Edited by Jamil Malik

1. MARKET STRUCTURE AND
PRICING PRACTICES

2. Meaning and classification of Market
An arrangement whereby buyers and sellers come in close contact with
each other directly or indirectly to sell and buy goods is described as
market
Classification of market
Local markets
Regional markets
National markets
World markets

3. Perfect Competition
A market structure in which a large number of firms all produce the same
product and no single seller controls supply or prices.
Perfect Competition is a market structure where there is a perfect degree
of competition and single price prevails. A perfectly competitive market is
a hypothetical market where competition is at its greatest possible level. It
is also called as pure competition.

4. Features of Perfect Competition
Many Sellers
Many Buyers
Homogenous Products
Zero Advertisement Cost
Free entry and Exit
Perfect Knowledge
No Government Intervention
No Transport Cost
Perfect Mobility of factors

5. Determination of Price under perfect competition
In prefect competition, price is determined by the market forces of
demand and supply. All buyers and sellers are price takers and not price
makers. Buyer represents demand side in the market. Every rational buyer
aims at maximising his satisfaction by purchasing more at lower price and
lower at higher price. This is called demand behaviour of buyer i.e. Law of
Demand.
Seller represents supply side in the market. Every rational seller aims at
maximizing his profits by selling more at higher price and lesser at lower
price. This is called supply behaviour of seller i.e. Law of supply.
But at a common price, buyer is ready to demand a particular quantity of
goods and seller is also ready to supply exactly the same quantity of goods
to buyer, such common price is called 'Equilibrium Price' and such quantity
is called 'Equilibrium Quantity'.

6. It is the price at which total demand is exactly equal to total supply.

8. Monopoly
The term monopoly is derived from Greek words 'mono' which means
single and 'poly' which means seller. So, monopoly is a market structure,
where there only a single seller producing a product having no close
substitute. This single seller may be in the form of an individual owner or a
single partnership or a Joint Stock Company.
Such a single firm in market is called monopolist. Monopolist is price
maker and has a control over the market supply of goods. But it does not
mean that he can set both price and output level. A monopolist can do
either of the two things i.e. price or output. It means he can fix either
price or output but not both at a time.
In monopoly, the firm has control over the price of output. Therefore, it
will choose the level of price and output that maximises profits.

9. Features of Monopoly
A single seller has complete control over the supply of the commodity.
There are no close substitutes for the product.
There is no free entry and exit because of some restrictions.
There is a complete negation of competition.
Monopolist is a price maker.
Since there is a single firm, the firm and industry are one and same i.e.
firm coincides the industry.
Monopoly firm faces downward sloping demand curve. It means he can
sell more at lower price and vice versa. Therefore, elasticity of demand
factor is very important for him.

10. Types of Monopoly
Perfect Monopoly
Imperfect Monopoly ( Telecom)
Private Monopoly ( Reliance)
Public Monopoly ( Railways, Defence)
Simple Monopoly
Discriminating Monopoly
Legal Monopoly ( Music Industry)
Natural Monopoly ( Gulf Countries)
Technological Monopoly ( Windows OS)
Joint Monopoly ( Pizza and Burger Joint)

11. Pricing under Monopoly
Be careful of saying that "monopolies can charge any price they like" - this
is wrong. It is true that a firm with monopoly has price-setting power and
will look to earn high levels of profit. However the firm is constrained by
the position of its demand curve. Ultimately a monopoly cannot charge a
price that the consumers in the market will not bear.
A pure monopolist is the sole supplier in an industry and, as a result, the
monopolist can take the market demand curve as its own demand curve.
A monopolist therefore faces a downward sloping AR curve with a MR
curve with twice the gradient of AR. The firm is a price maker and has
some power over the setting of price or output. It cannot, however, charge
a price that the consumers in the market will not bear. In this sense, the
position and the elasticity of the demand curve acts as a constraint on the
pricing behaviour of the monopolist. Assuming that the firm aims to
maximise profits (where MR=MC) we establish a short run equilibrium as
shown in the diagram below.

12. Assuming that the firm aims to maximise profits (where MR=MC) we
establish a short run equilibrium as shown in the diagram below.

