Prepared by:

Abhimanyu Kotwal Anshul Srivastav Deepak chaudhary Shivangi Luthra Sonali Bhoi Viren Sudan

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Classification of Market StructuresForms of Market

structure

Number of firms

Nature of product

Status of entry into industry

Price elasticity of

demand

Degree of control

over price

Perfect competition

Large No. of sellers

Homogeneous

product

Free entry & exit Infinite Nil

Imperfect competition

Monopolistic competition

Fairly large No. of firms

Close substitutes

Free entry & exit High Some

Pure Oligopoly Few firms

Homogeneous

products

Barriers to entry Small Some

DifferentiatedOligopoly Few firms Close

substitutes Barriers to

entry Small Larger

Monopoly One No close substitutes

Strong barriers to

entry

Very Small Very large

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Forms of Market Structures Market Structures

Perfect Competition Imperfect Competition Monopoly

. Large No. of sellers and buyers

. Free entry and exit

. Homogeneous Products

. Perfect Knowledge

. Uniform Price

. Single producer/seller

. No close substitutes

. Strict barrier to entry

.Price discrimination is possible

. Price maker

Monopolistic Competition Pure Oligopoly Differentiated Oligopoly

. Fairly large no. of firms

. Product differentiation

. Free entry and free exit

. Independent price policy

. High cross elasticity of demand

. Elements of both monopoly and competition

.

.Few sellers

.Homogeneous products

. Barriers to entry

. Interdependence exists

. Impor. of selling costs

. Price war and rigidity

. Indeterminateness of DC

.

.Few sellers

. Differentiated products

. Barriers to entry

. Interdependence exists

. Impor. of selling costs

. Price war and rigidity

. Indeterminateness of DC3

Difference between Perfect Competition and Imperfect Competition

Points of Difference Perfect Competition Imperfect Competition

Number of SellersNumber of sellers is more

than the sellers in imperfect competition

The number of sellers is lesser as

Price There is same price of the commodity

There are different prices of the same commodity and

close substitutes

Average Revenue Average revenue of all the firms are the same

AR of different firms are different

Factors of Production Factors of production are mobile

Factors of production are not mobile

AR ( Price) AR (Price)=MC AR (Price)> MC

Utilization of Capacity In the long run full capacity of the firm is utilized

There is never full capacity utilization of the firm

Selling Costs Selling cost are zero Selling costs are quite substantial

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Difference between Perfect Competition and Monopolistic Competition

Points of Difference Perfect Competition Monopolistic Competition

Nature of firms

Nature of product

Taker or maker

MR and AR

Mobility

MC and Price

Selling Costs

Production

Large no. of firms

There are homogeneous products

Firms are price takers

MR=AR and parallel to X axis

Perfect mobility of factors

MC=AR (Price)

No selling costs

Goods are produced at optimum scale

Fairly large no. of firms

There is product differentiation

The firms are price makers

MR<AR, both are downward sloping

No perfect mobility of factors

MC<AR (Price)

There is substantial selling costs

Goods are produced below optimum scale

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Equilibrium of the Firm and Industry under Perfect Competition

A Firm : A firm is a unit engaged in the production of a particular commodity for sale with profit.

An Industry : A group of firms producing homogeneous goods is called an industry.Meaning of Firm’s EquilibriumA firm is said to be in equilibrium when it does not intend to change the volume of

output which it is producing. The firm will be in this position when either it will be earning maximum profit or incurring minimum loss.

Meaning of Industry’s EquilibriumAn industry is said to be in equilibrium, when the size of its output does not alter.

The output of the industry consists of the output produced by all the individual firms which constitute that industry. Thus, the equilibrium of an industry is a situation where (a) all the individual firms are in equilibrium and hence do not change the level of their output and (b) where there is no incentive for the outside firms to come in and join the industry, or when there is no tendency for the existing firms to leave the industry. Firms will have no tendency to join or to leave the industry, if they are earning only normal profits.

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Short-run Equilibrium of the Firm

The short-run is a period of time in which the firm can alter its output by changing the variable factors of production while fixed factors remains constant.

The firm may have three situations.1. It may earn supernormal profits.2. It may earn normal profits and3. It may even suffer minimum losses.Supernormal profits:

MC=MR

AR=MR

MCAC

Supernormal Profit

COST/REVENUE

output

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Normal profits: AC

MC

AR=MRP

AC=AR

Q

E

minimum losses

MC AC

AR=MR

Q

P

P1 E

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Long-run Equilibrium of the FirmPrice = MC= Minimum Average Cost

LMCLAC

P

P1

P2

Q2 Q Q1

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Monopoly

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What is a Monopoly?

• While a competitive firm is a price taker, a monopoly firm is a price maker ( or price discoverer).

