Unit 8

Market Structures

Objectives:

After going through this unit, you will be able to explain:

The concept and significance of the structure of the market

Types of market structures

Difference between competitive and non-competitive markets

Behavior of firms in various market structures

Equilibrium conditions in various market forms

Structure:

1.1 Introduction

1.2 Structure Conduct Performance (S-C-P) model

1.3 Structure of the market

1.4 Competitive and Non-competitive markets

1.5 Perfect competition

1.6 Firm behavior in perfect competition

1.7 Monopoly

1.8 Limits to monopoly power

1.9 Monopoly equilibrium

1.10 Sources of monopoly

1.11 Monopolistic competition

1.12 Features of monopolistic competitive firm

1.13 Equilibrium for a monopolistically competitive firm in the short and long

run

1.14 Benefits of monopolistic competition

1.15 Oligopoly

1.16 Models of oligopoly

1.17 Comparison of various market structures

1.18 Summary

1.19 Key words

1.20 Self-assessment questions

1.1 Introduction

The concept of market form is central to economics. This is because in decision-making

analysis, market structure has an important role through its impact on the decision-

making environment. The extent and characteristics of competition in the market affect

choice behavior among the operating firms. In economics, markets are classified

according to the structure of the industry serving the market. Industry structure is

categorized on the basis of market structure variables which are, further, believed to

determine the extent and characteristics of competition.

1.2 Structure Conduct Performance (S-C-P) Model

The performance of an industry or a firm is determined by the behavior of buyers and

sellers in the market, which in turn is determined by the structural attributes of the market

in which it operates. This thought is propounded through the Structure Conduct

Performance(S-C-P) theory which links elements or attributes defining the structure or

form of the market to business policies and performance in industrial economies.

The basic tenet of the S-C-P paradigm is that the economic performance of a firm is a

function of its conduct which, in turn, is a function of the industry structure to which the

firm belongs (Mason, 1939; Bain, 1956). While the structure of the market is explained at

length in the following sections, conduct and performance can be explained:

Conduct refers to the activities and behavior of the sellers in the market. Sellers’

activities include installation and utilization of capacity, promotional and pricing policies,

research and development, and inter-firm competition or cooperation, product decisions,

operational decisions, resource planning etc.

Economic performance is the outcome of firm’s conduct and policies. It can be

measured in terms of resource utilization, profit margins, growth, market share,

competitiveness among rivals, turnover etc.

Consider the following figure which describes the relation between the structure of the

market and its impact of firm behavior and performance.

Structure of the Market

Number of firms

Product differentiation

Entry/exit conditions

Mobility of resources

Dissemination of information

Conduct/behavior of the firm

Strategic decisions

Pricing policy

Product decisions

Operational decisions

Resource planning

Research and development

Performance of the firm

Profitability

Growth

Market share

Competitive ability

Sales turnover

Equity

1.3 Structure of the market

Knowing and understanding market structure has an important bearing on the firm’s

conduct and performance and is, hence, vital for a business. It can be defined in terms of

the following elements,

a) Number of firms

b) Product differentiation

c) Entry/exit conditions

d) Mobility of resources

e) Dissemination of information

Each of the above elements defines the degree of competition in the market. Consider the

following table:

S.

N.

Element of the

market structure

Description Degree of

competition in the

market

a) Number of firms This defines the number of competing

firms in the market.

More the number

of competitors

higher is the

competition.

b) Product

differentiation

The differentiation of goods along key

features is an important strategy for firms

to establish their brands as distinct from

other brands in the same product category.

Successful

differentiation

strategy reduces

competition.

c) Entry/exit

conditions

If the market is characterized by barriers

then there exist obstacles on the way of

potential new entrant to enter the market

and compete with the existing firms. The

barriers can be strategic, natural, and

regulatory.

By creating

barriers in the

market firms

restrict

competition.

d) Mobility of This is more in terms of access to If firms have

resources resources and resource advantage that

some firms may over other firms in the

market

resource advantage

they build

competitive ability

e) Dissemination of

information

Flow of information among buyers and

sellers regarding various issues in the

market such as price, offers, strategy etc.

