Market structures

Meaning of market:

Generally the term “Market” refers to a place in which commodities are bought and sold.

For ex, cotton market, gold market ,etc

John .f. Due defines market as “A group of buyers and sellers who are in sufficiently close contact with one another so the exchange takes place among them”.

Thus a market is one which consists of limited or unlimited no. of buyers and sellers who have close contact either directly or indirectly so that buying and selling of goods take place between them.

Classification Of Markets:

Markets can be classified on the basis of place, time or competition.

The following chart gives a clear picture about the classification of markets.

Pure Competition

• Characteristics:

This term is generally used by the American Economists:

1. Existence of Large number of Buyers and Sellers

2. Homogenous Products

3. Free Entry and Exit of Firms

Perfect Competition

• Features:

This term is traditionally used by the British Economist:-

1. Existence of Large number of Buyers and Sellers

2. Homogeneous product

3. Free entry and exit of firms

4. Uniform price

5. Perfect mobility of factors of production

6. Perfect knowledge of market

7. Full and Perfect Competition

8. No Transport Costs

9. No Government Intervention

Distinction Between Pure and Perfect Competition

The pure competition is a part of perfect competition .

the term “pure competition” is generally used by the American economists.

The term “perfect competition” is used by the British economist.

For a market to be highly competitive, 3 fundamental conditions are:

1. Existence of large no. of buyers and sellers

2. Homogenous product

3. Free entry and exit of firms

For the market to be perfectly competitive

6 more conditions must be added to the above. They are:

1. Uniform price

2. Perfect knowledge of factors of production

3. Perfect mobility of factors of production

4. Full and perfect competition

5. No transport costs

6. No government intervention

Price–Output determination under Perfect Competition in an Industry (General model)

Under a perfectly competitive market, in case of the industry market price of the product is determined by the interaction of supply and demand.

The market price is not fixed by either the buyers or sellers, the firm or the industry.

It is only demand and supply that determines the equilibrium price of the product.

Under perfect competition a firm will not have any freedom to fix the price of its product.

The industry is the price maker or giver and a firm is a price taker or receiver. As a part of the industry, it has to simply charge the price that is determined by the industry.

Equilibrium of the Industry and Firm in the Short run period under Perfect Competition

Under conditions of Perfect Competition the industry is the “Price maker”, the firm is a “Price taker”.

In the short period the firm can adjust its output to the change in demand to a certain extent with the help of existing plant and machinery.

The fixed factors cannot be altered but the variable factors can be altered to produce more quantity.

Normal Profit

Normal profit is the minimum reasonable level of profit which the entrepreneur must get in the long run so that he is induced to continue the employment of his resources in its present form.

Normal profit is regarded as a part of factor cost.

When AR=AC it is implied that normal profit is included in the TC.

Super Normal Profit

Profits in excess of normal profit are considered as super normal profit.

Also called as pure business profit or excess profit.

It is obtained when TR exceeds TC.

It is the reward paid for the entrepreneur for bearing uncertainties or risks of business.

Sub-Normal Profit

When a firm earns only a part of the normal profit, it is called sub-normal profit.

It is below the normal profit earned, when TR covers explicit cost fully and a part of implicit cost of entrepreneurial services, i.e when revenue is less than the cost.

Equilibrium of Industry and Firm in the Long period under Perfect Competition. (OR) Price Output determination in the perfect Competition in the Long run

Equilibrium of Industry:

An industry is said to be in equilibrium when there is no tendency for the size of the industry to change i.e either to expand or contract.

The essential condition is that at a given price the total quantity demanded should be equal to the total quantity supplied.

All the firms should be in equilibrium i.e LMC=LMR(MC=MR).

Equilibrium Of a Firm:

In the long period the firm is able to adjust its output with the changes in demand, by varying all the factors of production that it has employed.

Thus it can bring about alterations in the cost of production and on account of economies of scale in production.

The essential condition of equilibrium of a firm is that LAR=LAC.

Imperfect competition

Imperfect competition is a comprehensive term to include all other kinds of market situations except pure and perfect competition.

Competition becomes imperfect when the number of sellers is reduced to one, or a few who offer products for sale.

At the same time restrictions are imposed on the flow of information, entry and exit of firms.

Monopoly

The term “Monopoly” is derived from two Greek words- Mono –Single and Poly—means to sell. Thus ‘Monopoly’ refers to a market situation in which there is a single seller for the product for which there is no close substitutes.

