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Market Structure Original Unit 3

The document discusses different market structures: 1. Perfect competition is characterized by many small firms, homogeneous products, free entry and exit, and firms that are price takers. 2. Monopolistic competition has differentiated products, easy entry and exit, and firms have some control over price. Common examples include restaurants, plumbers, and hairdressers. 3. Under monopolistic competition, firms use branding and non-price competition like advertising to differentiate their products and build customer loyalty. They can charge higher prices for well-known brands.
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0% found this document useful (0 votes)
25 views32 pages

Market Structure Original Unit 3

The document discusses different market structures: 1. Perfect competition is characterized by many small firms, homogeneous products, free entry and exit, and firms that are price takers. 2. Monopolistic competition has differentiated products, easy entry and exit, and firms have some control over price. Common examples include restaurants, plumbers, and hairdressers. 3. Under monopolistic competition, firms use branding and non-price competition like advertising to differentiate their products and build customer loyalty. They can charge higher prices for well-known brands.
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Market Structures

Market structure – identifies how a market is made


up in terms of:
– The number of firms in the industry
– The nature of the product produced
– The degree of monopoly power each firm has
– The degree to which the firm can influence price
– Profit levels
– Firms’ behaviour – pricing strategies, non-price
competition, output levels
– The extent of barriers to entry
– The impact on efficiency
Market Structure

Perfect Imperfect
Competition Competition

More Competitive to fewer


Competition

Less competitive greater degree of imperfection


More competitive lesser degree of imperfection
Market Structure

Perfect Pure
Competition Monopoly
Oligopol Monopol
Monopolistic Competition Duopoly
y y
Perfect Competition
Characteristics:
– Large number of firms
– Products are homogenous (identical) – consumer
has no reason to express a preference for any firm
– Freedom of entry and exit into and out of the industry
– Firms are price takers – have no control over the price they
charge for their product
– Each producer supplies a very small proportion of total
industry output
– Consumers and producers have perfect knowledge about the
market
– buyers are small and quantity supplied is insignificant, sellers
are small and quantity bought is also insignificant
– Market is well organised and trading is a continuous process
– There are many competitors (both sellers and buyers) each
acting independently
– The market price must be flexible over a period of time
constantly rising and falling in response to changing conditions
of supply and demand
Distinction between Pure and Perfect competition:

Pure and perfect competition is used synonymously many


times.
Pure competition is said to exist where only two conditions
are
Fulfilled:
1) There must be large number of firms in the industry
2) The products of the firm must be homogenous

Perfect competition is otherwise called as free competition.


Determination of Price under perfect competition:

Price under perfect competition are determined by the


forces of
supply and demand.
Price will be fixed at a point where the supply and demand
are at
Equilibrium.
The equilibrium will change by changes in the forces of
demand
and supply.
If demand rises, Price goes up
If supply rises , Price goes down.
At this output the firm is making normal profit.
Perfect Competition This is a long run equilibrium position.

Diagrammatic Given the assumption of profit maximisation, the firm produces at an output
where MC = MR (Q1). This output level is a fraction of the total industry supply.
representation The average cost curve is the standard ‘U’ – shaped curve. MC cuts the AC curve
at its lowest point because of the mathematical relationship between marginal and
average values.

Cost/
Revenue M The MC is the cost of producing
additional (marginal) units of
C output. It falls at first (due to the
law of diminishing returns) then
A rises as output rises.

P = MR =
AR The industry price is
determined by the
demand and supply of
the industry as a whole.
The firm is a very small
supplier within the
industry and has no
Q Output/ control over price. They
1 Sales will sell each extra unit for
the same price. Price
therefore = MR and AR
Monopolistic or Imperfect Competition