Greater ease in

flow of

information

increases

competition.

1.4 Competitive and non-competitive markets

Based on the above attributes market forms can be classified as competitive and non-

competitive as shown in the following figure,

A firm is the smallest unit of production. The objective of a firm is to maximize profits.

This it can achieve by minimizing cost of production, or maximizing total revenue. The

Market Forms

Competitive Markets Non-competitive markets

Perfect CompetitionMonopolistic Competition

Oligopoly

Monopoly

prospects of profit for a firm are further guided by market conditions. As shown in the

above diagram the market forms can be broadly competitive and non-competitive. Within

this broad categorization markets are defined in terms various attributes signifying

varying degrees of competition. Consider the following figure,

The above figure shows that as on moves from perfect competition to monopoly

competition in the market reduces. On the other hand as one moves from monopoly to

perfect competition in the market increases. The following section discusses in detail the

features of and firm behavior in various market forms.

1.5 Perfect Competition

Traditionally perfect competition is considered as an ideal form of market. This market

structure is a golden rule. As it is understood today, the Classical Competitive Model is

hypothetical in nature; it is not based on actual market conditions. Such a competitive

market is supposed to provide maximum justice to a maximum number of buyers and

sellers. Following features characterize this market structure:

Perfect Competition

Monopolistic Competition

Oligopoly Monopoly

Competition decreases

Competition increases

a) Large number of buyers and sellers: There are large number of buyers and

sellers. In that case the idea is that the individually each seller and buyer are too

small relative to the size of the market, so that no one of them can control price

fixation. Instead they regard the price as being determined by the market and

beyond their ability to influence. In other words, for buyers and sellers in this

market form “price is given”.

b) Product homogeneity: Firms in the market produce homogeneous products that

are perfect substitutes for each other. There are no real or perceived differences

between products. This leads to each firm being price takers and facing a perfectly

elastic demand curve for their product.

c) Entry/exit conditions: There is free entry or exit for any firm. Free entry means

that new firms can set up in business to compete with established companies

whenever the new competitors feel that the profits are high enough to justify the

investment. Similarly, if operating firms find it commercially discouraging to

continue in the perfectly competitive market they can quit as and when they want.

In other words there are no barriers to entry or exit.

d) Mobility of resources: All firms have access to resources. Even if there are

resource advantages that some firms may enjoy over other firms in the market in

the short run, in the long run the resource mobility ensures that this advantage is

killed.

e) Dissemination of information: In practice, this feature implies that each buyer

and seller knows all about her or his opportunities to make deals, that is, knows

the terms on which other market participants will buy and sell. Perfect

dissemination of information would mean that all sellers and consumers know all

things, about all products, at all times, and therefore always make the best

decision regarding sale or purchase.

These features consolidate competitive force and rule out the influencing capacity of

individual firms. When market conditions are perfectly understood there is no chance of a

higher price being charged or paid. When factors of production are freely mobile, entry or

exit of firms is facilitated. Proximity to the market further ensures that there is no extra

transport cost, which may otherwise cause a small variation in the price.

1.6 Firm behavior in perfect competition

Many economists have questioned the validity of studying perfect competition. However

the theory does yield important predictions about what might happen to price and output

in the long run if competitive conditions hold good. The investigative outcome of a

competitive market, derived from the characteristics of competition, is as follows,

a) Identical Prices : In a competitive market, an individual firm has no capacity to

influence market conditions. Therefore it has to take market price as given,

constant and uniform in nature. The price of a good is also known as the

Average Revenue (AR) of the firm. Consider the following figure,

Since Average Revenue or Price and Marginal Revenue are identical, when the

former is constant the latter is also constant. Moreover, the Average Revenue

curve of a firm is the same as the individual demand curve. Hence, the

competitive demand curve is a horizontal straight line parallel to the quantity axis.

This has been shown in the above figure. The quantity of output produced and

sold is shown on the x-axis and Price is measured along the y-axis. The firm

Price

Quantity

AR=MR =DP

0

cannot charge a higher or lower price than the OP. If it attempts to charge a

somewhat higher price assuming competition, the firm will be able to sell nothing.