• Traditionally a firm is considered a monopoly if it is the sole seller of its type of product.

• Best definition:… a firm is a monopoly if it can earn super-normal profits in the long run.

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WHY MONOPOLIES ARISE

1. Lack of substitutes– Not close in terms of perceived functions

• e.g. electricity

2. barriers to entry.– Key to prevent firms entering and competing away

super-normal profits

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WHY MONOPOLIES ARISE :

o Ownership of a key resource.o Costs of production make a single producer more efficient

than a large number of producers – economies of scale and scope

o Marketing advantages- Pricing and other strategic barrierso Financial barriers – cost of capital and risk premiao Information costs – market researcho The government gives a single firm the exclusive right to

produce some good.

3. Structural Barriers

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WHY MONOPOLIES ARISE?

4. Monopoly Resourceso Exclusive ownership of a key resource - in practice

monopolies rarely arise for this reason.

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WHY MONOPOLIES ARISE

5. Government-Created Monopolieso Governments may restrict entry by giving a single

firm the exclusive right to sell a particular good in certain markets.

o Patent and copyright laws

…. are two important examples of how government backs monopoly.

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WHY MONOPOLIES ARISE

6. Other structural barrierso Economies of scaleo Economies of scope

o Natural monopoly o when a single firm can supply a good or service to

an entire market at a smaller cost than could two or more firms.

o A natural monopoly arises when there are economies of scale over the relevant range of output.

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Monopoly

o Monopoly is a firm that produces the entire market supply of a particular good or service.

o The demand curve facing the monopoly firm is identical to the market demand curve for the product.

o The demand curve is always downward sloping.

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Profit Maximisation

o Price discovery: it needs to find the intersection of marginal cost and marginal revenue.

o This will give it the profit-maximising rate of output.

o Only one price is compatible with the profit-maximising rate of output.

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MR

Rs

Q O

MC

Qm

Profit maximised at output of Qm

(where MC = MR)

Profit maximising under monopolyProfit maximising under monopoly

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Profit MaximisationProfit Maximisation

o A monopoly maximises profit by producing the quantity at which marginal revenue equals marginal cost.

o It then uses the demand curve to find the price that will induce consumers to buy that quantity.

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Profit under Monopoly

REVNEU E&COST

MC

AC

MR

AR

Qo

pt

m

n

Output

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Losses under Monopoly

REVNEU E&COST

MC

AC

MR

AR

Qo

p m

nt

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No Profit No Loss under Monopoly

REVNEU E&COST

MC

AC

MR

AR

Qo

p m

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Price Price Discrimination Discrimination

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PRICE DISCRIMINATIONo Price Discrimination

o Where a monopolist can sell at different prices in different markets

o Price discrimination is not possible when a good is sold in a competitive market

o In order to price discriminate, the firm must have some market power.

o Perfect price discriminationo refers to the situation when the monopolist knows exactly the

willingness to pay of each customer and can charge each customer a different price

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PRICE DISCRIMINATION

o Two important effects of price discrimination:o It can increase the monopolist’s profits.o It can reduce deadweight loss.

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PRICE DISCRIMINATION

o Examples of Price Discriminationo Internationally

o International brandso Nationally

o Theatre ticketso Airline priceso Discount voucherso Quantity discountso Doctors service

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Price discrimination

• There are different degrees of price discrimination.– First degree: attempt to charge maximum price

(bartering)– Second degree: different prices for different

quantities (“buy in bulk”, utility prices)– Third degree: charging different prices in 2 (or

more) markets. This is more typical of monopolies

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Monopolistic Market

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Profit under Monopolistic Market

REVNEU E&COST

MC

AC

MR

AR

Qo

pt

m

n

30

Losses under Monopolistic Market

REVNEU E&COST

MC

AC

MR

AR

Qo

p m

nt

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Oligopoly Market

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Cournot’s Duopoly ModelAugustin Cournot, a French economist, was the first to develop a

formal duopoly model in 1838. The assumptions of this theory are.

1. Two firms, each owning an artesian mineral water well,2. Both operate their wells at zero marginal cost,3. Both face a demand curve with constant negative slope,4. Each seller acts on the assumption that his competitor will not

react to his decision to change his output and price. On the basis of this model, Cournot has concluded that each seller

ultimately supplies one third of the market demand and charges the same price. While one third of the market remains unsupplied.

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DM is the demand curve and MR the marginal revenue. OM is the total produce. There are only two sellers A and B, and at present A is the only seller of mineral water. In order to maximise profits he sells OQ quantity where MC=MR at price OP1. His total profit is OP1KQ.

