Market structure
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The market is made up of buyers and sellers who conduct exchange transactions. Markets can be classified based on area, the nature of transactions, volume, time period, and level of competition. Under perfect competition, there are many small firms and homogeneous products. Individual firms are price takers and maximize profits where marginal revenue equals marginal cost. Monopolies have single firms and differentiated products, allowing them to be price makers that also set output at the point where marginal revenue equals marginal cost. Oligopolies feature a few interdependent firms, and pricing may involve price leadership or tacit collusion to coordinate prices.
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Market structure
- 1. Market Structure Market is a set of conditions in which buyers and sellers contact each other and conduct exchange transactions. It comprises of the following compounds a. Consumers b. Sellers c. Commodity d. Price Classification of the market Market is classified on the following grounds Basis of Area – Local Market, Regional Markets, National and International
- 2. • Based on the nature of transactions – Spot markets – Goods are physically exchanged on the spot. • Future Markets – Transactions involving agreements of future exchange of goods • On volume of goods – wholesale and retail • Basis of time - very short period, long period and very long period. • Basis of status of sellers • Primary Market – Manufacturers who produce and sell to the wholesalers.
- 3. • Secondary , Wholesalers to Retailers • Terminal – Retailer to the ultimate consumer. • On regulations – Regulated if the Government imposes certain conditions on sale and purchase. • On the basis of competitions • Perfect Competition b. Imperfect Competition • Imperfect Competition • a. Monopoly – Single producer – Single Product – No close Substitute • Duopoly – Only two producers – identical or differentiated products.
- 4. • When differentiated each seller has his own set of clients and not affected by his rival. • When identical products – both will be aware of each others price and output policies. • Oligopoly – Two types- one without product differentiation and is called pure oligopoly. • • In this there exists competition among the few firms producing homogeneous product. • • Differentiated oligopoly – Differentiated products – each firm having some control over the price.
- 5. • Monopolistic Competition – Large number of firms with product differentiation. • Monopsony – Buyer’s monopoly – only one buyer and large number of producers Oligopsony – Only a few buyers in the market. • Concepts of Total Revenue (TR), Average Revenue (AR), Marginal Revenue (MR) •
- 6. • TR = PxQ i.e. the amount of money the firm realises by selling certain units of a Commodity. • • AR = TR i.e. Average Revenue is the revenue earned per • Q unit of out put. • • MR is the change in total revenue resulting from the sale of an additional unit of the Commodity
- 7. • MR is the change in total revenue resulting from the sale of an additional unit of the Commodity • MR = TR • Q
- 8. PERFECT COMPETITION Perfect Competition refers to the market situation where there are large number of buyers and sellers engaged in buying and selling homogeneous product at uniform price.
- 9. • Pure Competition • In a pure competition there must be large number of buyers and sellers, product must be homogeneous, free entry and exit and uniform price only exists. • Price Determination under perfect competition • Equilibrium of the Industry • An industry means large number of independent firms each having a number of factories, farms or mines. • Each factories produces homogeneous product – so there is no competition amongst which produced by different firms.
- 10. When total output of the industry = the total demand, then the industry is in equilibrium.
- 11. • Equilibrium of the Firm • A firm is in equilibrium when it maximises its profit • The out put which gives maximum output to the firm is called equilibrium output. • Firms in a competitive markets are price-takers. • They cannot influence the prince in their individual capacities. • Therefore they accept the price fixed by the industry through the interaction of demand and supply.
- 12. The demand curve facing the individual firm in a perfectly competitive market is horizontal at the level of market price set by the industry and the firms have the freedom of choosing the level of output which yields maximum profit.
