I am sharing 'Economics Unit 5' with you.pptx

UNIT 5: MARKET STRUCTURE –
IMPERFECT COMPETITION
 Imperfect Competition:
 Monopoly
 Monopolistic Competition
 Oligopoly
 Monopoly:
 A pure monopoly is a single supplier in a market. For the purposes of regulation,
monopoly power exists when a single firm controls 25% or more of a particular market.
A monopoly is a specific type of economic market structure. A monopoly exists when a
specific person or enterprise is the only supplier of a particular good. As a result,
monopolies are characterized by a lack of competition within the market producing a
good or service.
 Characteristics/ Features of a Monopoly:
A monopoly can be recognized by certain characteristics that set it aside from the other
market structures:

 Profit maximizer: a monopoly maximizes profits. Due to the lack of competition a
firm can charge a set price above what would be charged in a competitive market,
thereby maximizing its revenue.
 Price maker: the monopoly decides the price of the good or product being sold. The
price is set by determining the quantity in order to demand the price desired by the firm
(maximizes revenue).
 High barriers to entry: other sellers are unable to enter the market of the monopoly.
 Single seller: in a monopoly one seller produces all of the output for a good or service.
The entire market is served by a single firm. For practical purposes the firm is the same
as the industry.
 Price discrimination: in a monopoly the firm can change the price and quantity of the
good or service. In an elastic market the firm will sell a high quantity of the good if the
price is less. If the price is high, the firm will sell a reduced quantity in an elastic
market.
 Sources of Monopoly Power:
In a monopoly, specific sources generate the individual control of the market. Sources
of power include:
Economies of scale, Capital requirements,
Technological superiority, No substitute goods,
Control of natural resources, Network externalities,
Legal barriers, Deliberate actions.

 Monopoly vs. Competitive Market:
Monopolies and competitive markets mark the extremes in regards to market
structure. There are a few similarities between the two including: the cost functions
are the same, both minimize cost and maximize profit, the shutdown decisions are the
same, and both are assumed to have perfectly competitive market factors.
However, there are noticeable differences between the two market
structures including: marginal revenue and price, product differentiation, number of
competitors, barriers to entry, elasticity of demand, excess profits, profit
maximization, and the supply curve. The most significant distinction is that a
monopoly has a downward sloping demand instead of the “perceived” perfectly
elastic curve of the perfectly competitive market.
 Pricing under Monopoly:
In monopoly, there is only one producer of a product, who influences the price of the
product by making Change m supply. The producer under monopoly is called
monopolist. If the monopolist wants to sell more, he/she can reduce the price of a
product. On the other hand, if he/she is willing to sell less, he/she can increase the
price.
As we know, there is no difference between organization and industry
under monopoly. Accordingly, the demand curve of the organization constitutes the
demand curve of the entire industry. The demand curve of the monopolist is Average
Revenue (AR), which slopes downward.

 Monopoly Equilibrium:
Single organization constitutes the whole industry in monopoly. Thus, there is no
need for separate analysis of equilibrium of organization and industry in case of
monopoly. The main aim of monopolist is to earn maximum profit as of a producer in
perfect competition.
Unlike perfect competition, the equilibrium, under monopoly, is attained at
the point where profit is maximum that is where MR=MC. Therefore, the monopolist
will go on producing additional units of output as long as MR is greater than MC, to
earn maximum profit.

 Monopoly Equilibrium in Case of Zero Marginal Cost:
In certain situations, it may happen that MC is zero, which implies that the cost of
production is zero. For example, cost of production of spring water is zero. However,
the monopolist will set its price to earn profit.
 Short-Run and Long-Run View under Monopoly:
In the short run, the monopolist should make sure that the price should not go below
Average Variable Cost (AVC). The equilibrium under monopoly in long-run is same
as in short-run. However, in long-run, the monopolist can expand the size of its plants
according to demand. The adjustment is done to make MR equal to the long run MC.
In the long-run, under perfect competition, the equilibrium position is
attained by entry or exit of the organizations. In monopoly, the entry of new
organizations is restricted.
The monopolist may hold some patents or copyright that limits the entry
of other players in the market. When a monopolist incurs losses, he/she may exit the
business. On the other hand, if profits are earned, then he/she may increase the plant
size to gain more profit.
 Price Discrimination:
In a competitive market, price discrimination occurs when identical goods and
services are sold at different prices by the same provider.