13. The profit-maximising output can be sold at price P1 above the average
cost AC at output Q1. The firm is making abnormal "monopoly" profits (or
economic profits) shown by the yellow shaded area. The area beneath
ATC1 shows the total cost of producing output Qm. Total costs equals
average total cost multiplied by the output.
A change in demand will cause a change in price, output and profits.
In the example below, there is an increase in the market demand for the
monopoly supplier. The demand curve shifts out from AR1 to AR2 causing
a parallel outward shift in the monopolist's marginal revenue curve (MR1
shifts to MR2). We assume that the firm continues to operate with the
same cost curves. At the new profit maximising equilibrium the firm
increases production and raises price.
Total monopoly profits have increased. The gain in profits compared to the
original price and output is shown by the light blue shaded area.

15. Price Discrimination
Price discrimination occurs when a firm charges different
prices to different customers for reasons other than
differences in costs
Price-discriminating monopoly does not discriminate based
on prejudice, stereotypes, or ill-will toward any person or
group
– Rather, it divides its customers into different categories based on their
willingness to pay for good

16. Forms of Price Discrimination
Personal Discrimination ( Doctor)
Age Discrimination ( Bus Fares)
Sex Discrimination ( Concession for ladies)
Location or Territorial Discrimination (petrol in Goa)
Size Discrimination (Economy size Toothpaste)
Quality variation discrimination ( Book Prices)
Special service or comforts ( Restaurants)
Use discrimination ( Electricity)
Time discrimination ( Telephone charges)
Nature of commodity discrimination ( Freight charges in railways & Bus)

18. Second Degree Price Discrimination

19. Third Degree of Price Discrimination

20. When is price discrimination profitable?
Price discrimination is possible when there are different separate markets.
But, the profitability aspect of price discrimination basically depends upon
the nature of the elasticity of the demand in these markets.
The basic condition of profitable price discrimination are –
Elasticity of demand differs for different markets
The cost differential of supplying output in different markets should not be
large in relation to the price-differential based on elasticity differential

21. Monopolistic Competition
Monopolistic competition is a market structure characterized by a large
number of relatively small firms. While the goods produced by the firms in
the industry are similar, slight differences often exist. As such, firms
operating in monopolistic competition are extremely competitive but each
has a small degree of market control.
Monopolistic Competition is a market structure in which many firms sell
products that are similar but not identical.
In effect, monopolistic competition is something of a hybrid between
perfect competition and monopoly. The real world is widely populated by
monopolistic competition.

22. Features of a Monopolistic Competition
Large number of small firms
Product differentiation
Relative resource mobility
Extensive knowledge

23. Pricing under Monopolistic Competition
Short run Equilibrium
Over the short-run, firms can usually gain some abnormal profit, it is a
time period in which at least one factor of production is fixed. The firm will
produce quantity Q at price P. The firm produces where marginal cost
(MC) and marginal revenue (MR) curves meet, because MC is the cost of
producing an one more of the good and MR is the revenue of selling one
more good and their meeting point is the most efficient production. This
means that the shaded area between Ps, b (average cost of producing one
good at this quantity) and the AR curve (average revenue curve) is the
abnormal profit the firm makes. AR is equivalent to the demand curve and
is the average revenue the firm makes per item sold. Producing at this
point ensures the highest amount of profit. Thus, equilibrium is created in
the short run.

24. Short run equilibrium

25. Long run Equilibrium
In the long run, there are no abnormal profits because of the features of
Monopolistic competition. There are a few large firms, but many small firms
that will compete for profit and thus drive the price down. Also, low entry
barriers mean new firms will enter the market and further add competition.
Finally, the goods are similar enough to ensure that competition will always
remain high.
In this diagram, the firm produces where the LRMC, or long run marginal cost
curve, and the marginal revenue curve meets. The LRMC describes the cost of
producing one more of the good when no factors of production are fixed over
the long run. That point is, in the long run, equivalent to the LRAC, or long run
average cost curve, which shows them average cost of producing one good at
this quantity over the long run. Because the LRAC curve is above the AR curve,
there is no abnormal profit, as the average cost of the good equals the average
revenue of the good. Thus, in the long run, equilibrium is acquired.
Essentially, the difference between short and long run equilibrium is that in
short run equilibrium, the firm can gain abnormal profits. Over the long run,
that is impossible.