- 13. • Conditions for equilibrium • A firm in order to attain equilibrium position has to satisfy two conditions. • MC= MR • MC must cut MR from below and MC must be rising after the point of equilibrium. • There are two approaches to determine equilibrium. – Total Cost and Total Revenue Approach – Marginal Cost and Marginal Revenue Approach
- 14. Total Cost and Total Revenue Approach
- 15. • The equality between total cost and total revenue at a point is called equilibrium output. In the above diagram TC represents Total Cost and TR represents Total Revenue. • TC curve starts at the height of OF. This is because it has bear certain cost of production due to fixed factors. • When the output is OM the firm is at break even point also at point P the firm is at break even point. • The maximum profit is where the vertical distance between the total revenue and the total cost curves is the greatest.
- 16. MR and MC approach
- 17. • The firm under perfect competition can not influence the price by its individual action. • Therefore the AR curve of the firm is a horizontal straight line (Perfectly Elastic) • Since additional output is sold at the same price MR curve coincides with the AR curve. • In order to decide the equilibrium level of output the firm will compare MC with MR and it will be in equilibrium when the MC =MR = Price and MC curve cuts MR curve from below.
- 18. The level of output where marginal cost and marginal revenue are equal.
- 19. • Short run Equilibrium • Short run is a period in which out put can be increased by the existing plant. • If the firm produces more with existing size of the plant the average cost rises. • Since under perfect competition all firms are not alike cost differs. • Hence profit also differs. • If the firms are making super normal profits (AR is greater than AC) more firms will enter the industry and more output will be produced leading to a fall in the price.
- 20. • If price is equal to AC the firms earn only normal profit. • If price is lower than AC the firms experience losses. • The loss making firms leave the industry which means lesser output. • Hence in the short run industry will not be in equilibrium because the output is changing and the price is also changing.
- 22. • The left hand side of the diagram shows that the price is determined by the industry and the firms accepts the same. • It is represented by P1 P2 P3 • At OP1 price the firm will not produce because the price does not cover the cost. • If price increases to OP2 it may start producing but it will not make profits because only variable cost is covered. • At point E even though the firm reaches equilibrium it prefers to produce more at E1 at the higher price (OP3) which will give extra income • i.e. in the short period the firm tries to earn maximum profits.
- 23. • Long run Equilibrium • Long run is a period of time which is long enough to allow the firms to buy all the inputs including plant and machinery. • In the long run all costs are variable. • No firms will be making supernormal profit but only normal profit. • In the long run AC will be equal to AR (Price).
- 24. • The industry will be in equilibrium under the following conditions. • There should be equality between long period demand and supply of the Industry’s product. • All firms are making only normal profit (AC=AR). • There should be no incentive for new firms to enter the industry and old firms to leave the industry.
- 25. In the diagram the firms under perfect competition are making only normal profit the firm reaches equilibrium at point E where it produces OM level of output at OP price.
- 26. • PRICING UNDER MONOPOLY Monopoly may be defined as a market form in which a single producer controls the whole supply of a single commodity which has no close substitute.
- 27. • Causes of Monopoly • There are several causes for monopoly • By means of engulfing the small firms through cut-throat competition. • By means of natural monopoly eg. Possession of certain raw materials, patent rights, secret methods of production, specialised skill. • Public utility services. Eg. Water supply and Electricity.
- 28. • OUTPUT AND PRICE DETERMINATION UNDER MONOPOLY • Monopolies are price makers and not price takers. • AR revenue curve of the monopolist is a downward sloping curve if a monopolist wants to sell more he has to reduce the price of his product. • When he decreases the price to sell additional units of his product then the price of his total output goes down. • A monopolist wants to maximise his profit and attain equilibrium. • In order to maximise the profit he has to raise the price. • The monopolist has to look into the market forces also.
- 29. • Therefore price and output determination depends upon the demand and cost consideration. • AR is a downward sloping curve. • The MR curve falls below the average revenue curve. • The AC is U shaped and MC cuts AC curve at its minimum point. • The monopolist is in equilibrium by equating MC and MR. • He will produce up to the point and charges a price which bring its maximum money profits.
- 30. • The firm will go on producing as long as MR=MC. • At this point profits are maximised and the firm stops producing further.