 Price discrimination occurs when identical goods or services are sold at different prices
from the same provider. There are three types of price discrimination:
 First degree – the seller must know the absolute maximum price that every consumer is
willing to pay.
 Second degree – the price of the good or service varies according to quantity demanded.
 Third degree – the price of the good or service varies by attributes such as location, age,
sex, and economic status.
The purpose of price discrimination is to capture the market’s consumer surplus. Price
discrimination allows the seller to generate the most revenue possible for a good or service.
 Industries that Use Price Discrimination:
 Travel industry: airlines and other travel companies use differentiated pricing often. Travel
products and services are marketed to specific social segments. Airlines usually assign
specific capacity to various booking classes. Also, prices fluctuate based on time of travel
(time of day, day of the week, time of year). Prices fluctuate between companies as well as
within each company.
 Pharmaceutical industry: price discrimination is common in the pharmaceutical industry.
Drug-makers charge more for drugs in wealthier countries. For example, drug prices in the
United States are some of the highest in the world. Europeans, on average, pay only 56% of
what Americans pay for the same prescription drugs.
 Textbooks (physical ones, not your Boundless one!): price discrimination is also prevalent
within the publishing industry. Copyright protection laws increase the price of textbooks.
Also, textbooks are mandatory in the United States while schools in other countries see them
as study aids.

 Monopolistic Competition:
Monopolistic competition is a type of imperfect competition such that many producers sell
products that are differentiated from one another as goods but not perfect substitutes (such
as from branding, quality, or location). In monopolistic competition, a firm takes the prices
charged by its rivals as given and ignores the impact of its own prices on the prices of
other firms.
Unlike in perfect competition, firms that are monopolistically competitive maintain spare
capacity. Models of monopolistic competition are often used to model industries. Textbook
examples of industries with market structures similar to monopolistic competition include
restaurants, cereal, clothing, shoes, and service industries in large cities.
 Key difference with monopoly:
In monopolistic competition there are no barriers to entry. Therefore in long run, the
market will be competitive, with firms making normal profit.
 Key difference with perfect competition:
In Monopolistic competition, firms do produce differentiated products, therefore, they are
not price takers (perfectly elastic demand). They have inelastic demand.
 Characteristics/ Features of Monopolistic Competitive markets:
 have products that are highly differentiated, meaning that there is a perception that the
goods are different for reasons other than price;
 have many firms providing the good or service;
 firms can freely enter and exits in the long-run;

 firms can make decisions independently;
 there is some degree of market power, meaning producers have some control over
price; and
 buyers and sellers have imperfect information.
 Pricing under Monopolistic Competition:
 Monopolistic competition short run:

In the short run, the diagram for monopolistic competition is the same as for a
monopoly. The firm maximises profit where MR=MC. This is at output Q1 and price
P1, leading to supernormal profit.
 Monopolistic competition long run:
Demand curve shifts to the left due to new firms entering the market. In the long-run,
supernormal profit encourages new firms to enter. This reduces demand for existing
firms and leads to normal profit.

