the basis of reaction from the competitor) Demand curve slopes downwards and ep is small ( Relatively Inelastic) Kind of firms:  Manufacturing sector-, oil refineries, tobacco, steel automobile, soft drinks
  11. 11. AR and MR under Perfect competition      Demand curve is perfectly elastic Price is beyond the control of the firm AR remains constant If price or AR remains the same , then MR = AR As with addition of one more unit, price does not fall No of Price Units Q (AR) TR P*Q MR 1 16 16 16 2 16 32 16 3 16 48 16 4 16 64 16 5 16 80 16
  12. 12. AR and MR under Perfect competition  The price or average remain the same at OP level  TR slopes upwards TR AR = MR P O
  13. 13. AR and MR under Perfect competition  Demand curve is      downward sloping Firm increases production and sale of its product, price starts falling AR starts falling MR falls more rapidly MR is +ve as long as TR is increasing MR is -ve when TR starts declining No of Price TR Units (AR) P*Q Q MR 1 16 16 16 2 15 30 14 3 14 42 12 4 13 52 10 5 12 60 8 6 11 66 6 7 10 70 4 8 9 72 2
  14. 14. AR and MR under Perfect competition P AR O Q M M MR TR
  15. 15. AR and MR under Imperfect competition  In all forms of imperfect competition  AR curve of a firm slopes downwards i.e If firms lowers the price of the product, the quantity demanded and sales would increase  MR is zero TR is maximum
  16. 16. Equilibrium of the Firm and Industry under Perfect Competition
  17. 17. Meaning and Condition of Perfect Competition  Large Number of Firms - Individual firm exercises no control over the prices - Output constitutes a very small fraction of total output - Price taker and output adjuster  Homogenous Product - Perfect substitutes - Cross elasticity is Infinite
  18. 18. Meaning and Condition of Perfect Competition  Perfect Information about the prevailing Price - Buyer and seller are fully aware about the price in the market - Buyer would shift if seller increase the price - Seller are aware and will not charge less price.  Free entry and Exit - If firms are making super normal profit in short run, in long run new firms will enter and compete away the profits - If firms are making losses in the short run, some of the existing firm will leave the industry in the long run and the firms left will make normal profit.
  19. 19. Equilibrium of the Firm Short Run  In short run perfect competition we are assuming that        All firms are working under identical cost condition Shapes of AR and MR curve are same All firms are of equal efficiency The MC= Price to attain equilibrium output F At point F the firm can further increase its profits as MR > MC At point E, MC = MR MC cuts MR from below O SMC E AR =-MR M
  20. 20. How much profit does the firm earn in the short run?  Profit per unit of output = AR – AC  It should produce at that level of output at which the additional revenue received from the last unit is equal to the additional cost of producing that unit.  MC = MR  It depends upon the average cost curve ( AC)  Which determine whether the firm earns     Super normal profit Normal profit Losses Shut down
  21. 21. a) Super Normal Profit  Equilibrium output of OM  Average Revenue = ME  Average Cost = MF SAC  Profit per unit is EF ( AC- AR)  Total profit is HFEP  Super normal profit in short run  As normal profits are included in average cost Super Normal Profit SMC E P AR = MR H F O M
  22. 22. b) Normal Profit  When AC is tangent to AR and MR curve SAC i.e AR = AC  Then firm makes normal profit SMC E P AR =-MR H O M
  23. 23. c) Losses  If the AR and MR curve lies below the AC curve  Firm would be making a loss since AR < AC SAC  Loss is of PEFH SMC Losses AVC F H E P O M AR =-MR
  24. 24. Will the firm decide to shut down?  Why do they not suspend production if they are making loss?  The firm cannot dispose of the fixed capital equipment in the short run The firm has to incur losses equal to fixed cost So if the firm shuts down it can avoid only variable cost    Therefore if the firm earn revenue which covers variable cost as well as part of fixed cost, its quite rational for to be in business  Two instances in which it can operate  If AVC curve lies below the Price  If AVC = P