• Where the conditions of perfect competition


do not hold, ‘imperfect competition’ will exist
• Varying degrees of imperfection give rise to
varying market structures
• Monopolistic competition is one of these –
not to be confused with monopoly!
Monopolistic or Imperfect Competition
Characteristics:
1. 25-75 buyers and sellers must exist. Firms act independently but no
single firm is large enough to change the supply or price of a good.
2. The products are similar but they emphasize product differentiation
(differences among products). This is the one thing that separates
monopolistic competition from perfect competition. The differences
may be real or imaginary (a refrigerator with plastic or metal trays).
Revlon offers 157 shades of lipstick – 41 are pink)
3. Buyers must be well informed about differences in products.
Monopolistic competitors rely on informative and competitive
advertising.
4. Easy to enter or exit the industry. Few restrictions exist.
5. Large number of firms in the industry
6. May have some element of control over price due to the fact that they
are able to differentiate their product in some way from their rivals –
products are therefore close, but not perfect, substitutes.
7. Entry and exit from the industry is relatively easy – few barriers to entry
and exit
8. Consumer and producer knowledge imperfect
Monopolistic Competition – fairly large number (25-75) of sellers
competing to sell slightly differentiated products. Product
differentiation (real or imaginary) is vital. This is the most common
market structure
Sellers try to. decrease competition by making their products
different from the others. Since each firm attempts to make its product
unique, unique, there is an “element of monopoly”, thus monopolistic
competition. Product differentiation, when it is successful, enables a
firm to “establish a kind of monopoly” so that loyal customers will prefer it
rather than buy from the competition. [They try to monopolize a small
portion of the market.]
Even virtually identical products may be differentiated by brand
name, packaging, or design but they are still similar. They have all the
conditions of perfect competition except for product “differentiation.

They use “nonprice” methods of competition such as


advertising and improved service to increase sales. Reputation
is important [builds loyalty]. Most manufactured goods are made by
only a few producers
Monopolistic or Imperfect Competition
• Restaurants
• Plumbers/electricians/local builders
• Solicitors
• Private schools
• Plant hire firms
• Insurance brokers
• Health clubs
• Hairdressers
• Funeral directors
• Estate agents
• Damp proofing control firms
Branding and Pricing under Monopolistic Competition:
A brand distinguishes a product or service from similar offerings on
the basis of unique features perceived by the consumer. Buyers
feel that well known firm have a reputation to maintain and the
resources to do so. In course of time, consumers tend to become
more or less attached to particular brand names.

Firms with reputed brands are in a position to change higher price


for their products. It has been found that an unknown brand must
be offered at a price somewhat lower than that of the leading brand
in order to sell a substantial quantity.
This is a short run equilibrium position for a

Monopolistic or firm in a monopolistic market structure.

If the firm produces Q1 and sells each unit for

Imperfect Competition £1.00 on average with the cost (on average)


for each unit being 60p, the firm will make 40p
x Q1 in abnormal profit.

We assume that the firm produces where


MR = MC (profit maximising output). At
Implications for the diagram: this output level, AR>AC and the firm
MC makes abnormal profit (the grey shaded
Cost/Revenue area).
The demand curve facing
the firm will be downward
sloping and represents
A the AR earned from sales.
£1.0 C
0
Since the additional revenue received
from each unit sold falls, the MR curve
Abnormal Profit lies under the AR curve.

£0.60

Marginal Cost and Average


Cost will be the same
shape. However, because
the products are
differentiated in some way,
the firm will only be able to
M D sell extra output by lowering
Q1 R (AR) price.
Output / Sales
Pricing under Monopolistic Competition:
There is some control over price because differentiation creates buyer
loyalty [jeans]. Non-price competition is used to control price.
Developing brand name loyalty will enable a firm to marginally increase
price without losing customers. If the increase is too much, buyers will
switch to a competitor’s product