According to Prof. Watson “A Monopolist is the only producer of a product that has no close substitutes”.

Features of Monopoly:

1. Absence of Competition

2. One Producer or Seller

3. No Close Substitutes

4. Complete Control over Supply

5. Price Maker

6. No New Firms

7. No Difference between a firm and industry

8. Monopoly Firm may be Proprietary or Partnership / Joint Stock / Government organization

9. There is a scope for super normal profits.

Ex: Indian Railways , P&T, BMTC; BWSSB;BESCOM, etc.

Price and Output Determination under Monopoly OR Equilibrium under Monopoly

According to MR and MC approach , a monopolist will be in equilibrium when 2 conditions are fulfilled. They are

1. MC=MR

2. When MC curve cuts MR curve from below.

The study of price equilibrium can be conducted in 2 time periods.

1) Short period

2) Long period

Short Period Equilibrium under Monopoly

(1) Earning Super Normal Profits

(2) If the price determined by the monopolist is more than AC he will get super normal profits.

(3) The monopolist will produce upto the level where MC=MR.

(4) This limit will indicate equilibrium point.

(2) Normal Profits

A monopolist in the short run would enjoy normal profits when average revenue is just equal to average cost.

The average cost of production is inclusive of normal profits i.e. remuneration paid to the entrepreneur for his services in the process of production.

(3) Minimum Losses

In the short run the monopolist may have to incur losses certain times.

This situation occurs if price falls due to depression and fall in demand, the monopolist will continue to produce as long as price covers the average variable cost (AVC).

Once the price falls below the AVC, monopolist will stop production.

Long Run Equilibrium Under Monopoly

Long run is the period in which output can be changed by changing the factors of production.

Here equilibrium wo0uld be attained at that level of output where the long run marginal cost curve cuts marginal revenue curve.

Price Discrimination

• Meaning and definition:

Price discrimination means the practice of selling the same commodity at different prices to different buyers. If the monopolist charges different prices for different customers for the same commodity it is called discriminating monopoly.

Mrs. John Robinson defines price discrimination as “the act of selling the same article produced under a single control at different prices to different customers”.

Types of Price Discrimination:

• There are mainly three types of price discrimination. They are

1. Personal discrimination

2. Place discrimination

3. Trade discrimination

4. Personal discrimination:

In this case the monopolist charges different prices for different customers on the basis of their ability to pay. This is possible in specialised personal services of doctors, lawyers, etc.

Place discrimination:

Monopolist may have different markets in different places and charge different prices for the same commodity. Generally “dumping” is considered as the best example of place discrimination.

• Trade discrimination:

Here the monopolist charges different prices for the same commodity for different types of users for which the commodity is put to.

For ex, electricity at very low rates for agricultural purposes and at very high rates for domestic and industrial purposes.

Conditions For Price Discrimination

1. Existence in imperfect market

2. Existence of different degrees of elasticity of demand in different markets

3. Existence of different markets for the same commodity

4. No contacts among the buyers

5. No possibility of resale

6. Legal sanction

7. Buyers illusion

8. Ignorance

9. Product differentiation

Price-Output Determination under Discriminating Monopoly

Under discriminating monopoly in order to discriminate the prices, the entire market will be divided into sub markets on the basis of the elasticity of demand for the product.

This is explained by the revenue curves of the 2 sub markets A and B and the aggregate situation in the entire market under the control of the monopolist.

Duopoly

Duo means ‘two’ and ‘Poly’ means ‘To sell’.

Thus ‘Duopoly’ refers to a market situation in which there are only TWO sellers for a product.

The two firms of sellers may either resort to

1) Competition

or

1) Come Together

2) Competition:

With the intention of elimination the other from the market and

setting himself as a monopolist. It may be ruinous for both.

Come to an understanding/ Come Together:

On the other hand they may come to an understanding and fix a common price & restrict the competition to advertisement only.

Oligopoly

Oligoi : a few ; Poly : to sell

Oligopoly is that form of imperfect competition where there are a few firms in the market producing either homogenous or differentiated products which are close but not perfect substitutes of each other.

Identical product : cooking gas, cement, cable wire, Petroleum, Vegetable oil , etc.

Differentiated products : Cars, T.V Sets , Refrigerators, washing machines, scooters, Fans, etc.

Features of Oligopoly:

1. Very few sellers

2. Interdependent

3. Indeterminant demand

4. Element of Monopoly

5. Price Rigidity

6. Selling Cost

7. Conflicting Attitude of Firms

8. Constant Struggle

Kincked Demand Curve reference: Dwivedi

• The kincked demand curve model of oligopoly was developed by Paul M. Sweezy.

