Market Structure

Market Structure

Market structure – identifies how a market is made up in terms of:

The number of firms in the industryThe nature of the product producedThe degree of monopoly power each firm hasThe degree to which the firm can influence priceProfit levelsFirms’ behaviour – pricing strategies, non-price

competition, output levels The extent of barriers to entryThe impact on efficiency

Types of Market Structure

Perfect Competition

Monopoly

Monopolistic Competition

Oligopoly

Market Structure

More competitive

Perfect Competition

Pure Monopoly

Greater degree of monopoly power

Perfect Competition

Large number of buyers and sellersHomogeneous productsPerfect mobility of factors of productionFree entry & free exit of firmsPerfect knowledgeAbsence of collusion or artificial restaraintNo govt. intervention

Features

Price Determination under Perfect Competition

Market period or very short runShort runLong run

Price determination under perfect competition is analyzed under three different time periods:

Supply determined Price

Pricing in “Market Period”Demand

determined Price

industry Firm

Pricing in the “Short Run”

Industry Firm

Pricing in the “Long Run”

MonopolyOnly one seller of a particular product

Characteristics of Monopoly

Single ProducerNo close substituteInelastic demand curvePrice MakerBarriers to entryLegal restrictions or barriers to entry of

other firmsControl over key raw materialExamples: Public utilities – telephones and

electricity etc.

Pricing & Output Decision: Monopoly

Costs / Revenue

Output / Sales

AC

MC

ARMR

AR (D) curve for a monopolist likely to be relatively price inelastic.

Q1

7.00

3.00

Monopoly Profit

Given the barriers to entry, the monopolist will be able to exploit abnormal profits in the long run as entry to the market is restricted.

Price Discrimination It refers to discrimination of price for

different consumers on the basis of their income or purchasing power, geographical location, age, sex, colour, marital status, quantity purchased, time of purchase etc. for eg:-

• Physicians and hospitals• Merchandise sellers• Railways and Airlines• Cinema shows or musical concerts• Domestic and foreign markets

Necessary conditions• Different Markets must be separable for

a seller

• The Elasticity of demand must be different in different markets

• There must be imperfect competition in the market

• Profit maximizing output should be larger than the quantity demanded in a single market or section of consumers

First Degree of Price Discrimination

Costs / Revenue

Output / Sales

S

DQ

P

0

Second Degree of Price Discrimination

Costs / Revenue

Output / Sales

S

DQ

P

0

P3

P2

P1

Q3Q2Q1

Third Degree of Price Discrimination

Costs / Revenue

Output / SalesOutput / SalesOutput / Sales

QA QBQ0 00

MRB

ARA

MRAARB

Market A

MC

MR

AR=D

Total MarketMarket B

PA

PB

Monopolistic Competition

Large no. of sellersFree entry & free exitPerfect factor mobilityComplete dissemination of market

informationDifferentiated product

Features:

Differentiated & Homogeneous productsDecision making

Monopolistic vs. Perfect Competition

Price & output decisions in “Short Run”

Price & output decisions in “Long Run”

Two common forms of non price competition are

Product InnovationAdvertisement

Non Price Competition: Selling Cost

Oligopoly

Ipod Zune

OligopolyFew producers control supply and price

Characteristics of Oligopoly

Small number of sellersHomogenous or differentiated productsInterdependence of decision makingBarriers to entryIndeterminate price and outputExamples : Aluminum, steel, cigarettes,

cars etc

Sweezy’s Kinked Demand Curve

d1 is relatively elastic

d2 is relatively inelastic

The kinked demand curve indicates the possibility of price rigidity

Changes in cost do not impact output and prices as long as MC remains in the vertical portion of MR

Price Leadership Models Sometimes, a Leading role is played by the

dominant firm due to its size, efficiency, economies of scale or firm’s ability to forecast market conditions accurately. It initiates a change in price and other small firms follow.

The dominant firm may also serve as a means to price discipline and price stabilization which is knows as “Effective Price leadership”

Price Leadership by Low Cost Firm

AC’

MC

AR

MR

Q1 Q2

P3

Costs / Revenue

Output / Sales

MC’

AC

P2

P1

0

E

E’

Price Leadership by Dominant Firm

Cost/Revenue

Output/SalesQD

Cost/Revenue

Output/Sales 0

MCD

P3

P’

P2

P1

P

DM DD

SD

MRD0

FC

A B

E P3

P’

P2

P1

Barometric Price Leadership The barometric Firm may not necessarily

be the largest firm but it is supposed to have a better knowledge of the prevailing market conditions.

Advantages:Better PriceDependenceReaction to Economics warfare

Collusion Model : The Cartel

A cartel is an association of business firms formed by an explicit agreement between them. They jointly establish a cartel organization to:

Make Price and output decisionsEstablish Production Quotas. Supervise market activities of the firms.

Market Allocation under Cartel

Costs / Revenue

Output / SalesOutput / SalesOutput / Sales

q1 q2 Q0 00

mc2

ac1

mc1 ac2

Firm A

MC

MR

AR=D

C

P

IndustryFirm B

Thank You!