  25. 25. i) When AVC = Price  If the AVC = Price  The firm is able to recover its variable cost of OMEP SAC  No Fixed cost (PEFH) is recovered SMC  The firm should operate and bear losses equal to its fixed cost AVC F H AR =-MR P E O M
  26. 26. ii) When AVC is below the Price  The firm is able to recover its variable cost of OMBA SAC  And a part of Fixed cost of ABEP SMC  The firm should operate and bear losses of PFEH AVC F H E P A B O M AR =-MR
  27. 27. d) Shut Down  If the price falls below the AVC.  Then it makes losses greater than total fixed cost SAC  It will be rational for the firm to close down  As the firm is not able to recover even SMC AVC its variable cost F H AR =-MR P O M
  28. 28. Long Run  It is a period of time which is sufficient to allow firm to have a change in all the factors of production.  Long run the market price will settle at the point where the firms earn Normal profit.  Price that enable firm to earn above normal profit would induce other firms to enter the market  Whereas prices below the normal level would cause firms to leave the market.  Price = Marginal Cost = Average cost
  29. 29. Long Run  Price = Marginal Cost = Average cost LMC LAC P AR = MR OUTPUT
  30. 30.  Long run equilibrium is established at the minimum point of the long run average cost curve.  i.e working a the minimum efficient scale.  With utmost technical efficiency and the resources are used efficiently.
  31. 31. Why to competitors stay in business if they make Zero economic profit  The producers are earning fair rate of return in the long run  Earlier the firm enters a market, the better the chance of earning above normal profit.  Firms can innovate to earn positive economic profit  Or to survive firms must find ways to produce at the lowest possible cost or atleast at cost levels below those of their competitors.
  32. 32. Equilibrium of the Firm and Industry under Monopoly
  33. 33. Meaning  Monopoly is said to exist when one firm is the sole producer or seller of a product which has no close substitutes. - One single producer - No close substitutes should be available in the market. - Strong barriers to the entry into the industry. That is there is NO COMPETITION.
  34. 34. Sources / Reasons of Monopoly Power 1. Patent / Copyright For a certain period of time, firm can attain a patent right on the new product from the government. 2. Control over an essential Raw – material. 3. Grant of Franchise by the Government A firm is granted the exclusive legal rights by the Government to produce a given product. Government keep with itself the right to regulate its price and quality.
  35. 35. Sources / Reasons of Monopoly Power 4. Advertising and Brand Loyalties of the established Firms. Strong loyalties to the brands of the established firms . And their heavy advertising campaigns, to enhance the market power of the producer and prevent the entry of potential competitors. 5. Economies of Scale: Natural Monopoly When significant economies of scale are present, the AC of production goes on falling over a wide range of output, which (output) meets the demand of entire market. Natural monopoly are regulated by the Government so that the Firm does not charge a high prices and exploit the consumers.
  36. 36. Nature of MR and AR Curve  Both AR and MR curve are Downward sloping  MR curve lies below the AR curve. As when the monopolist sells more, the price of the product falls and the MR would be less than the price.  Monopolist has to choose a price –quantity combination which yields him maximum possible profits.  Monopolist ability to set its price is limited by the demand curve of its product i.e Price elasticity of demand for its product.
  37. 37. Nature of MR and AR Curve P AR O Q M MR
  38. 38. Monopoly Equilibrium and Price Elasticity of Demand  Monopolist ability to set price is limited by the demand curve for its product i.e the price elasticity of demand.  The price elasticity of demand indicates how much more or less people are willing to buy in relation to price decrease or increase.  Monopolist will never be in an equilibrium at a point on demand curve where price elasticity of demand is less than one.  As when price elasticity is less than one, marginal revenue is negative.  Monopoly equilibrium will always lie where price elasticity is greater than one if marginal cost is positive.