Now B enters the market and open area for him is QM, which is half of total area OM. AT QN=NM. At N, MR=MC. His total revenue is QRLN. B supplies ON that is ¼ of the market.

With Bs entry price falls to OP2. The profits of A falls to OP2RQ. This process goes on continuously. The entry of one reduces the profits of the other.

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The Cournot’s Duopoly Model

PRICE

QUANTITYMRa MRb

MNQ

R

K

L

P1

P2

D

0

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Price LeadershipTypes of Price Leadership1. Price leadership by a low cost firm2. Price leadership of the dominant firmPrice-Output determination under low cost Price leadership firm: Lets take the following assumptions-a. There are two firms, A and B. The firm A has a lower cost of production than B.b. The product produced by the two firms are homogeneous so that the

consumers have no preference between them.c. Each of the two firms has equal share in the market. In other words, DC facing

each firm will be the same and will be half of the total market demand curve of the product.

Each firm is facing demand curve d which is half of the total market demand curve DD for the product. MR is the marginal revenue curve of each firm. ACa and MCa are the average and marginal cost curves of firm A and ACb and MCb are the average and marginal cost curves of firm B. Cost curves of firm A lie below the cost curves of firm B because we are assuming that firm A has a lower cost of production than firm B.

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Firm A will be maximizing its profits byselling output OM and setting price OP, since at OM, MC=MR. Firm B’s profits will be maximum whenit fixes price OH and sells output ON.Thus the price OP of firm A is lower than of B. Therefore, A will dictate the Price. Thus firm B is the follower.

Price-Output determination under Dominant Price leadership Firm: The dominant firm is having a large share of the market with a number of small firms as followers each of which has a small share of the market. DD is the market demand for the product. At each price the leader will be able to sell the part of the market demand not fulfilled by the supply from the small firms.

MRQMN

HP

d

D

Market Demand

MCb ACb

MCa

E

D

Pric

e &

Cos

t

o

Output

ACa

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At price P1, the small firms supply the wholeof the quantity of the product demanded atthat price. Therefore, demand for leadersProduct is zero. At price P2, the small firmssupply P2C and therefore, the remainingpart of CT will be supplied by the leader. Like wise it goes on.

Kinked Demand Curve

Pric

e &

Cos

t

Quantity

S mD

D

R

S

T

U

P1

P

P2

P3o

B

C

MR

MC

d

K

D/ AR

p

m

h

output

Price & Cost

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The Game TheoryThe nature of the problem faced by the Oligopoly firms is best explained by the

Prisoners Dilemma Game. Let us suppose that there are two persons, A and B who are partners in an illegal activity of match fixing. On a tip-off, the CBI arrests A and B on suspicion of their involvement in fixing cricket matches. They are arrested and lodged in separate jails with no possibility of communication between them. They are being interrogated separately by the CBI officials with following conditions disclosed to them in isolation.

1. If you confess your involvement in match fixing, you will get a 5 year imprisonment.

2. If you deny your involvement and your partner denies too, you will be set free for lack of evidence.

3. If one of you confesses and turns approver, and other does not, then one who confesses gets a 2 year imprisonment, and one who does not confess gets 10 year imprisonment.

Given these conditions, each suspect has two options open to him: (i) to confess, and (ii) not to confess. Now both A and B face a dilemma on how to decide whether or not to confess. While taking a decision both have a common objective, i.e. to minimize the period of imprisonment. Given this objective, the

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Option is quite simple that both of them deny their involvement in match-fixing. But there is no certainty that if one denies, the other will also deny: the other may confess and turn approver. With this uncertainty, the dilemma in making a choice still remains. For example, if A denies his involvement, and B confesses (settles for a 2 year imprisonment), then A gets a 10 year jail term. So is the case with B. if they both confess, then they get a 5 year jail term each. Then what to do? That is the dilemma. The nature of their problem is illustrated in the form of Pay-Off Matrix.

Given the conditions, it is quite likely that both the suspects may opt for confession, because neither A knows what B will do, nor B knows what A will do. When they both confess, each gets a 5 year jail term. This is the second best option. For his decisions to confess A might formulate has strategy in the following manner. He reasons: if I confess (though I am innocent), I will get a maximum of 5 year’s imprisonment. But, if I deny (which I must) and B confesses and turns I will get 10 year’s imprisonment. But, if I deny (which I must) and B confesses and turns I will get 10 year’s imprisonment. And, that will be the worst. It is quite likely that suspect B also reasons in the same manner, even if he too is innocent. If they both confess, they would avoid 10 year’s imprisonment, the maximum possible jail sentence under the law. This is the best conditions they can achieve under the given conditions.

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A’s Options Confess

Deny

Confess DenyB’s Options

A5

B5

A10

B2

A2

B10

A0

B0

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Thank you

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