Unit 4

UNIT –IV
MARKET STRUCTURES :
(8HRS)
Perfect and Imperfect Market Structures , Perfect Competition, features,
determination of price under perfect competition. Monopoly: Feature,
pricing under monopoly, Price Discrimination. Monopolistic: Features,
pricing under monopolistic competition, product differentiation.
Oligopoly: Features, kinked demand curve, cartels, price leadership.
Pricing Strategies; Price determination, full cost pricing, product line
pricing, price skimming, penetration pricing
7/5/2016Deepak Srivastava
1

INTRODUCTION
Market
Consumer
Seller
Commodity
Price
The function of a market is to enable
an exchange of goods and services
to take place. A market is any
organization whereby buyers and
sellers of a good are kept in close
touch with each other.
Price determination is one of the
most crucial aspects in
microeconomics.
Business managers are expected to
make perfect decision based on their
knowledge and judgment. Since
every economic activity in the market
is measured as per price, it is
important to know the concepts and
theories related to pricing under
various market forms.
2

PERFECT COMPETITION
• Perfect competition is a market structure
characterized by a complete absence of rivalry
among the individual firms. Thus, perfect
competition in economic theory has a meaning
diametrically opposite to the everyday use of this
term. In practice, businessmen use the world
competition as synonymous to rivalry. In theory,
perfect competition implies no rivalry among firms.
3

ASSUMPTIONS OF PERFECT
COMPETITION
•Large numbers of sellers and buyers.
Product homogeneity.
Free entry and exit of firms.
Profit maximization.
No government regulation.
Perfect mobility of factors of production
Perfect knowledge
4

LARGE NUMBERS OF SELLERS AND
BUYERS:
• The industry in perfect competition includes a
large number of firms (and buyers).
• Each individual firm, however large, supplies only
a small part of the total quantity offered in the
market.
• The buyers are also numerous so that no
monopolistic power can affect the working of the
market.
• Under these conditions each firm alone cannot
affect the price in the market by changing its7/5/2016Deepak Srivastava
5

PRODUCT HOMOGENEITY:
• The technical characteristics of the product as well as the
services associated with its sale and delivery is identical.
There is no way in which a buyer could differentiate
among the products of different firms. If the products
were differentiated the firm would have some discretion in
setting its price. This is ruled out in perfect competition.
• The assumption of large number of sellers and of product
homogeneity implies that the individual firm in pure
competition is a price-taker: its demand curve is infinitely
elastic, indicating that the firm can sell any amount of
output at the prevailing market price. 7/5/2016Deepak Srivastava
6

FREE ENTRY AND EXIT OF FIRMS:
•There is no barrier to entry or exit from the
industry.
•Entry or exit may take time but firms have
freedom of movement in and out of the
industry.
•If barriers exist, the number of firms in the
industry may be reduced so that each one of
them may acquire power to affect the price in
the market. 7/5/2016Deepak Srivastava
7

Profit
maximization:
• The goal of all firms is profit
maximisation.
• No other goals are pursued.
No
government
regulation:
• There is no government
intervention in the market (tariffs,
subsidies, rationing of production
or demand and so on are ruled out).
8

Perfect mobility
of factors of
production:
• The factors of production are free
to move from one firm to another
throughout the economy.
• It is also assumed that workers can
move between different jobs.
• Finally, raw materials and other
factors are not monopolised and
labour is not organised.
Perfect
knowledge:
• It is assumed that all the sellers and
buyers have complete knowledge of
the conditions of the market.
• This knowledge refers not only to
the prevailing conditions in the
current period but in all future
periods as well.
• Information is free and cost less.
9

PERFECT COMPETITION
10

RELATIONSHIP BETWEEN THE MARKET
AND THE FIRM IN PERFECT COMPETITION
11

EQUILIBRIUM OF THE FIRM
• Firms aim to maximise profit and they can be in equilibrium only when they
achieve this. For all firms, profit maximisation is achieved when marginal
revenue, (MR), equals marginal cost (MC). If MR>MC, the firm adds more to
revenue than it does to costs by increasing output and sales. When this
happens profits will rise. On the other hand, if MR<MC, the firm adds more
to costs than it does to revenue by expanding output and sales. When this
happens profits will fall. It follows thus, that the firm is in equilibrium when
MC=MR.
•MR = MC
Profit
Maximization
Condition
12

EQUILIBRIUM OF THE INDUSTRY
• The industry is in long run equilibrium when a price is reached at which all
firms are in equilibrium (producing at the minimum point of their LAC curve
and making just normal profits). Under these conditions there is no further
entry or exit of firms in the industry, given the technology and factor prices.
At the market price P, the firms produce at their minimum cost, earning just
normal profits. The firm is in equilibrium because at the level of output Q
• LMC = SMC= P = MR
• This equality ensures that the firm maximises its profit. At the price P, the
industry is in equilibrium because profits are normal and all costs are
covered so that there are no incentives for entry or exit.
13

PRICE AND OUTPUT
DETERMINATION UNDER PERFECT
COMPETITIVE FIRM
14

SUPERNORMAL
PROFIT
The adjacent panel shows d which is
the demand curve for the output of a
perfectly competitive firm. The
marginal cost cuts the SATC at its
minimum point. The firm is in
equilibrium (maximises its profits) at
the level of output defined by the
intersection of the MC and the MR
curves (point E in Figure 9.3). To the
left of E profit has not reached its
maximum level because each unit of
output to the left of Xe brings revenue
greater than its marginal cost. To the
right of Xe each additional unit of
output costs more than the revenue
earned by its sale so that a loss is
made and total profit is reduced.
15