  39. 39. Monopoly Equilibrium and Price Elasticity of Demand e >1 e=1 P e<1 AR O M MR M TR
  40. 40. Price – Output Equilibrium under Monopoly Short Run   Monopolist will go on producing as long as MR > MC Profits will be maximum at which MR = MC  The price under perfect competition is equal to marginal cost But price under monopoly is greater than marginal cost  In Monopoly equilibrium    MR = MC P > MC
  41. 41. Price – Output Equilibrium under Monopoly Q P TR TC AC MC MR Remarks Profit or Loss 0 200 0 100 - - - 1 200 200 250 250 150 200 MR > MC -50 2 180 360 350 175 100 160 MR > MC +10 3 160 480 420 140 70 120 MR > MC +60 4 140 560 500 125 80 80 MR = MC +60 5 120 600 600 120 100 40 MR < MC 0 6 100 600 720 120 120 0 MR < MC _80 7 80 560 870 120 150 -40 MR < MC -20 -
  42. 42. Price / Output Equilibrium a) Super Normal Profits
  43. 43. Price / Output Equilibrium b) Losses
  44. 44. Long Run Equilibrium under Monopoly  In long run monopolist make adjustments to the plant size  The monopolist would choose that plant size which is most appropriate with particular level of demand.  In the Long run the equilibrium would be at the level of output where given MR cuts the long run MC curve  The firm will operate where LAC is tangent to SAC MR = LMC = SMC  SAC = LAC  P = > LAC  As the price cannot fall below LAC, in long run the monopolist will quit the industry if it is not even able to make normal profits. 
  45. 45. Long Run Equilibrium under Monopoly SMC LMC P H G LAC SAC F AR O Q MR
  46. 46. Difference Perfect Competition Monopoly 1. In equilibrium P= MC 1. In equilibrium P > MC 2. 2. In long run equilibrium Average cost is still declining In long run MR / P= MC= minimum AC 3. In long run they make normal profits 3. In long run they can also make super normal profits 4. Price Discrimination is not there 4. Price Discrimination is there if elasticity's of demand are different in different market. 5. In equilibrium price and output are determined by demand and supply curve 5. In equilibrium price is higher and output smaller
  47. 47. Is there Price Discrimination in Monopoly? Yes
  48. 48. Meaning  It refers to the practice of a seller selling the same product at different prices.  Sellers does this when it is possible and profitable.  i.e “ Sales of technically similar products at prices which are not proportional to Marginal cost”.
  49. 49. Types  First Degree – Personal When the monopolist is able to sell each separate unit of output at different prices  Second Degree - Local When monopolist is able to charge separate prices for different blocks or quantities of commodity from buyers.  Third Degree - According to use or Trade When the seller divides his buyers into two or more than two submarket depending upon the price elasticity of demand ( A manufacture who sells his product at a higher price at home and at a lower price abroad)
  50. 50. When is Price Discrimination Possible?  If its not possible to transfer any unit of the product from one market to another.  It should not be possible for the buyer in the dearer market to transfer themselves into the cheaper market to buy the product at lower price.      The nature of the commodity ( Surgeon or lawyer) Long distance / Tariff Barrier (Distance increases the cost) Legal Sanction ( Electricity supplied at different prices in Residential / Commercial areas) Ignorance of Buyers Preferences of Buyers
  51. 51. Equilibrium Under Price Discrimination  Monopolist will charge different prices in different sub- markets.  Which is on the basis of differences in price elasticity of demand.  Monopolist can divide his total market into several sub – market.  For example     Two market – Relatively Elastic and Relatively Inelastic Higher price in relatively inelastic market, so profit margin high Lower price relatively elastic market, so profit margin are low So put together higher profits collectively by Price discrimination
  52. 52. Managerial Decision Making in Monopoly  Monopoly can earn economic profits in the short run or long run.  It depends upon demand for its product  It can earn higher profits by discriminating prices  Dumping the products at lower rate in international market and charging higher profits in domestic market can maximise profits.  But the changes in economies of business ( customers, technology and competition) can break down the a dominating company’s monopolistic power.