On the other hand, if it charges a somewhat lower price the firm will

unnecessarily suffer losses. Because of the large number of competing firms,

individual firm faces highly elastic demand curve and any rise in price will lead to

a large fall in demand and total revenue.

b) Competitive equilibrium in the short run: In the short run, it is possible for

an individual firm to make more than the normal profit. This situation is shown

in the following diagram; the firm gets the price P from the equilibrium in the

market. P is above the average cost denoted by C. The volume of economic

profit is shown by the arrow.

c) Competitive equilibrium in the long run: In the long run, economic profit

cannot be sustained. Freedom of entry causes the arrival of new firms in the

market which further causes the demand curve of each individual firm to shift

downward, bringing down at the same time the price, the average revenue and

marginal revenue curve. The final outcome is that, in the long run, the firm will

make only normal profit (or zero economic profit). Its horizontal demand curve

Price

Quantity

AR=MR =D

P

0

AR

MR

Qe

C

Economic Profit

D S

e

Price

Quantity

Market Firm

will touch its average total cost curve at its lowest point, as shown in the

following figure.

In a competitive market, a firm will be in equilibrium at a point where all the four

variables are equal.

d) MR = MC = AR = AC.

A firm in such equilibrium earns only normal profit.

d) Economic efficiency due to competition: Competition will ensure that firms

attempt to minimize their costs and move towards productive efficiency. The threat

of competition should lead to a faster rate of technological development and process

efficiency, as firms have to be responsive to the needs of consumer.

1.7 Monopoly

Monopoly is the market condition in which there is only one provider of a particular

commodity. Such a situation is beneficial for the firm as it enjoys lack of market

competitors. The customer has no alternatives for the available goods and services and

has to buy them at given facilities for the dictated price.

The primary characteristics of monopoly market form include the following:

a) Single Seller : For a pure monopoly to take place, only one firm can be selling the

good. A company can have a monopoly on certain goods and not on other goods.

b) No close substitutes: A monopolist’s product is perceived as non-substitutable in

the market.

c) Price maker: Monopolist exercises market power and is hence called a price

maker. This market power is reflected by the firm’s control in the market through,

(i) Product differentiation, and

(ii) Supply

d) Very high barriers to entry: In a monopoly market structure, because there is a

single seller selling a product with no close substitutes, there exist very high

barriers to entry making it difficult for other firms o enter the market. These

barriers can be of three types:

(i) Strategic barriers such as control on source of the raw material

(ii) Legal barriers such as patents, government granted permits and licenses

(iii) Economies of scale and natural monopolists

1.8 Limits to the Monopoly Power

From the above features it would seem that monopolists enjoy unlimited power in the

market. This may not be true however. A monopolist may have complete freedom in

determining his own price, yet there are some limits to his power. These are:

(i) The demand curve of a monopolist slopes downwards, as shown in the

following figure:

A downward sloping demand curve faced by a monopolist implies that a

monopolist cannot choose both price and quantity of output to be sold. He has

to determine one of these. If he chooses to exercise monopoly power by

charging a higher price he will be able to sell lower quantity and if prefers to

sell larger quantities he can do so only for lower prices.

(ii) Another constraint on monopoly power arises out of the income and

willingness of consumers. Even though a monopolist has complete freedom

to charge any price this freedom is restricted by the consumer’s ability to

purchase goods which is further limited by his income..

(iii) Finally, monopoly power also depends upon elasticity of the demand curve.

If the demand curve is rigid or less elastic the monopolist has a greater

degree of control. As the demand curve becomes more flexible or flatter the

monopolist’s control starts declining as shown in the following diagram,

Quantity

Price

AR=D

This is explained with the help of above figure. In the figure there are two

demand curves. D1 is rigid or less flexible showing greater monopoly control.

D2 is flatter or more flexible and depicts a lower degree of monopoly control.

In case of a flexible demand curve there is a danger that even at a higher price,

the total revenue of a monopolist may be smaller.

