Economics+Market+Structure

8/8/2019 Economics+Market+Structure

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Perfect Competition:

1. Large number of buyers and sellers:-In this market structure there are large number of buyers and

sellers e.g. many farmers growing wheat. If one of them,produces more or less that will not affect the market supply orthe market price. In this there are large buyers also. Even thebuyers cannot influence the price by changing their demandbecause each buyer and seller is like a drop in ocean

2. Homogeneous product:-It is the most important feature. It says that the product which

these large number of buyers buy from large number of sellers areidentical or we can say perfect substitute that means, if one buyer

increase the price the buyer will buy it from other seller as theproducts are identical e.g. rice.

3. Free entry and exit of firms:-An entrepreneur who has enough capital and still can start the

business and enter the industry and any one who is incurring loss canstop the production and exit the industry.

4. Firms are price takers:-As there are many buyers and sellers nobody can influence the

price or the supply in the industry. They are like drop in the ocean.Producers are price takers as he cannot affect the market price.Consumers are price taking consumer as they cannot influence theprice by any of his or her action.

5. Perfect Knowledge:All the buyers and sellers have perfect knowledge about the market.

A market which comes to exhibit all these conditions is the stockmarket. About one stock there are many information available as it ispublished.

6. No Cost of Transportation:-It is assumed cost of transportation does not exist.

7. Perfect mobility of factors of production:-

It is assumed that all the factors of production can be migratedfrom one place to another. There is no hindrance in the movement.This helps in entry of new firm and exit of a loss making firm.


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Now after discussing the features we will differentiate between perfectand pure competition. As perfect competition has all the features of pure competition and some more features. The first three featuresgiven under perfect competition constitutes pure competition (that islarge number of sellers and buyers, free entry and exit and identical

products) where as perfect competition has the features of purecompetition and two more features they are perfect knowledge aboutthe market and perfect mobility of inputs and output.

Shut Down Point:-

In short run, firm may continue its production to recover losses in longrun. In short run as we have discussed in cost concept fixed cost isincurred even if the output is 0. Now when the firm is incurring lossthen it may go on producing till the loss is less then or equal to totalfixed cost. then the firm may go on producing till the loss less is thenand equal to TFC. If the firm is able to cover its variable cost and partof fixed cost it will go on producing because if it stops, the firm has toincur the complete fixed cost as loss and as there will be no variablecost if there is no production but if the loss is more than fixed cost thatis when producers will decide to shut down. Therefore not only thewhole of fixed cost but also the part of variable cost the firm has toincur from its pocket, not through revenue. It is advisable to shutdown and incur loss equal to fixed cost as there will be no variable costwhen production is nil.

Long Run Equilibrium:-

We assume that all the firms have identical cost condition in theindustry. In short run the firm will keep on producing even when it isincurring loss but in long run the firm not even getting normal profitswill shut down. As due feature of free entry and exit when a firm atshut down point will exit the industry which will decrease the supplyand the profit increase and other firms who where are incurring losswill start getting normal profit. When most of the firms are incurring

profits the industry looks attractive many new firms enter the industrywhich increase the supply in the industry and the profit comes downand the existing firms will return to normal profits from super norm atprofits so in long run under perfect competition the firm incurs normalprofit there are no super normal profit and no huge loss.


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MONOPOLY

Monopoly is said to exist when one firm is the sole producer or seller of the product. In case of monopoly, one firm constitutes the wholeindustry. Mono means one and Poly means seller.Conditions

1. One seller or producer.2. No close substitutes for the product of that firm should be

available.3. monopoly implies no competition4. Other firms for one reason or the other reason are prohibited to

enter the industry. There is strong barrier to the entry of thefirms.

Price discrimination

Practice of selling the same commodity, at different price to differentbuyers by a seller. A seller makes price discrimination betweendifferent buyers, when it is both possible and profitable for him to doso. Its difficult to charge different price for the identical good fromdifferent buyer.Three degrees of price discrimination

1. First degree price discrimination first degree pricediscrimination is also called the perfect price discriminationbecause this involves maximum possible exploitation of eachbuyer in the interest of the sellers profit. It is said to occur whenthe seller is able to sell each separate unit of the product atdifferent price. So every buyer is forced to pay the price whichis equal to maximum amount he is willing to pay rather than togo without the good altogether, which means seller leaves noconsumer surplus to the to buyer. Seller makes separatebargain with each seller instead of setting down with just two or three few market prices each. In this all and nothing bargain thetotal amount of money which the buyer is required to give equalto the maximum price he is wiling to pay.

2. Second degree price discrimination - second degree pricediscrimination will occur if the monopolist is able to chargeseparate price in such a way that buyers are divided into


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different groups and each group is charged a different price.The seller divides his market into different group of buyer andcharges different price for each group of buyer.