  53. 53. Equilibrium of the Firm and Industry under Monopolistic Competition
  54. 54. Introduction  The difference between the price and MR at equilibrium output is regarded as the Degree of Imperfection  The relative magnitudes of price and MR at equilibrium output help us to distinguish between different degrees of Imperfection or Monopoly power in various market structure.  The product differentiation is a distinguishing feature of monopolistic competition which makes it as a blending of competition and Monopoly.,
  55. 55. Introduction Thus as each Monopolist has a competitor which produces a product not homogenous but differentiated though closely related, it becomes a Monopolistic Competition.
  56. 56. Overview of Competitive Environment Perfect Competition Monopoly Monopolistic Competition Oligopoly Market Power No Yes, subject to Yes Govt regulation Yes Mutual Interdependence among competing Firms No No No Yes Non- Price Competition No Optional Yes Yes Easy Market entry or Exit Yes No Yes, relatively Easy No, relatively Difficult
  57. 57. Features of Monopolistic Competition 1. A large number of Firms: Each firm having a small share of the market demand There exist a stiff competition Size of each firm is relatively small 2. Product Differentiation 3. Some influence over Price A firm has to choose a price and output which maximises profits 4. Non Price Competition Expenditure on Advertising and other selling cost
  58. 58. Non- Price Competition The ability to differentiate their product in Imperfect competition with the variable other than price.         Advertising Promotion Location and distribution channels Market segmentation Loyalty program Product extension / new product development Special customer service Product tie-ups
  59. 59. Shape of MR and AR curve  Sine close substitutes are available in the market, the demand curve for the product of an individual firm under monopolistic competition is fairly Elastic.  Both AR and MR curve are Downward sloping  MR curve lies below the AR curve.  Producer has to choose a price –quantity combination which yields him maximum possible profits.
  60. 60. Nature of MR and AR Curve P M AR O Q MR
  61. 61. Short Run Equilibrium 1) Super Normal Profits
  62. 62. 2) Losses
  63. 63. Long Run Equilibrium  If the firm earn supernormal or economic profits in the short run, it will lead to entry of new firms in the long run.  The cross elasticity of demand between the products of various firms will increase.  Which will cause a resultant shift in the demand curve to the left.  Equilibrium will be at a point where AR becomes tangent to the AC curve.  The firm would be making normal profits in the long run, but its price would be higher and output smaller than under Perfect Competition.
  64. 64. Long Run Equilibrium
  65. 65. Equilibrium of the Firm and Industry under OLIGOPOLY
  66. 66. Introduction  It is refereed to as “Competition among few firms”.  Two kinds   Pure Oligopoly : Oligopoly without Product Differentiation Differentiated Oligopoly: Oligopoly with Product Differentiation
  67. 67. Features / Characteristics  Few Sellers  Interdependence Competitors are few, any change in price, output, product will have a direct effect on competitors .  Importance of Advertising and selling cost Aggressive and defensive marketing strategies.  Group Behaviour Do the few firms cooperate with each other in promotion of common interest or do they fight to promote individual interest.  Constant shifting of the demand curve. Competitors keep on changing the price with the change in price of the firm.