- 31. • In the diagram AR is the demand curve and MR is the Marginal Revenue Curve. • MC and MR are equal at the point Q. • The firm produce OM output and sells OM output at OP price. • OT is the Average Cost and AR is higher than OT and the firm is earning monopoly profits. (PRTS) • Discriminating Monopoly • Charging different prices to different consumers for their product is called price discrimination.
- 32. • Types of Price discrimination • There are various forms • They are (a) Personal Discrimination • (b) Local Discrimination • (c) According to the use or trade • (d) Age, product, sex,size, quality
- 33. Table Pg-246cpt
- 34. • Degrees of price Discrimination • There are three types • Price discrimination of the first Degree or Perfect price discrimination • Buyers are fully exploited • Charges the maximum • Each buyer is willing to pay • Price discrimination of the second degree where a monopolist classify buyers into different groups and different price is charged which is the lowest demand price.
- 35. • Price discrimination of the third degree • Here the monopolist divides the buyers into different groups and then charges different prices to different groups this is a very common practice. • A manufacturer sells his goods at a higher price at home and at lower price abroad • another eg. is electricity.
- 36. • Conditions necessary for Price Discrimination • Nature of the product. • When the markets are separated. • Legal sanction. • Preference or the prejudice of buyers. • Let go attitude. • Illusion. • Prevent re-exchange of goods.
- 37. • Equilibrium under Price Discrimination (Third degree discrimination) • Under single monopoly the firm charges uniform price for the whole product. • Under price discrimination different prices are charged. • Hence the monopolist divides his total market into two submarkets on the basis of elasticity of demand.
- 38. • To reach equilibrium he takes two decisions. • How much total output he should produce. • How he should distribute between the two markets and what prices should be charged.
- 40. • To determine equilibrium the monopolist has to equate MR with MC. • Since he has to sell the output in two separate markets at different prices he has separate demand and MR curves. • He adds marginal revenues in two markets and then compares this to the marginal cost of the total output. • The third diagram reveals this
- 41. • AM R is the aggregate marginal revenue • AMR curve cuts the marginal revenue curve at E and the total output produced is OM and this is to be distributed to the two markets in such a way that marginal revenues are equal. • In order to attain equilibrium marginal revenues must be equal to the marginal cost of the whole output i.e. at equilibrium output OM marginal cost is ME.
- 42. • The diagram reveals that OM1 output is sold in market A because M1E1 is equal to the marginal cost ME. • Similarly OM2 output is sold in B market and marginal revenue M2E2 is equal to the marginal cost ME for the whole output. • Thus a discriminating monopolist produces OM output and sells OM1 in market A at M1P1 price and OM2 output in market B at M2P2 price.
- 43. Methods to control monopoly
- 44. • Monopolistic Competition • Monopolistic competition refers to a market situation in which there are either many producers producing goods which are close substitute one another or the product is differentiated.
- 45. • Equilibrium of a firm under monopolistic competition • Short run equilibrium • Every firm under monopolistic competition is required to attain equilibrium if it wants to continue in business. • Equilibrium means marginal revenue equal to marginal cost. • Marginal revenue closely follows average revenue of affirm. • AR curve or demand curve is a downward sloping curve. • Since various firms under monopolistic competition produce products which are close substitutes of each other the position and elasticity of demand curve depends upon the availability of competing substitutes and their prices.
- 46. • The demand curve (AR) curve of a firm under monopolistic competition is more elastic since there are several substitute available in the market. • Even if each firm under monopolistic competition has monopolistic control over the product its control is restricted with the availability of its close substitutes. • If it sets too high a price for his product many customers will shift to the rival products.
- 48. • Selling Cost • Selling Costs represent the costs on all selling activities which are directed to persuade the buyers to change their preferences. So as to raise the demand for a given article.