• He has tried to show through his kincked demand curve analysis that price and output once determined under oligopolistic conditions, tend to stabilize rather than fluctuating.

• It seeks to establish that once a price-quantity combination is determined, an oligopoly firm does not find it profitable to change its price even if there is a considerable change in cost of production.

• There are three possible ways in which rival firms may react:

1. The rival firms follow the price changes, both cut and hike;

2. The rival firms do not follow the price changes;

3. The rival firms follow the price cuts but not the price hikes;

PRICE LEADERSHIP

Under this system, a particular strong firm which is enjoying the benefits of large scale production will ominate the small firms.

The price fixed by the dominating firm will be followed by all others firms in the market. Hence the dominating firm becomes the Price Leader.

Generally the leadership arises in a market on account of the following reason:

1. The leading firm will be enjoying the benefits of lower cost of production and possesses huge financial resources at its disposal.

2. It may have a substantial share in the market.

3. It will have reputation for sound pricing policy.

4. 4. It may take the initiative in dominating and controlling other firms in the industry as a normal method of functioning.

5. 5. It may follow aggressive price policy and thereby it can acquire control over other firms.

6. 6. If a dominant firm is unable ton perform its role as a price leader it will give the leadership role to others.

Advantages of Price Leadership

Helps the small firms to formulate price policy.

Simple and economical.

Ensures stability in the markets.

Puts an end to operations of trade cycles or fluctuations in the market.

Ensures the spirit of live and let live.

Monopolistic Competition

Prof. Chamberlin is considered to be the main builder of the theory of monopolistic competition.

Features:

1. Existence of sufficiently Large number of Firms.

2. Product Differentiation

3. Selling Cost

4. Free Entry and Exit of Firms

5. No Possibility of Combination

6. Consumers Divided

7. Element of Monopoly and Competition

8. Non price Competition

Price-Output Determination under Monopolistic Competition

Price output determination under monopolistic competition is governed by cost and revenue curves of the firm.

Equilibrium of the Individual Firm In the Short Period Earning Profits:

Under monopolistic competition a firm will come to equilibrium on the same principle of equalising MR to MC. Each firm will choose that price and output where it will maximize its profits.

Group Equilibrium in the Long Run under Monopolistic Competition

Prof. Chamberlin made some assumptions of uniformity to arrive at the long run equilibrium of the group.

1. The firms produce more or less similar products.

2. The shape of AR curves will be the same for all the firms.

3. All firms have equal efficiency in productions and cost curves are similar.

The abnormal profits earned by the firms will attract new firms to the group. This will result in increase in competition and fall in prices.

Product Differentiation

An important feature of the monopolistic competition is that there is product variation or differentiation.

Different varieties of the same commodity are treated by the consumers as different products under monopolistic competition.

Product differentiation is the term used by Prof. Chamberlin for quality competition.

Product differentiation is very common in the case of manufactured goods.

The producers may bring about product differentiation through differences in the quality of the raw materials used, workmanship, size, colour, etc.

The producers may bring about differences in their products by offering special services to their customers before and after the sale of their products. Ex: credit, home delivery, etc.

The producers may bring about product differentiation through sales promotion, such as advertisement, publicity and propaganda.

Differences are also brought about by the location and distances of the selling depots.

Descriptive Pricing Strategies

Full Cost Pricing or Margin Pricing

This pricing method is widely adopted by the business firms for its simple and easy procedure.

Under this method, the price is set to cover costs (materials, labour and overhead) and a pre-determined percentage for profit. The percentages added to the costs are called margins.

Firms adopting this method of pricing should consider following costs:

a. Fixed and Variable Costs of Production

b. Variable and Fixed Selling and Administrative Costs.

It is determined by a variety of considerations:

1. Common practice followed in a particular business.

2. Trade associations by means of advisory price-lists distributed to the members.

3. Guidelines provided by the government.

Advantages :

1. Helps in setting fair and plausible prices.

2. Can be adopted by all types of firms, single product or multiple product firms.

3. Pricing is factual and precise and can be defended on the moral grounds.

4. Safeguards the interest of the firm against the risks and uncertainties of demand for its products.

Limitations:

1. Ignores the influence of demand in the pricing process.

2. Fails to reflect the forces of competition.

3. Exaggerates the precision of allocated costs.

4. Regards costs as the main factor influencing the price.

5. Ignores the marginal or incremental cost but uses average cost instead.

Product-Line Pricing

Meaning of Product Line:

A product line may be defined as a group of products which have similar physical features and perform generally similar functions.