  68. 68. Causes for the Oligopolies  A large amount of Fixed Cost  Barriers to Entry : Technological and Legal Barriers  Product differentiation creates Market Power  Takeovers / Mergers create oligopolies.  Economies of Scale Few firms can fulfil the demand of the product by producing at large scale and thus lowering the average cost of production.  Economies of Scope  Production of multi-products leads to lower average cost
  69. 69. Causes for the Oligopolies Are oligopolies due to Economies of scale or Mergers / Take-over?  Both  In some industries few firms dominate due to Economies of scale  But in some its get dominated due to policy of mergers and takeovers
  70. 70. Cooperative Vs Non Cooperative Behaviour  The behaviour of oligopolistic firm can be strategic in deciding about their price and output policies.  The strategic behaviour means that the oligopolistic firms must take into account the effect of their price- output decision on their firms and on the reaction they expect from other firms.  Two types of strategies:   Compete with their rivals to promote their individual interests Cooperate with them to promote mutual interest ( maximise profits)
  71. 71. Collusive Oligopoly : Cooperative Model  To avoid uncertainty of interdependence, price wars, cut throat competition, firms enter into agreement regarding uniform priceoutput policy.  The agreement can be formal (open) or tacit (secret)  These agreements are called as Collusive agreements:   A) B) Cartels Price leadership
  72. 72. A) CARTELS  Firms jointly fix a price and output policy through agreements  Now-a-days all types of formal or informal and tacit agreements are made among oligopolisitic firms. Cartel Perfect Cartel Market Sharing Cartel Non- Price Competition Output Quota
  73. 73. Perfect Cartels When member firms agree to surrender completely their rights of price and output determination to Central Administrative agency, so as to secure maximum joint profits. The total profits is distributed among the member firm already agreed between them. The output to be produced by each firm is decided by the central agency in such a way that total cost of the total output is minimum. The total cost will be minimum when firms in cartel produces such output so that their marginal cost is equal. Perfect Cartel is quite rare in the world As both Price and output get decided by the central Agency
  74. 74. Market Sharing Cartels  1) Non- Price Competition:      A uniform price is fixed and members are free to produce and sell the amount of output which will maximise their individual profits. The firms agree not to sell at a price below the fixed price. But they are free to vary the style of their product and advertising expenditure. If the members firms have identical cost then the price (monopoly price) will ensure maximisation of joint profits But when the cost differs firms the cartel price will be fixed by bargaining between the firms. But with cost differences such loose cartels are unstable.
  75. 75. Market Sharing Cartels  2) Output Quota:     Agreement between firms regarding quota of output and sold by each of them at the agreed price. As the cost of firms are different , the quotas will be fixed and market share differ Which are decided through bargaining between the firms. Which is based on  Past – period sales  Productive capacity  Division of market share region wise
  76. 76. B) Price Leadership  One firm sets the price and other follows it.  The follower firm adopts the price of the leader, even though they have to forgo from their profit maximising position.  Price leadership are illegal, so it is a result of informal and tacit understanding.  Types of Price Leadership  Price set by low- cost firm  Price by dominant firm  Barometric price
  77. 77. Difficulties of Price Leadership  Success of Price leadership depends upon the correctness of his estimates about the reactions of the followers. If its not correct then it jeopardise his position in the market  If the leader fixes a higher price than the price preferred by followers, the followers can make hidden price cuts in order to increase their share.  Tendency on part of the followers to indulge in non- price competition to increase sales
  78. 78. Pricing in a Oligopolistic Market  In oligopoly there is a degree of price rigidity or stability.  Price rigidity is been explained by Kinked Demand Curve  As in oligopoly the products are differentiated, it is unlikely that when the firm raises it price all customers would leave.  As a result the demand curve is not perfectly elastic or inelastic.  The kink is formed at the price because the segment of the demand curve above the price is highly elastic and the segment of the demand curve below the price is inelastic
  79. 79. Pricing in a Oligopolistic Market  Kinked Demand Curve: Each oligopolist believes that if he lowers the price below the prevailing level, his competitor will follow him and will accordingly lower their prices. Whereas if he raises the price, competition will not follow his increase in the price.  Oligopolist will not gain a large share by reducing its price, and will have reduction in sales P if it increase price. So there is Price Rigidity d K  dK of the demand curve is relatively elastic D  KD is relatively inelastic M
  80. 80. Equilibrium in a Oligopolistic Market  Oligopoloist will be maximising his profits at the current price level.  MR curve is a discontinuous curve  The length of the MR discontinuity depends upon the relative     elasticities of the demand curve (dK and KD) Greater the difference in two elasticities, greater the length of the discontinuity. MR curve is drawn with a gap of BC If the MC passes between this gap say point C it will be maximising profit at the price of OP Even if there is change in cost and MC1 shifts to MC2, equilibrium output will remain unchanged
  81. 81. Equilibrium in a Oligopolistic Market
  82. 82. Critical Appraisal of Kinked Demand Curve Theory  It does not explain how price has been determined.  It does not apply to the oligopoly cases of prices of Price leadership and price cartels which account for quite a large part of oligopolist markets.