Difference between Perfect competition and Monopolistic


Competition

1. Perfect competition is a myth, Monopolistic is fact of life.


2. Under perfect competition, the products are homogenous; under
monopolistic competition, products are differentiated
3. Under perfect competition, the price prevailing in the market is
the same for all producers; under monopolistic competition, there
are different prices for differentiated products.
4. Advertisement does not help in perfect competition; it is rather
necessary to sustain monopolistic competition.
Oligopoly
• Competition between the few - . “Oligo” – few in an industry.
• May be a large number of firms in the industry but the industry is
dominated by a small number of very large producers
• Concentration Ratio – the proportion of total market sales (share) held
by the top 3,4,5, etc firms:
4 firm concentration ratio of 75% means the top 4 firms account for
75% of all the sales in the industry.
• Two Types of Oligopolies Pure (Undifferentiated) Oligopoly – 3 or 4
producers dominate the production of an identical product (steel, zinc,
copper, aluminum, lead, cement, industrial alcohol)
• Differentiated Oligopoly – 3 or 4 producers dominate the production of
differentiated (similar) products. [typewriters, tires, soap, cigarettes,
refrigerators, cereals, TVs & autos]
Oligopoly
• Features of an oligopolistic market structure:
– Price may be relatively stable across the industry –
kinked demand curve?
– Potential for collusion
– Behaviour of firms affected by what they believe their rivals
might do – interdependence of firms
– Goods could be homogenous or highly differentiated
– Branding and brand loyalty may be a potent source of
competitive advantage
– Non-price competition may be prevalent
– Game theory can be used to explain some behaviour
– High barriers to entry
Market Conditions For Oligopolies
1. A few sellers control over 70% of market.
2. Firms offer identical or differentiated products (real or
imaginary). Advertising important.
3. Product
. information must be easily available. They use
informative advertisement (price, quality, and special
features) to introduce new products.
4. There are huge barriers to entry into the industry. The
three major barriers are technological knowledge, money,
& brand name loyalty.
5. Entry is difficult because many have patents or own
essential raw materials. This makes it difficult for new firms to
try to compete.
Oligopoly and Price : Oligopolies control price to some degree by creating brand name
loyalty and using non-price competition.
Price Leadership – when one firm, usually the largest and most powerful in the industry,
offers a new product at a certain price. The others then follow because they fear a
price war or because they would be better off financially by doing so. In other words,
oligopolists play the game, “follow the leader”.
Price leadership is legal because it does not involve any agreement among
competitors. If the competition does not follow the leader’s price, the leading firm may
be forced to change its price and fall in line with the prices of the competition. The firm
therefore, effectively faces a ‘kinked demand curve’ forcing it to maintain a stable or rigid
pricing structure.
Oligopolistic firms may overcome this by engaging in non-price competition. The principle of
the kinked demand curve rests on the principle that: If a firm raises its price, its rivals will not
follow suit If a firm lowers its price, its rivals will all do the same. If the firm seeks to lower its
price to gain a competitive advantage, its rivals will follow suit. Any gains it makes will quickly
be lost and the % change in demand will be smaller than the % reduction in price – total
revenue would again fall as the firm now faces a relatively inelastic demand curve.
The kinked demand curve - an explanation for price stability?

Oligopoly
If the firm seeks to lower its price to gain a competitive advantage, its
Pric rivals will follow suit. Any gains it makes will quickly be lost and the %
e change in demand will be smaller than the % reduction in price – total
revenue would again fall as the firm now faces a relatively inelastic
demand curve.

£
5
Total
Revenue
B
Total Revenue A
D=
Total Revenue B Kinked D Curve elastic
D = Inelastic

100 Quantit
y
Duopoly
• Market structure where the industry is dominated
by two large producers
– Price leadership by the larger of the two firms may exist – the
smaller firm follows the price lead
of the larger one
– Highly interdependent
– High barriers to entry
– Duopoly – when 2 firms dominate an industry. Coke products have
43% of the market and Pepsi products have 32%.
Monopoly
• Pure monopoly – where only one producer exists in the industry
• In reality, rarely exists – always some form of substitute available!
• Monopoly exists, therefore, where one firm dominates the market
• Firms may be investigated for examples of monopoly power when
market share exceeds 25%
• Monopoly power – refers to cases where firms influence the market in
some way through their behaviour – determined by the degree
of concentration in the industry
– Influencing prices
– Influencing output
– Erecting barriers to entry
– Pricing strategies to prevent or stifle competition
– May not pursue profit maximisation – encourages unwanted
entrants to the market
– Sometimes seen as a case of market failure
Monopoly
• Origins of monopoly:
– Through growth of the firm , Through amalgamation, merger
or takeover, Through acquiring patent or license
– Through legal means – Royal charter, nationalisation, wholly owned
place
• characteristics of firms exercising monopoly power:
• Price – could be deemed too high, may be set to destroy competition
(destroyer or predatory pricing), price discrimination possible.
• Efficiency – could be inefficient due to lack of competition or… could
be higher due to availability of high profits.
• Innovation - could be high because of the promise of high profits,
Possibly encourages high investment in research and development
(R&D)
• High levels of branding, advertising and non-price competition
• Monopolies not always ‘bad’ – may be desirable in some cases but
may need strong regulation.
• Monopolies do not have to be big – could exist locally
Features of Monopoly:
• There is single producer or seller of a product
• There is a complete absence of competition
• There is no close substitute for the product
• There is complete control over the market supply on the
part of the monopolist.
• There is no distinction between firm and industry
• There is prevention of entry of new firm in the long run.
• Monopolist is a price-maker and not a price taker. He is
independent of making his price decisions.
• He can fix both price and output to be sold in the market.
• The aim of the monopolist is to maximize his total money
profits.
• He will be in equilibrium at the price-output level at which
his profits are maximum.
Government Monopoly Natural Monopoly
Owned & operated by Competition would be
G chaotic. It is natural
Ex: State Highways, to give it to one co.
Postal, Rail services Ex: Utilities
Cable TV
“Price Makers”
Monopoly
[mono(1) poly (seller)]
Control over price:
Total
Product: unique