According to Prof. W. J. Staton, “a broad group of products intended for essentially similar uses and possessing reasonably similar physical characteristics, constitute a product line”.

Ex: BPL company – TV, Fridge, Washing machine, Music system, Micro oven, etc.

Meaning of Product-Line Pricing:

Product line Pricing refers to the determination of prices of individual products and finding proper relationship among the prices of members of a product group.

In product line, a few products may be regarded as less profit-earning products and others as more profit-earning products.

Important Aspects in Product-Line Pricing

The three important aspects of product-line pricing are:

1. Opportunities for multiple products

2. Criteria for adding new products

3. Considerations for dropping of a product.

(A) Opportunity for Multiple Products

A firm will go for multiple products when there is “Excess Capacity”. Excess capacity may arise on account of the various reasons given below:

• Mechanical indivisibilities

• Managerial abilities

• Seasonal variations

• Depression of trade cycles

• Secular shifts

• Research

(B) Criteria for Adding New Products

At present most of the companies have become multiple-product firms.In order to build up competitive strength, to exploit goodwill of consumers and to earn more profits –a firm aims at adding one or more new products to the product line.

Following are the main criteria for adding new products:

1. Excess Capacity

2. Variation of existing products

3. Pressure from distributors and salesmen

4. Competitive nature of business

While introducing new products, the management has to consider the following points:

a. Comparing incremental costs with incremental revenues.

b. Finding out potential product additions

c. Maximum chance of success.

(C) Considerations for Dropping Old Products

Product elimination may be undertaken on account of many reasons:

a) They are produced because of the past mistakes

b) Because of merger and acquisitions

c) They have become old and obsolete

d) Changes in consumers tastes and preferences

e) No longer it fits into the organizational portfolio

f) The demand for product has come down

When a particular product does not record satisfactory performance, a firm can think of four alternatives given below:

1. Improve the present product

2. Selling in bulk

3. Buying in bulk

4. Product life cycle: Total elimination

Pricing Strategies

Price Skimming

Pre-conditions for such a strategy are:

• A sufficiently large segment whose demand is relatively inelastic, not sensitive to a high price.

• Unit costs relatively unaffected by small volume, high ratio of variable to fixed costs.

• High price unlikely to attract competition.

The policy aims at “skimming the cream” by taking advantage of the target segment’s willingness to pay a high price. Policy is, therefore, essentially discriminatory.

Advantages of such a policy are that it enhances the quality image, thus providing maneuverability adjustment if the initial price is too high.

Price Penetration

Pre conditions for such a strategy are:

1. A highly price-sensitive market, high price elasticity.

2. Economies of scale in production or distribution; ratios of variable to fixed costs are low.

3. Low price likely to discourage competition.

Policy is to charge a low price, so as to stimulate demand for the product of the firm and capture a large share of the market.

Loss Leader pricing

According to Haynes and Henry, “A loss leader is an item which produces a less than customary contribution or a negative contribution to overhead but which is expected to create profits on increased future sales or sales of other items”. This pricing approach is widely used in retailing business.

This policy may be confused with the pricing which results in losses. In fact it is a policy which aims at increasing profits.

Sometimes the firms, which manufacture or sell multiple products, charge relatively low price on some popular product with the hope that the customers, who come for this product, will also buy some other products produced or sold by the firm. Such a product is known as a loss leader.

It must be noted that the loss leader does not mean that this product is necessarily sold at a loss. It only means that the actual price charged is lower than what could have been charged.

The basic idea of making a popular product a loss leader is that the profits thus sacrified will be made good by profits on the other products.

It has also been seen that the firms sometimes compel their customers to buy some product or products along with the purchase of a popular product. The customer in turn sees the products forced on him as a loss, hoping to make up the loss through profit on the popular product.

Bob R Holdren did a study of the market behavior of the grocery stores and found out some features which are required for a good to serve as a loss leader. These features are:

1. The buyers should have knowledge of prices of the same good other selling units.

2. The quantity to be bought by the buyers should be large enough so as to feel the benefit of price reduction.

3. Demand for commodity should not be elastic.

4. The price reduction should be significant to be perceptible.

5. Goods should be more or less of the same quality as others are selling; neither should price reduction give an impression of quality reduction.