- 49. • Need for Selling Cost • People have imperfect knowledge about the product. • There is a possibility of altering the desire of the people through advertisement. • Advertising increases a sellers market and changes the location of the demand curve for a product. • The aim is to increase the sales of one firm at the expense of the other. • Selling cost is considered as a variable cost required to dispose the output at the same price. • When the selling cost are added to the production cost then the cost curve moves up.
- 51. • In this diagram PC is the production cost curve and shaded area B is the selling cost. By adding these two we get average total cost (ATUC=PC+SC). • RS is the net return per unit while RM is the price. The total revenue OPRM – The total cost OTSM is the net return PRST.
- 52. • Oligopoly • Oligopoly is defined as competition among the few firms or sellers in the market producing or selling a product. • Characteristics of Oligopoly
- 53. • Pricing under Oligopoly • Important forms of price determination under Oligopoly are Kinked Demand Curve • The demand curve facing the Oligopolist is indeterminate under Oligopoly the firm can not change its price assuming that the rivals do not take any retaliatory action. Therefore the demand curve facing the Oligopoly firm loses its definiteness. • The shape of the demand curve under Oligopoly is called Kinky Demand curve. The Kink is always at the ruling price.
- 54. A rise in the price by an Oligopolistic firm will not invite retaliation. Therefore the upper part of the demand curve is more elastic while the downward part of the curve is less elastic. i.e. the price cut will invite retaliation from the rivals.
- 56. • In the above diagram AR is the demand curve, MR is the marginal revenue curve. • Since MR follows AR, there is discontinuity in the MR curve below the point corresponding to the Kink. • MC cuts the MR curve between the point T&S. Therefore equilibrium output and price do not undergo any change. • The firm will be in equilibrium producing OM level of output at OP price.
- 57. • Price Leadership • Pricing under Oligopoly is not very easy. • Usually there is a formulation of collusion thereby work out and agreed pattern of price and output determination.
- 58. • There are three main types of price leadership. • Price leadership of the dominant firm • One of the few firms in the Industry which produces a large portion of the product is selected as a leader. • This is a dominant firm which has great influence in the market. It sets the price and makes other firms to accept this price. • The dominant firm estimates its own demand for the product and fixes a price which maximises its own profit.
- 59. • The other firms being very small follow the dominant firm and accept the price and adjust their output accordingly. • Barometric Price Leadership • Here an old experienced or most respected firm assumes the role of a custodian and thus protects the interest of all. • It assess the market conditions with regard to demand for the product, costs of production, competition from others, etc., fixes the price which is suitable to all firms in the industry. • All firms are thus protected by the dominant firm and all firms follow the leader who may change from time to time willingly.
- 60. • Exploitative or Aggressive Price Leadership • Here one big firms comes establish its leadership and follows aggressive price policies and thus compels other firms to follow their leader and accept the price fixed by it. • If any firms shows any independent it is threatened with dire consequences.
- 61. • Collusive Oligopoly • In this situation Oligopolist arrive at a tacit or formal agreement or a common policy to be followed by them. • This agreement is after indulging price war. • They know that cut throat competition is harmful to all of them. • They may show for sight and enter into collusion with each other believing they can promote their interest and survive with the market. • This is also called a cartel.
- 62. • Independent Pricing • Under differentiated Oligopoly each firm produces differentiated products and they may face “price war” in the market. It may result in competitive price. • The upper limit is known as monopoly price. • In reality the firm may fixed the price between the two limits. • It leads to in stability in the market sometimes the firm may also accept the long run price in the market. Since it leads to uncertainty and insecurity it can not last long.
- 63. • Effects of Oligopoly • Small output and higher prices • The price exceed the average cost – this is due to restriction on the entry of new firms. Therefore productive capacity of the economy is under utilised. • Lower efficiency – Due to the production of the output based on the quota fixed by the industry. • Selling Cost – Huge amount on advertisement, changing the design and on improving the quality. • Welfare effect – Price is higher than average and marginal cost. Huge money is spent on advertisement. Therefore the welfare of the people is not given due consideration.