3. Third degree price discrimination - when the seller divides hisbuyer into two or more than two sub markets or group andcharges a different price in each submarket. The price chargedin each sub market depends upon the output sold in thatsubmarket and demand condition of that submarket. It is themost common, e.g. price discrimination found in the practice of manufacturers who sells his product at a higher price at homeand lower price abroad.

Monopsony

Monopsony refers to a market situation when there is a single buyer of a commodity or services. It applies to any situation in which thereis a monopoly element in buying. E.g. when a single factory in anisolated locality is the sole buyer of some grades of labour or when aindividual happens to have a taste for some commodity which no oneelse requires. Just as in monopoly seller is able to influence the priceof the product by the amount he offers for sales. Similarly monopsonybuyer is able to influence the supply price of his purchase by theamount he buys. Monopoly aim to maximum profit and monopsonyaims to maximum consumer surplus.

Bilateral monopoly

Bilateral monopoly refers to market situation in which a singleproducer (monopoly) of a product faces a single buyer (monopsony)of that product. There is a single commodity with no close substitutes,the monopolist is the sole producer and the monopsonist is the onlybuyer. Both are firm to maximize their individual profits. The actualquantity sold and its price depends upon the relative bargainingstrength of the two. The price tends to settle down between themonopoly price and monopsonist price.

Monopolistic competition


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Monopolistic competition is a form of market structure in which alarge number of independent firms are supplying product that areslightly differentiated from point of view of buyer. This situation ariseswhen the same commodity is being sold under brand names e.g. lux,rexsona, dove etc. each firm is sole producer of particular brand.They are monopolist as far as that particular brand is concerned.Since various brands are close substitutes, there is keen competitionwith each other.

Product differentiationIt does not mean that the product of various firms are altogether different, they are slightly different which means they are closesubstitutes. They are not identical as in perfect competition butneither are they remote substitutes as in monopoly. The products are

fairly similar and serves as close substitutes for each other Two bases of product differentiation

1. Characteristic of the product- such as features, trademark,trade names etc. real quantitative difference like those of material used, design and workmanship are no doubt importantmeans of differentiating products. But imaginary differencecreated through advertising, the use of attractive package,brand name are more usual methods by which products aredifferentiated even if physically they are identical or almost so.

2. Condition surrounding the sales of the product- the servicerendered in the process of selling the product by one seller isnot identical to that of the other. E.g. sellers reputation of fair dealing, efficiency, general terms, his way of doing business,sellers location etc.

Selling cost and advertisement

Under monopolistic competition, the firm often competes throughselling cost and advertisement expenditure. To increase the demandfor their product and thereby increase the revenue made. The sellingcost is broader than advertisement expenditure, where asadvertisement expenditure includes cost incurred only on getting theproduct advertised in newspaper, magazines, radio, television butselling cost includes the salaries and wages of salesmen, allowanceto retailers for the purpose of getting their products displayed and somany types of promotional activities besides advertisement.


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Production cost is the cost of production includes all those expenseswhich are incurred to manufacture and provide a product to meet thegiven demand or want, while the selling cost are those which areincurred to change, alter or create the demand for the product. Itshould however be noted that the distinction between productioncosts and selling costs cannot always be sharply made e.g. it isdifficult to say whether the extra cost of attractive packaging isproduction cost or selling cost, since purpose of advertisement is toincrease or create the demand for the product.

Importance of selling cost

Under monopolistic competition with product differentiation theadvertisement and other selling cost becomes important as a

competitive weapon at the disposal of the firm to increase the sales atthe expense of the other. This is because the products are closesubstitutes; each firm tries to convince the buyer that its product isbetter than the other in the industry. A firm under monopolisticcompetition may keep its price and product design constant and seekincrease in demand fir its product by increasing the amount of advertisement expenditure and through it persuading the buyers thathis brand is superior to the others.

Oligopoly

In oligopoly the competition between the few

Characteristics1. Interdependence- the most important feature of oligopoly is the

interdependence in decision making between the few firmswhich comprises the industry. When the numbers of competitors are few, any change in price, output etc by a firmwill have direct effect on the rivals which will then retaliate inchanging their own prices.

2. importance of selling cost and advertisement- a direct effect of interdependence of oligopolies is that the various firms have toemploy various aggressive marketing weapons to gain agreater share in the market or to prevent a fall in the share for which the firms have to incur a great deal of cost on


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advertisement and other measures of sales promotion. Thus,there is great importance for selling cost and advertisement

3. Group behaviour- perfect competition, monopoly andmonopolistic pose no problem of making suitable assumptionabout human behaviour. Assumption of profit maximizationgives overall good results in these situations where mass of people are involved and there is no interdependence of thefirms. But in oligopoly the theory of group behaviors is importantas there is interdependence between the members of thegroup. Do they form a group and agree to pull together inpromotion of common interest or will they fight to promote their individual interest.