1.9 Monopoly Equilibrium: In order to study equilibrium under monopoly let us draw

the demand and supply or cost curves of a monopolist.

D1

D2

Quantity

Price

MR

AR

Quantity

Price

ACMCR

SC

P

MR

AR

Quantity

Price

ACMCR

C

P

MR

AR

Quantity

Price

ACMCR

SC

P

QO

In the above figure AR and MR are the demand and marginal revenue curves of a

monopolist. AC and MC are the respective cost or supply curves. The usual equilibrium

of MR=MC is equally applicable to the monopolist. At equilibrium, the monopolist

produces and supplies output quantity Q. This is the only profit-maximizing condition for

the monopolist. Under the given demand-cost structure no other level of output can help

to enhance his profit.

At equilibrium the monopolist charges price P which is determined by a corresponding

point R on the average revenue curve. The total revenue of the monopolist is then,

TR = OQ X P = OQRP

Similarly the total cost of the monopolist is governed by a point on the average cost

curve. S or C is the average cost of producing output Q in which the total cost will be,

TC = OQ XAC = OQSC

The profits of the monopolist as the difference between TR and TC are,

Profits = TR - TC = OQRP - OQSC = CSRP

Hence CSRP are the monopoly profits. These profits look similar to economic profits

under competition.

Monopoly profits differ in two respects:

(i) Monopoly profits are permanent and enjoyed in the short as well as long

run. There is no fear of monopoly profits being competed away.

(ii) Monopoly profits arise out of control over conditions in the market. The

monopolist follows restrictive policies and charges a higher price. This is

the source of his profits

1.10 Sources of Monopoly

Traditionally monopoly is considered as an evil form of market. Restrictive practices of

the monopolist cause prices to be higher and supply of goods to be smaller than what

would normally be available. But sometimes monopoly is unavoidable. These

circumstances are called sources of monopoly. They are:

(i) There are some natural resources such as land with specific properties,

mines, oil deposits, fields, etc. the supply of each of which is absolutely

limited. When such products are essential and not available anywhere else

the owners of the resources automatically acquire natural monopoly powers.

(ii) In some enterprises, large amount of capital is required to be invested right

from the beginning. Steel production, railway construction etc. are examples

of such enterprises. Those who possess such capital resources enjoy

monopoly powers. Other small investors cannot compete with them and the

monopoly survives unrivaled.

(iii) In certain enterprises, specialized technical resources are required to be

employed. Ship building, aeronautics, space research are examples of these

enterprises. Those who possess such technical resources will have monopoly

power.

(iv) In modern times certain legal provisions create monopoly rights. These are

in the form of intellectual property rights (IPR) leading to monopoly power.

(v) Finally there are monopolies in the form of public utilities. Road

construction, postal services, water supply, telecommunications, etc. are

some of the examples. In the case of such services it is necessary to maintain

a high quality and a uniformity of products or services. This results in

monopoly power.

In all such cases monopoly form of the market becomes unavoidable. Though there are

certain evils of the monopoly market form these have to be suffered and tolerated. In

absence of monopoly production and supply of these goods and services the society will

be totally deprived of certain benefits.

1.11 Monopolistic competition

Monopolistic competition refers to a market structure that is a traverse between the two

extremes of perfect competition and monopoly. The model retains many features of

perfect competition but depicts a market form having competition which is imperfect. As

a result, the model offers a somewhat more realistic depiction of many common

economic markets. The model best describes markets in which numerous firms supply

products which are each slightly different from that supplied by its competitors.

Examples include automobiles, toothpaste, furnaces, restaurant meals, motion pictures,

romance novels, wine, beer, cheese, shaving cream and many more.

1.12 Features of Monopolistic Competition

Monopolistic competition is a modern form of the market. A large variety of goods are

sold in such a market. Its main features can be stated as follows:

a) Many sellers: The number of firms operating under monopolistic competition is

sufficiently large implying a great degree of competition.

b) Product Differentiation: Under monopolistic competition products are

differentiated. This is one of the most important features of this form of market.