26. Long run Equilibrium

27. Product Differentiation
The goods produced by firms operating in a monopolistically competitive
market are subject to product differentiation. The goods are essentially
the same, but they have slight differences.
Product differentiation is usually achieved in one of three ways
Physical Differentiation
Perceived Differentiation
Support Services
Product differentiation is the primary reason that each firm operating in a
monopolistically competitive market is able to create a little monopoly all
to itself.

28. Oligopoly
A market structure characterized by competition among a small number of
large firms that have market power, but that must take their rivals’ actions
into consideration when developing their competitive strategies.
Oligopoly is a market structure in which the number of sellers is small. It
requires strategic thinking, unlike perfect competition, monopoly, and
monopolistic competition. Under oligopoly, a seller is big enough to affect
the market. You must respond to your rivals’ choices, but your rivals are
responding to your choices.
In oligopoly markets, there is a tension between cooperation and self-
interest. If all the firms limit their output, the price is high, but then firms
have an incentive to expand output.

29. Features of Oligopoly
large number of potential buyers but only a few sellers
homogenous or differentiated product
buyers are small relative to the market but sellers are large
Firms have market power derived from barriers to entry
Each firm doesn’t have to consider the actions of other the actions of
other firms, thus, behavior is interdependent.
However, a small number of firms compete with each other.
Imperfect dissemination of information
Advertising
Constant struggle

30. Kinked Demand Curve
The kinked demand curve or the average revenue curve is made of
Relatively elastic demand curve
Relatively inelastic demand curve
At given price P, there is a kink at point K on the demand curve DD. DK is
the elastic segment and KD is the inelastic segment of the curve. Here, the
kink implies an abrupt change in the slope of the demand curve. Before
the kink the demand curve is flatter, after the kink it becomes steeper.
The kink leads to indeterminateness of the course of demand for the
product of the seller. Raising the price would contract sales as demand
tends to be elastic at this stage. Lowering the price would imply an
immediate retaliation from the rivals on account of close interdependence
of price output movement in oligopolistic market.

31. Kinked Demand Curve

32. It is observed that quite often in oligopolistic markets, once a general price
level is reached whether by collusion or by price leadership or through
some formal agreement, it tends to remain unchanged over a period of
time. This price rigidity is on account of conditions of price
interdependence .Discontinuity of the oligopoly firm’s marginal revenue
curve at the point of equilibrium price, the price combination at the kink
tends to remain unchanged even though marginal cost may change.
In the figure, it can be seen that the firm's marginal cost curve can
fluctuate between MC1,MC2 and MC3 within the range of the gap in the
MR curve, without disturbing the equilibrium price and output position of
the firm. Hence, the price remains at P and output at Q, despite change in
marginal costs.

35. Price Leadership
Another type of oligopolistic behaviour is 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.
As the name implies, the price leadership consists of a leader and a bunch
of followers. The leader, however, is always mindful of the demand and
will set prices low enough that a satisfactory demand remains after all the
followers have made production decisions.
This implies that the dominant firm is better off with larger amounts of
the market share and less competition. As a result, the price leader may
choose prices to minimize the participation of smaller firms. This pricing
strategy is called predatory pricing.

36. The price leadership of a firm depends on number of factors as
Dominance in the market
Initiative
Aggressive pricing
Reputation

37. cartel
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 collusive behaviour. When this
happens the existing firms decide to engage in price fixing agreements or
cartels. The aim of this is to maximise joint profits and act as if the market
was a pure monopoly. It is considered illegal under anti-trust laws, such as
competition act 2002, India.
Collusion is often explained by a desire to achieve joint-profit
maximisation within a market or prevent price and revenue instability in
an industry. Price fixing represents an attempt by suppliers to control
supply and fix price at a level close to the level we would expect from a
monopoly.