Indeterminateness of demand curve

The demand curve shows what amount of the product a firm will beable to sell at various prices. In case of other market situation we canhave definite demand curve but under oligopoly the interdependenceof the firm. Under oligopoly the firm cannot assume the rivals willkeep their price unchanged, so the demand curve faced byoligopolistic firm loses its definiteness. Since, it goes on constantlyshifting as the rivals change the prices in reaction to price changes byfirm.

Is price and output under oligopoly indeterminate?

The interdependence of firms and uncertainty about the reactionpatterns of individual reaction patterns of individual rivals, the easyand determinate solution to the oligopoly problem is not possible

1. in the market situation wide variety of behaviour pattern arepossible, rivals may decide to get together and co-operate or atthe other extreme, they may try to fight each other to death.

2. another difficulty is indetermination of demand curve facingindividual firms, because of the interdependence of oligopolisticfirm cannot assume that its rivals firm will keep their price andquantity constant, when it makes change in its price. Thereforean oligopolistic firm cannot have sure and definite demand


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curve, since it keeps shifting as the rivals change their prices inreaction to the price changes made by it.

The determinate solution to the oligopoly problem has beenprovided in the following ways 1. oligopolistic firm ignores interdependence. Now when

interdependence disappears from decision making of the firms,the demand curve facing them becomes determinate and canbe ascertained

2. second approach to provide determinate solution to the priceand output problem of oligopoly is to assume that the oligopolyfirm is able to predict the reaction pattern and counter moves of the rivals

3. Third approach assumes that the oligopolistic firms realizing

their interdependence will purse their common interest and willform collusion and enter into agreement and work in commoninterest. They will maximize the joint profit and share the profit,market or output as agreed between them.

4. Another approach is the game theory in the theory of game,an firm does not guess at its rivals reaction pattern butcalculates the optimal moves by rival firms that is their bestpossible strategies and in view of that adopt its policies andcounter moves.

Collusive oligopoly

Setting price independently is rare in oligopoly markets. Thisunderstanding or agreement among the oligopolist may be either formal or informal. A formal agreement is one when the oligopolistafter consultation and discussion agree to observe certain commonrules of conduct in regard to price. They may make a writtenagreement which may also provide for penalties to those who violatethe agreement reached.Tacit or informal agreement is without face to face contact,consultation or discussion they come to have some understandingbetween them and pursue a uniform policy with regard to price outputetc. in order to avoid price war and cut throat competition, they enter agreement regarding a uniform price-output policy to be pursued bythem.


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Collusive oligopoly is of two types

1. cartels2. price leadership

Cartels

in cartel type of collusive oligopoly price is jointly fixed and outputpolicy through agreement.

Joint profit maximizationLet us assume that two firms have formed a cartel by entering intoagreement, we also assume that the cartel will aim at maximizing

joint profit for the member firms. As the demand curve facing a cartel

will be aggregate demand curve facing consumers of the product, itwill be downwards sloping. Joint profits are maximized by fixing theindustry output at the level at which marginal revenue curveintersects the marginal cost. having decided the output to beproduced, the cartel will a lot output quota to be produced by eachfirm as that the marginal cost for each firm is the same, the profitmade by individual firms will not be retained by them but instead theywill be brought under a common pool. These profits will be divided bythe member firms according to the terms of agreement reachedbetween them at the time of forming the cartel. The allocation of output quotas of each of them is made on the grounds of minimizingcosts and not as a basis for determining profit distribution.

Market sharing cartelsUnder market sharing by non-price competition only on uniform priceis set and member firms are free to produce and sell the amount of output which will maximize the individual profits. Though the firmsagree not to sell at a price below the fixed price, they are free to varythe style of their product and advertisement expenditure. Of thedifferent member firms have identical costs, then the agreed uniformprice will be the monopoly price which will ensure the maximization of

joint profits. But if the cost differs, the cartel price will be fixed bybargaining between the firms. The level of the price will be such that itensures some profits to high cost firms. With cost difference thecartels are quiet unstable. low cost firms will have incentives to cut heprice and increase their profits and therefore that will led to break


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away from cartel. However they will not openly charge low price butby giving secret price concessions to the buyers, when this isdiscovered and open war may commences and the cartel breaks.Market sharing by quotasThis type of market sharing cartel is the agreement reached betweenthe firms regarding quota of output to be produced and sold by eachof them agreed price. When costs of member firms are different, thedifferent quota for various firms will be fixed and therefore their market share will differ. The quotas and market shares in case of costdifference are decided by bargaining between the firms. The quotasand market sharing is the division of market region-wise that isgeographical division of the market between the cartel firms.