Product differentiation may be real or perceived.

(i) Real differentiation implies an evident distinctiveness about the product

one that can be maintained in some physical or chemical composition of the

product or in the taste and appearance of that product.

(ii) Perceived differences refer to the product distinctiveness that is created in

the consumers mind primarily through advertising or promotion, although

the product itself may not be “really” different.

When products are differentiated more buyers are likely to be attracted. Thereby t

he firm gains extra control over demand and market conditions.

c) Selling Cost : Selling Cost is another important feature of a monopolistically

competitive market. This is primarily in the form of advertisement expenditure.

Whenever a product is differentiated it is necessary to inform buyers; and

advertisement is a medium through which buyers can be told about superiority of

that product. Selling Cost is inevitable if products are differentiated. Infact, many

a times, advertising itself is used a strategy to create product differentiation. For

example using celebrities in product endorsements etc.

d) Entry/exit conditions: There is freedom of entry. There are no quantitative

restrictions or differences in market conditions. However qualitative differences

may create some barriers in the short run. In the long run, all such barriers may

not exist.

e) Resource Mobility: There is a great degree of resource mobility allowing firms

to have access and minimizing resource advantages.

f) Dissemination of information: In monopolistic competition, buyers do not know

everything, but they have relatively complete information about alternative prices.

They also have relatively complete information about product differences, brand

names, etc. Each seller also has relatively complete information about production

techniques and the prices charged by their competitors.

1.13 Equilibrium for a monopolistically competitive firm in the short and long run

The equilibrium for a monopolistically competitive firm in the short run is shown the

following diagram:

A monopolistically competitive firm acts like a monopolist in that the firm is able to

influence the market price of its product by altering the rate of production of the product.

In the short-run, the monopolistically competitive firm can exploit the heterogeneity of its

brand so as to reap positive economic profit. As shown in the above diagram the firm

earns economic profit equal to CPRS. In the long run, however, freedom of entry,

mobility of resources, and ease of flow of information may nullify the short run economic

profit.

The equilibrium for a monopolistically competitive firm in the long run is shown the

following diagram.

MR

AR

Quantity

Price

ACMCR

SC

P

QO

As shown in the above figure, in the long run, whatever distinguishing characteristic that

enables one firm to reap monopoly profits will be duplicated by competing firms. This

competition will drive the price of the product down and, in the long run, the

monopolistically competitive firm will make zero economic profit.

1.14 Benefits of monopolistic competition

Monopolistic competition has several advantages which are:

(i) Monopolistic competition creates more variety for the consumer.

(ii) The price of every variety sold in the market will be lower. This is because

of competition. Competition in the industry, forces each firm towards

efficiency improvements whose benefits are passed along to the consumers

in the form of lower prices.

(iii) The improvement in productive efficiency for each firm may lead to a

reduction in the use of resources in the industry as well as efficient

utilization of the existing resource base.

1.15 Oligopoly

Oligopoly denotes a market situation where there are few sellers for a product or service.

It exhibits the following features:

a) Few interdependent firms: Interdependence means that firms must take into

account likely reactions of their rivals to any change in price, output or forms of

non-price competition.

b) Product branding: Each firm in the market is selling a branded or differentiated

product.

c) Entry barriers: Significant entry barriers into the market prevent the dilution of

competition in the long run which maintains economic profits for the dominant

firms.

d) Non-price competition : Non-price competition is a consistent feature of the

competitive strategies of oligopolistic firms. Examples of non-price competition

include:

(i) Free deliveries and installation

(ii) Extended warranties for consumers and credit facilities

(iii) Longer opening hours (e.g. supermarkets and petrol stations)

(iv) Branding of products and heavy spending on advertising and marketing

(v) Extensive after-sales service

(vi) Expanding into new markets + diversification of the product range

1.16 Models of Oligopoly

There is no single theory of how firms determine price and output under conditions of

oligopoly. Some models of oligopoly describing firm behavior and pricing and output

decisions are:

a) Collusions and cartels

b) Price leadership

c) Game theory

d) Kinked demand curve

a) Collusions and cartels

It is often observed that when a market is dominated by a few large firms, there is

always the potential for businesses to seek to reduce market uncertainty and

engage in some form of friendly behavior. When this happens the existing firms

decide to engage in price fixing agreements or cartels. The aim of this is to

maximize profits mutually and act as if the market is a pure monopoly. This

behavior is deemed illegal by the competition authorities of many countries. But it

is hard to prove that a group of firms have deliberately joined together to raise

prices.