Technological Monopoly
Geographic Monopoly
“Patent”
Only seller in a specific
Ex: Process and
area
product
Example: Remote Store

Monopoly – the “power of one”


Pure Monopoly – one firm industry [“monopolist”] Market Condition.
1. One firm is the only seller. Advertising promotes image.
2. No close substitute goods are available.
3. Prohibitive barriers to entry in the industry. High investment costs and
technological expertise prevent others from entering the market.
Legal restrictions make entry in government-supported monopolies
nearly impossible.
4. Almost complete control of market price.
5. Monopolist have much control over price because they are the only
seller. A higher price would hurt demand. The state may control the
price on some legal monopolies. These single suppliers are “price
makers.”
Four Types of Legal Monopolies:
• Natural Monopoly – where competition would be chaotic, it is natural
to give the business to one firm. Examples: Public Utilities (electric &
gas) – privately owned companies (buses-Continental Trailways) but
regulated by the government. Market where average costs are lowest
when all output is produced by a single firm.
Government Monopoly – monopoly owned and operated by the government.
The difference between natural [privately owned] & government monopolies
[government owned] is that these monopolies are owned operated by any level of
government. Examples would be interstate highway system, public libraries,
public schools, Postal Service. In most cases, government monopolies deal with

economic products needed for the public welfare . Most tend to provide goods
that enhance the general welfare rather than seek profits.
Geographic Monopoly – when a firm is the only seller of a good in a
specific location.
Technological Monopoly – results from the invention of a new product
(patent) or when technology changes the way a good is produced. Production
submarines, Super computers, medicine to cure cancer.
Voluntary, Legal and Social otherwise called as Government Monopoly also
exist.
Reasons for Monopoly:
1.Restriction by Law: when government makes it a law no to
allow
any competition in the production and distribution of a particular
product. (EB, Army, Water Service, Tourist Places)
2. Control over Key raw materials: when the strategic raw
material
To produce a particular commodity is scarce and is fully
controlled
by a single firm, that firm may not allow the use of this important
Raw material by other firm and may thus acquire monopoly
status.
Eg. Nuclear weapons.
3. Specialized Technology – technique of production
4. Economies of Scale – a single firm being large can eliminate
competition by reduces its cost to low level without affecting the
Discriminating Monopoly: Price discrimination exists when
the same
product is sold at different prices to different buyers. Eg.
Different
locations of seats with limited features as in train, theatre,
aircraft.
Is monopoly an unmixed evil?
1. A monopoly firm generally possess large financial
resources. It can thus sufficiently on innovation and
technological progress so as to introduce new inventions
and better techniques.
2. Monopoly also enables savings in expenditure on
advertisement.
3. Large capital investment and confidentiality and service to
public and no profit is needed for few services, eg.
Electricity, water, transport, army in such cases monopoly
is exercised.
Competition and the Market Structure
Price Control and the Market Structure
Least control over price

Most control over price


Very Agric. products
Many Fishery

Some Extensiv
e

Fair amount
Fair with Extensiv
differentiated e
Amount
oligopolies

Cable TV
Water

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