Price leadership

Price leadership is the important form of collusive oligopoly

1. Price leadership by low cost firm in order to maximize profitthe low cost firm sets a lower price then the profit maximizingprice if the high cost firms. Since the high cost firms will beunable to sell their product at the higher price, they are forcedto agree to the low price set by the low cost firms. The low costleader will ensure that price he sets must yield profits to highcost firms

2. Dominant firm price leadership this dominant firm yields agreat influence over the market of the product while other firmsare small and are not capable of making any impact on themarket. As a result a dominant firm estimates its own demandcurve and fixes prices which maximize its own profit. The other firms which are small having no individual influence on the pricefollow the dominant firm and accept the price set by him, adjusttheir output accordingly.

3. Barometric price leadership - under which in old, experienced,largest and the most respected firm assumes the role of custodian who protects the interest of all. He assesses thechange in the market condition with regard to the demand for the product, cost of production, competition from the related


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product etc and makes changes in the price which are bestfrom the view point of all firms in the industry.

4. Exploitation or aggressive price leadership under which avery large and dominant firm establishes its leadership byfollowing aggressive price policies and thus compels the other firms in the industry to follow him in respect of price. Such a firmwill often initiate a move threaten to compete the other out of the market, if they don not follow him in setting their price.

Kinked demand curve

In oligopoly price remains sticky that is there is no tendency on thepart of the firm to change price of the commodity even if theeconomic condition under go changes.The demand curve facing an oligopolist has a kink at the level of prevailing price. The kink is formed at the prevailing price levelbecause the segment of demand curve above the prevailing priceis highly elastic and the segment of the demand curve below theprevailing price is less elastic.

A kinked demand curve dD with a kink at point P has be shown.The prevailing price level is OP and the firm is producing andselling the output OM. Now, the upper segment dk of the demandcurve dD is relatively elastic and the lower segment KD isrelatively inelastic. Each oligopolist believes that if he lowers theprice below the prevailing price, his competitor will follow him andwill accordingly lower their prices, where as if he raises the price


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above the prevailing price level, his competitors will not follow hisincrease in price. Rivals will not match his increase in price abovethe prevailing level; they will indeed match its price cuts.

1. Price reduction if the oligopolist reduce its price below theprevailing price level on order to increase his sales, thecompetitor will fear the customers will go to other firms who hasreduced the price, so to retain the customers he has match therice cut. The competitor will quickly follow the reduction in priceby the oligopolist, he will gain in sales only very little, whichmeans the demand is inelastic below the prevailing price.Demand from D to k which lies below the prevailing price isinelastic as very little increase in sales can be obtained by areduction in price by an oligopolist.

2. Price increase if an oligopolist raises his price above theprevailing level, there will be substantial reduction in his sales.This is because as a result rise in price many of his customerswill withdraw from him and will go to his competitor who willwelcome them and will gain in sales. These happy competitorswill have no motive to match the rise in price, so small increasein price is followed by large reduction in sales above theprevailing price that is why the demand curve dk tend to behighly elastic.

Price does not always remain sticky

The kinky oligopoly demand curve theory, dose not follow that theprice always remains the same. Whenever the costs and demandconditions undergo changes and when it is likely to remain inflexiblein the face of changing costs and demand conditions is explainedbelow

1. Decline in costs - when the cost of production declines, theprice is more likely to remain stable. When the cost of production falls, then the segment of demand curve above theprevailing current price will become more elastic because withlower costs there is a greater certainty that in increase in priceby oligopolist will not be followed by the rivals and thus willcause greater loss in sales. On the other hand the lower segment of the demand becomes more inelastic as there is


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great certainty that reduction is price will be followed by therivals.

2. Rise in price if there is a rise in the cost, the price is not likelyto stay rigid. When there is rise in the cost of the industry anoligopolist can reasonably expect that his increase in price willbe followed by the other in the industry. As a result, thesegment of the demand curve above the prevailing price willbecome less elastic.

3. Decrease in demand prices are likely to remain inflexible andnot fall when the demand decreases, it becomes more certainthat if one oligopolist decreases the price, others will follow withthe reduction, as a result the lower segment of the demand

curve which below the prevailing price becomes more inelastic.

4. Increase in demand when the demand increases, the priceis unlikely to remain stable instead price is likely to rise. Anoligopolist can expect that if initiates the increases in price, hiscompetitor will most probably follow him. Therefore, the upper segment of the demand curve will become less elastic.

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Economics+Market+Structure