Collusion is often explained by a desire to achieve mutual profit maximization

within a market or prevent price and revenue instability in an industry. Price

fixing represents an attempt by suppliers to control supply and fix price at a level

close to the level we would expect from a monopoly. To fix prices, the producers

in the market must be able to exert control over market supply.

The distribution of the cartel output may be allocated on the basis of an output

quota system or another process of negotiation. Although the cartel as a whole is

maximizing profits, the individual firm’s output quota is unlikely to be at their

profit maximizing point. For any one firm, within the cartel, expanding output and

selling at a price that slightly undercuts the cartel price can achieve extra profits.

Unfortunately if one firm does this, it is in each firm’s interest to do exactly the

same. If all firms break the terms of their cartel agreement, the result will be an

excess supply in the market and a sharp fall in the price. Under these

circumstances, a cartel agreement might break down.

(i) Collusion in a market or industry is easier to achieve when:

(ii) There are only a small number of firms in the industry and barriers

to entry protect the monopoly power of existing firms in the long

run.

(iii) Market demand is not too variable i.e. it is reasonably predictable

and not subject to violent fluctuations which may lead to excess

demand or excess supply.

(iv) Demand is fairly inelastic with respect to price so that a higher

cartel price increases the total revenue to suppliers in the market -

this is clearly easier when the product is viewed as a necessity by

the majority of final consumers.

(v) Each firm’s output can be easily monitored - this enables the cartel,

more easily, to control total supply and identify firms who are

cheating on output quotas

Most cartel arrangements experience difficulties and tensions and some producer

cartels collapse completely. Several factors can create problems within a collusive

agreement between suppliers:

(i) Enforcement problems: The cartel aims to restrict total

production to maximize total profits of members. But each

individual member of the cartel finds it profitable to raise its own

production. It may become difficult for the cartel to enforce its

output quotas. There may be disputes about how to share out the

profits. Other firms who may be not members of the cartel, may

opt to take a free ride by producing close to but just under the

cartel price.

(ii) Falling market demand: An economic slowdown or recession

creates excess capacity in the industry and puts pressure on

individual firms to cut prices to maintain their revenue.

(iii) The successful entry of non-cartel firms into the industry: This

undermines a cartel’s control of the market.

(iv) The exposure of illegal price fixing by market regulators: Such

legal pressures may also cause the cartel to breakdown.

b) Price leadership

Another type of oligopoly behavior is explained by Price Leadership. This

is when one firm has a clear dominant position in the market and the firms

with lower market shares follow the pricing changes prompted by the

dominant firm. If most of the leading firms in a market are moving prices

in the same direction, it can take some time for relative price differences to

emerge which might cause consumers to switch their demand.

c) Game theory

A game is a situation in which the fate of a player in a game depends not

only on the actions of that player but also on the other players involved in

the game. Game theory is mainly concerned with predicting the outcome of

games of strategy in which the participants have incomplete information

about the others’ intentions. Game theory analysis has direct relevance to

the study of the conduct and behavior of firms in oligopoly market, for

instance the decisions that firms must take over pricing, and how much

money to invest in research and development spending. Costly research

projects represent a risk for any business - but if one firm invests in R&D,

can another rival firm decide not to follow? They might lose the competitive

edge in the market and suffer a long term decline in market share and

profitability. The dominant strategy for both firms is probably to go ahead

with R&D spending. If they do not and the other firm does, then their profits

fall and they lose market share. However, there are only a limited number of

patents available to be won and if all of the leading firms in a market spend

heavily on R&D, this may ultimately yield a lower total rate of return than if

only one firm opts to proceed.

d) Kinked demand curve

The demand or average revenue curve used in this analysis is kinked. It has

a Kink or a knot. The demand curve is not a smooth straight line but has two

segments with a varying degree of flexibility or slope. Let us begin with its

underlying assumptions.