SUBNORMAL
PROFIT
If the ATC is above the price
(Figure 9.5), the firm makes a
loss (equal to the area FPeC). In
the latter case the firm will
continue to produce only if it
covers its variable costs.
Otherwise it will close down,
since by discontinuing its
operations the firm is better
off: it minimises its losses. The
point at which the firm covers
its variable costs is called "the
closing down point". 7/5/2016Deepak Srivastava
16

NORMAL PROFIT
The point at which the firm
covers its variable costs is
called "the closing down point".
In the figure the closing down
point of the firm is denoted by
point W. If price falls below Pw
the firm does not cover its
variable costs and is better off
if it closes down.
17

LONG RUN ANALYSIS OF A
PERFECTLY COMPETITIVE FIRM
• In the long run, all inputs and costs of production are variable and the firm
can construct the optimum or most appropriate scale of plant to produce
the best level of output.
• The best level of output is one at which price P equals the long run marginal
cost (LMC) of the firm.
• The optimum scale of the plant is the one in which short run average total
cost (SATC) curve is tangent to the long run average cost of the firm at the
best level of output.
• Thus, when a competitive market is in long run equilibrium, all firms
produce at the lowest point on their long run average cost (LAC) curve and
break-even. This is shown by point E in Figure
18

SUMMARY
• In theory, perfect competition implies no rivalry among firms.
• In a perfectly competitive market structure there is a large number of buyers and
sellers of the product and the product is homogeneous.
• There is free mobility of factors of production and the buyers and sellers have
perfect knowledge of the market.
• In the short run the best level of output of the firm is the one at which the firm
maximizes profits or minimises losses. This is possible at P = MR = MC. The point
at which the firm covers its variable costs is called "the closing down point".
• In long run the best level of output is one at which price P=LMC. At equilibrium the
short run marginal cost is equal to the long run marginal cost and the short run
average cost is equal to the long run average cost. Thus, given the above
equilibrium condition, we have.
SMC = LMC = LAC = SAC = P = MR
20

MONOPOLISTIC: FEATURES,
PRICING UNDER MONOPOLISTIC
COMPETITION
• Introduction
• Pricing decisions tend to be the most important decisions made by
any firm in any kind of market structure. The concept of pricing has
already been discussed in unit . The price is affected by the
competitive structure of a market because the firm is an integral part
of the market in which it operates.
• We have examined the two extreme markets viz. monopoly and
perfect competition in the previous unit. In this unit the focus is on
monopolistic competition and oligopoly, which lie in between the two
extremes and are therefore more applicable to real world situations.
21

IMPERFECT COMPETITION – MONOPOLY
7/5/2016Deepak Srivastava 22

INTRODUCTION
• Monopoly is exactly opposite to the perfect competition. We can
define a Monopolist as a sole supplier to particular market. In fact,
after going through this topic you will realise that monopoly is an
extreme case and it is rarely found in practice. However, we may also
understand the case of monopoly by analysing two different cases -
one that is presented in textbooks which says that in a monopoly
there is only one firm producing the good. And other, the real world
case such as the operating system monopoly, that says that in
monopoly there is one firm that provides the overwhelming majority
of sales (say, for example Microsoft), and a handful of small
companies that have little or no impact on the dominant firm. In this
unit, we will stress more on the former case.
23

FEATURES OF MONOPOLY
• From the above discussion it follows that for monopoly to exist,
following conditions are essential:
1. One and only one firm produces and sells a particular commodity
or a service.
2. There are no rivals or direct competitors of the firm.
3. No other seller can enter the market for whatever reasons —
legal, technical or economic.
4. Monopolist is a price maker. He tries to take the best of whatever
demand and cost conditions exist without the fear of new firms
entering to compete away his profits.
24

SOURCES OF MONOPOLY
1. Legal Restrictions: Some public sector services are statutory monopolies,
which means their position is protected by law.
• A monopoly position might also be protected by a patent which prevents other firms
from producing an identical good during the life of the patent. However, similar products
can often be produced and it is easy to exaggerate the protection afforded by patents.
25

MONOPOLISTIC
COMPETITION
Monopolistic competition normally
exists when the market has many
sellers selling differentiated
products, for example, retail trade,
whereas oligopoly is said to be
a stable form of a market where a
few sellers operate in the market
and each firm has a certain
amount of share of the market and
the firms recognize
their dependence on each other.
26

MONOPOLISTIC COMPETITION
• Edward Chamberlin, who developed the model of monopolistic
competition, observed that in a market with large number of sellers,
the products of individual firms are not at all homogeneous, for
example, soaps used for personal wash. Each brand has a specific
characteristic, be it packaging, fragrance, look etc., though the
composition remains the same. This is the reason that each brand is
sold Pricing Decisions individually in the market. This shows that
each brand is highly differentiated in the minds of the consumers.
27

• The effectiveness of the particular brand may be attributed to continuous
usage and heavy advertising. As defined by Joe S.Bain ‘Monopolistic
competition is found in the industry where there are a large number of
sellers, selling differentiated but close substitute products’. Take the
example of Liril and Cinthol. Both are soaps for personal care but the
brands are different. Under monopolistic competition, the firm has
some freedom to fix the price i.e. because of differentiation a firm will not
lose all customers when it increases its price. Monopolistic competition is
said to be the combination of perfect competition as well as monopoly
because it has the features of both perfect competition and monopoly. It is
closer in spirit to a perfectly competitive market, but because of product
differentiation, firms have some control over price. The
characteristic features of monopolistic competition are as follows:
28

• A large number of sellers: Monopolistic market has a large
number of sellers of a product but each seller acts
independently and has no influence on others.
• A large number of buyers: Just like the sellers, the market
has a large number of buyers of a product and each buyer
acts independently.
• Sufficient Knowledge: The buyers have sufficient knowledge
about the product to be purchased and have a number of
options available to choose from.
29

Unit 4

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