 Examples of monopolistic competition:
 Restaurants – restaurants compete on quality of food as much as price. Product
differentiation is a key element of the business. There are relatively low barriers to
entry in setting up a new restaurant.
 Hairdressers. A service which will give firms a reputation for the quality of their hair-
cutting.
 Clothing. Designer label clothes are about the brand and product differentiation
 TV programmes – globalisation has increased the diversity of tv programmes from
networks around the world. Consumers can choose between domestic channels but
also imports from other countries and new services, such as Netflix.
 Product Differentiation:
One of the defining traits of a monopolistically competitive market is that there is a
significant amount of non- price competition. This means that product differentiation
is key for any monopolistically competitive firm. Product differentiation is the
process of distinguishing a product or servi Product differentiation is done in order to
demonstrate the unique aspects of a firm’s product and to create a sense of value.
In economics, successful product differentiation is inconsistent with the
conditions of perfect competition, which require products of competing firms to be
perfect substitutes.

Consumers do not need to know everything about the product for differentiation to
work. So long as the consumers perceive that there is a difference in the products, they
do not need to know how or why one product might be of higher quality than another.
For example, a generic brand of cereal might be exactly the same as a brand name in
terms of quality. However, consumers might be willing to pay more for the brand
name despite the fact that they cannot identify why the more expensive cereal is of
higher “quality.”
There are three types of product differentiation:
 Simple: the products are differentiated based on a variety of characteristics;
 Horizontal: the products are differentiated based on a single characteristic, but
consumers are not clear on which product is of higher quality; and
 Vertical: the products are differentiated based on a single characteristic and consumers
are clear on which product is of higher quality.
Differentiation occurs because buyers perceive a difference. Drivers of differentiation
include functional aspects of the product or service, how it is distributed and
marketed, and who buys it.
The major sources of product differentiation are as follows:
 Differences in quality, which are usually accompanied by differences in price;
 Differences in functional features or design;

 Ignorance of buyers regarding the essential characteristics and qualities of goods they
are purchasing;
 Sales promotion activities of sellers, particularly advertising; and
 Differences in availability (e.g. timing and location).
The objective of differentiation is to develop a position that potential
customers see as unique. Differentiation affects performance primarily by reducing
direct competition. As the product becomes more different, categorization becomes
more difficult, and the product draws fewer comparisons with its competition. A
successful product differentiation strategy will move the product from competing on
price to competing on non-price factors.
 Oligopoly:
The word Oligopoly is derived from two Greek words – ‘Oligi’ meaning ‘few’ and
‘Polein’ meaning ‘to sell’.
An oligopoly is a market structure in which a few firms dominate. When a
market is shared between a few firms, it is said to be highly concentrated. Although
only a few firms dominate, it is possible that many small firms may also operate in the
market.
It is a market structure with a small number of firms, none of which can
keep the others from having significant influence.

 Characteristics/ Features of Oligopoly:
 Few firms: Under Oligopoly, there are a few large firms although the exact number
of firms is undefined. Also, there is severe competition since each firm produces a
significant portion of the total output.
 Barriers to Entry: Under Oligopoly, a firm can earn super-normal profits in the long
run as there are barriers to entry like patents, licenses, control over crucial raw
materials, etc. These barriers prevent the entry of new firms into the industry.
 Non-Price Competition: Firms try to avoid price competition due to the fear of price
wars in Oligopoly and hence depend on non-price methods like advertising, after
sales services, warranties, etc. This ensures that firms can influence demand and build
brand recognition.
 Interdependence: Under Oligopoly, since a few firms hold a significant share in the
total output of the industry, each firm is affected by the price and output decisions of
rival firms. Therefore, there is a lot of interdependence among firms in an oligopoly.
Hence, a firm takes into account the action and reaction of its competing firms while
determining its price and output levels.
 Nature of the Product: Under oligopoly, the products of the firms are either
homogeneous or differentiated.
 Selling Costs: Since firms try to avoid price competition and there is a huge
interdependence among firms, selling costs are highly important for competing
against rival firms for a larger market share.