(i) If the firm reduces its price the producer expects other competitors

to introduce a similar price cut; the market demand will increase but the

share of the firm will remain unaltered.

(ii) If the firm raises the price then other competing firms will not follow the

price rise. There will be a very small rise in demand but a significant

reduction in the sales of the firm.

The two assumptions suggest that neither a fall nor a rise in price would benefit

the firm. Oligopoly price is rigidly fixed. Moreover, such price rigidity causes a

kink in the demand curve with its lower segment steeper or inelastic and its upper

segment flatter and more flexible. Consequently there is no incentive to alter price

under oligopoly. This will be clearer when explained with the help of a figure.

In the above figure, there are two demand curves, DED, which is flatter and more

flexible and D1ED1, which is steeper and less flexible. The two demand curves

interest at point E which itself is a point of kink. The upper portion of the flatter

demand curve DE and the lower portion of the steeper demand curve ED1

together make up the Kinked Demand Curve. Under the above stated assumptions

the lower portion of the flatter demand curve ED and the upper portion of the

steeper demand curve D1E are not operative. Taking into account only relevant

segments of the two demand curves a kinked demand curve DED1 has been

formed and presented in the following figure,

Once we locate the point of Kink there is no further problem in oligopoly

analysis. The point of Kink, E, is itself an equilibrium point. At such point

equilibrium output produced is Q and price charged is P.

Once a kink in the demand curve is known and given, oligopoly equilibrium

automatically follows. The point of kink such as E is itself an equilibrium point.

Moreover, such equilibrium is rigid and stable. There is no incentive on the part

of the oligopoly firm to move away from the point of kink. Any attempt on his

part either to lower or raise the price will not be to his advantage. This can be

explained with the help of the following figure,

The lower segment ED1 of the demand curve is steeper. Even with a significant

fall in price from P to P1 increase in the quantity demanded QQ1 is very small.

Reduction in price will then result in smaller total revenue for the firm. On the

other hand, any attempt to cause a small rise in price as PP2 on the flatter portion

ED of the demand curve causes a significant fall in the quantity demanded from Q

to Q2. This again will cause total revenue of the firm to be smaller at higher price.

The firm is rigidly fixed at E, the point of kink with P as the price. This therefore

is also called sticky price solution.

1.17 Comparison of various market structures

We have established that the structure of the market and its attributes has an important

bearing on the firm’s behavior and its pricing and output decisions. The following table

compares and contrasts various market forms:

Element of

the market

structure

Market forms

Perfect

competition

Monopolistic

Competition

Oligopoly Monopoly

Number of

firms

Large Many Few One

Product

differentiation

Homogenous

product

Slightly

differentiated

product

Slightly or

highly

differentiated

product

Highly

differentiated

product with no

close substitutes

Entry

conditions

Complete

freedom of

entry

Relative

freedom of

entry

Slight or high

restrictions in

entry of new

firms

Very high barriers

to entry

Mobility of

resources

Perfect

mobility of

resources

Relative

mobility of

resources

Slight or high

restrictions in

mobility of

resources

Restriction in

mobility of

resources

Dissemination

of

information

Free flow of

information

Slight

restrictions in

flow of

information

Slight or high

restrictions in

flow of

information

Restriction in flow

of information

Profit

potential

Economic

profits in the

short run but

only normal

profits in the

long run

Economic

profits in the

short run but

only normal

profits in the

long run

Indeterminate Economic profits

in the short run and

long run

Demand

curve

Perfectly

elastic

Relatively

elastic

Indeterminate Relatively inelastic

1.18 Summary

In this unit we have highlighted the important bearing that the structure of the market has

on a firm’s pricing and output decisions. The structure of the market can be described in

terms of number of buyers and sellers, product differentiation, entry conditions, mobility

of resources, and flow of information. Based on these criteria we have analyzed four

market forms – perfect competition, monopoly, monopolistic competition, and oligopoly.

A comparison of them brings about the existence of varying degrees of competition in the

market and the consequent impact on a firm’s decisions.

1.19 Key words

a) Structure Conduct Performance (S-C-P) Model : Economic performance of a

firm is a function of its conduct which, in turn, is a function of the industry

structure to which the firm belongs.

b) Market structure: The structure of the market can be described in terms of

number of buyers and sellers, product differentiation, entry conditions, mobility

of resources, and flow of information.

c) Product differentiation: The differentiation of goods along key features to

establish brands as distinct from other brands in the same product category.

d) Barriers to entry: Obstacles on the way of potential new entrant to enter the

market and compete with the existing firms.

e) Perfect competition: Ideal markets form with a very high degree of competition

so that a single seller or buyer is too small relative to the size of the market and no

one of them can individually control market or its conditions.

f) Monopoly: Market condition in which there is only one provider of a particular

commodity.

g) Monopolistic competition: Markets in which numerous firms supply products

which are each slightly different from that supplied by its competitors.

h) Oligopoly : A market situation where there are few interdependent sellers for a

product or service.

i) Collusions: Covert interdependence between competing oligopoly firms for

pricing and output decisions.

j) Cartel: Overt and contractual interdependence between competing oligopoly

firms for pricing and output decisions.

k) Price leadership: One firm has a clear dominant position in the oligopoly market

and the firms with lower market shares follow the pricing changes prompted by

the dominant firm.

l) Game theory: A proposition according to which the fate of a firm in the market

depends not only on its own actions but also on the other firms, as in a game

where the fate of a player depends on all the players involved in the game.

1.20 Self-assessment questions

1) Explain the importance of the structure of the market based on the S-C-P model.

2) What are the various elements that describe the market structure? Discuss

3) Explain Perfect Competition. How does a firm arrive at equilibrium in such a

market?

4) How can a monopoly be created? Discuss the advantages of a monopoly situation

in the market?

5) Explain monopolistic competition. Discuss firm’s behavior in such a market.

6) Write a note on models of oligopoly.

7) Economic performance of a firm is a function of its conduct which, in turn, is a

function of the

a) Industry structure to which the firm belongs.

b) Government policy

c) Size of the firm

d) Goods and services

8) The structure of the market can be described in terms of number of buyers and

sellers, product differentiation, entry conditions, mobility of resources, and flow

of information.

a) True

b) False

c) Can’t say

d) None of the above

9) Product differentiation can be

a) Real

b) Perceived

c) Both a) and b)

d) Can’t say

10) Barriers to entry can be

a) Natural

b) Regulatory

c) Strategic

d) All of the above

11) Fill in the blanks:

a) The differentiation of goods is done along ______________features to

establish______________ as distinct from other______________ in the

same product category.

b) ______________ are obstacles on the way of potential new entrant to

enter the market and compete with the existing firms.

c) ______________ is an ideal markets form with a very high degree of

competition so that a single seller or buyer is too small relative to the size

of the market and no one of them can individually control market or its

conditions.

d) ______________ is a market condition in which there is only one provider

of a particular commodity.

e) ______________ is a market in which numerous firms supply products

which are each slightly different from that supplied by its competitors.

f) Oligopoly is a market situation where there are few

______________sellers for a product or service.

g) ______________ are covert interdependence between competing

oligopoly firms for pricing and output decisions.

h) ______________ is an overt and contractual interdependence between

competing oligopoly firms for pricing and output decisions.

i) When one firm has a clear dominant position in the oligopoly market and

the firms with lower market shares follow the pricing changes prompted

by the dominant firm it is called ______________.

j) ______________ is a proposition according to which the fate of a firm in

the market depends not only on its own actions but also on the other firms,

as in a game where the fate of a player depends on all the players involved

in the game.

k) A demand curve which is not a smooth straight line but has two segments

with a varying degree of flexibility or slope to explain behavior of an

oligopoly firm is called______________.