 No unique pattern of pricing behavior: Under Oligopoly, firms want to act
independently and earn maximum profits on one hand and cooperate with rivals to
remove uncertainty on the other hand. Depending on their motives, situations in real-
life can vary making predicting the pattern of pricing behavior among firms
impossible. The firms can compete or collude with other firms which can lead to
different pricing situations.
 How firms compete in oligopoly?
There are different possible ways that firms in oligopoly will compete and behave this
will depend upon:
 The objectives of the firms; e.g. profit maximisation or sales maximisation?
 The degree of contestability; i.e. barriers to entry.
 Government regulation.
There are different possible outcomes for oligopoly:
 Stable prices (e.g. through kinked demand curve) – firms concentrate on non-price
competition.
 Price wars (competitive oligopoly)
 Collusion- leading to higher prices (Cartels)

 Non-Collusive Oligopoly-Sweezy’s Kinked Demand Curve Model (Price-
Rigidity):
 Usually, in Oligopolistic markets, there are many price rigidities. In 1939, Paul
Sweezy used an unconventional demand curve – the kinked demand curve to explain
these rigidities.
 Reason for the kink in the demand curve:
It is assumed that firms behave in a two-fold manner in reaction to a price change by
a rival firm. In simple words, firms follow price cuts by a rival company but not price
increases. So, if a seller increases the price of his product, his rivals do not follow the
price increase.
Therefore, the market share of the firm reduces significantly as a result of
the price rise. On the other hand, if a seller reduces the price of his product, then the
rivals also reduce their price to bring it at par with the price reduction of the firm.
This ensures that they prevent their market share from falling. Once the
rivals react, the firm lowering the price first cannot gain from the price cut.
 Why the price rigidity?
As can be seen above, a firm cannot gain or lose by changing its price from the
prevailing price in the market. In both cases, there is no increase in demand for the
firm which changes its price. Hence, firms stick to the same price over time leading to
price rigidity under oligopoly.

 This assumes that firms seek to maximise profits.
 If they increase the price, then they will lose a large share of the market because they
become uncompetitive compared to other firms. Therefore demand is elastic for price
increases.
 If firms cut price then they would gain a big increase in market share. However, it is
unlikely that firms will allow this. Therefore other firms follow suit and cut-price as
well. Therefore demand will only increase by a small amount. Therefore demand is
inelastic for a price cut.
 Therefore this suggests that prices will be rigid in oligopoly
The diagram above suggests that a change in marginal cost still leads to
the same price, because of the kinked demand curve. Profit maximisation occurs
where MR = MC at Q1.
 Cartels:
A cartel is defined as a group of firms that gets together to make output and price
decisions. The conditions that give rise to an oligopolistic market are also conducive
to the formation of a cartel; in particular, cartels tend to arise in markets where there
are few firms and each firm has a significant share of the market. The organization
of petroleum exporting countries (OPEC)
‐ is perhaps the best known example of an
‐
international cartel; OPEC members meet regularly to decide how much oil each
member of the cartel will be allowed to produce.

Oligopolistic firms join a cartel to increase their market power, and members work
together to determine jointly the level of output that each member will produce and/or
the price that each member will charge. By working together, the cartel members are
able to behave like a monopolist. For example, if each firm in an oligopoly sells an
undifferentiated product like oil, the demand curve that each firm faces will be
horizontal at the market price. If, however, the oil producing firms form a cartel like
‐
OPEC to determine their output and price, they will jointly face a downward sloping
‐
market demand curve, just like a monopolist. In fact, the cartel's profit maximizing
‐
decision is the same as that of a monopolist.
 Price Leadership:
If changes are usually or always introduced by a firm and usually or always followed
with similar price changes by other sellers, price competition may be said to involve
Price Leadership.
A major policy change on the part of one firm will have immediate effects on its
competitors and the competitors are then likely to react with their counter strategies.
Oligopoly tends to reduce the freedom of action a firm has in taking its price decision
because the firm is not sure of the reactions of its rivals.
 Example:
Scooter-Bajaj Auto LML, TVS Motor Cycles-Hero Honda, Kinetic, Escort. Among the
competing business firms, mutual distrust and unwilling to surrender their
sovereignty’s make the collusion of firms imperfect. Most important form of imperfect
collusion is Price Leadership.

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