Market Structures

Market Structures Market structure refers to the number and size of buyers and sellers in the market for a good or service. A market can be defined as a group of firms willing and able to sell a similar product or service to the same potential buyers.

Classification of market structures 4 broad categories – Perfect competition Monopoly Monopolistic competition Oligopoly

Major features that determine market structure Number of sellers Product differentiation Entry and exit conditions

Profit Normal Profit : That part of the cost that is paid to the entrepreneur as a part of his compensation. Super-normal Profit : The profit that the entrepreneur may get over and above the compensation he gets from the firm, for his contribution.

Characteristics Of Perfect Competition Large number of buyers and sellers Homogeneous product Free entry and free exit for firms Perfect knowledge Perfect mobility of factors of production Non existence of transportation cost

Monopoly The term monopoly is made up of two words: mono (which means alone) and poly (which means sell). Monopoly thus means power to sell alone. Monopoly refers to a market situation where there is only one seller or one firm having control over the supply of a product which has no close substitute.

Monopoly A monopoly has only one seller, who is able to influence the total supply and price of the goods and services. Further, there are no close substitutes for the goods produced by the monopolist and there are barriers to entry.

Characteristics Of Monopoly Single seller Absence of close substitute Closed entry

Main factors that lead to monopoly are: Ownership of strategic raw materials and exclusive technical know-how Possession of product/process patent rights Acquisition of government license to procure certain goods High entry costs The size of the market may not allow more than one firm to exist. Hence, the market creates a natural monopoly. Thus, the government usually supplies and produces the commodity to avoid consumer exploitation

Types Of Monopoly Natural monopoly Legal monopolies Private monopolies and public monopolies Simple monopolies and discriminating monopolies

Comparison of monopoly with perfect competition Perfect competition as we know is a market situation in which there are a large number of firms and no individual firm by its own action can affect the market price because the output of an individual firm forms only a very small part of the total output. Under monopoly there is only one firm and its output forms the entire output of the industry. It can fix any price it likes.

A perfectly competitive firm in the long run as we know can earn only normal profits, it can earn supernormal profits only in the short run, but these will be competed away in the long run because of the free entry of new firms in the industry. On the other hand a monopoly firm can earn supernormal profits not only in the short run but also in the long run because there are strong barriers to the entry of new firms in the industry.

Under perfect competition a firm can not discriminate amongst its various customers, that is to say, it is not possible for a firm under perfect competition to charge different prices to different customers. This is so because the buyers as well as sellers have a perfect knowledge of the market condition. If a firm exercise price discrimination it would lose all its customers. On the other hand it is both possible and profitable for a monopoly firm to exercise price discrimination.

Under perfect competition the demand curve or the average revenue curve of an individual firm is perfectly elastic, that is, it is a horizontal straight line parallel o to x axis, and therefore marginal revenue curve coincides with the average revenue curve. But under monopoly the demand curve of the average revenue curve of the firm is less than perfectly elastic that is it slops downwards from left to right.

Price Discrimination. Discriminating monopoly or price discrimination occurs when a monopolist charges different prices for different units of a commodity even though these units are in fact homogeneous so far as their physical nature is concerned.

Types Of Price Discrimination Personal discrimination Local discrimination Trade discrimination or use discrimination Price discrimination may be based on the nature of the product. Based on the time.

Personal Discrimination Different prices are charged from different persons according to their desire or income.

Local Discrimination Takes place when a monopolist sells his product at a lower price in one market and charges a higher price in another market.

Trade Discrimination Occurs when a monopolist charges a lower price for one trade or use than for another trade or use. Electricity is supplied at a lower price for industrial purpose and a higher price for the domestic purpose, namely cooking, freeze etc. and still higher price for domestic lighting.

Loose tea is sold at a lower price than packed tea. Economic size tooth paste is relatively cheaper than the ordinary sized tooth paste.

Cinema house charge half the rates in the morning shows than in the afternoon shows. Off season rates of the hotels at hill stations are very low as compared to the peak season rates.

Monopolistic Competition In real life there prevails neither pure competition nor pure monopoly but a blending of both competition and monopoly which he calls monopolistic competition.

What is Imperfect Competition? A market structure between the extremes of perfect competition and monopoly

What is Monopolistic Competition? many small sellers differentiated product easy entry and exit

Monopolistic Competition Monopolistic competition is a form of imperfect competition It can be found in many real world markets ranging from clusters of sandwich bars, other fast food shops and coffee stores in a busy town centre to pizza delivery businesses in a city or hairdressers in a local area Monopolistic competition is similar to perfect competition, some economist regard it as more realistic, because the products are differentiated

Assumptions of the Market There are many producers and many consumers - the concentration ratio is low Consumers perceive that there are non-price differences among products i.e. there is product differentiation – competition is strong, plenty of consumer switching takes place Producers have some control over price - they are “price makers” not “price takers” but the price elasticity of demand is higher than it would be under a situation of monopoly The barriers to entry and exit into and out of the market are low

How does Monopolistic Competition differ from Perfect Competition? Number of producers (sellers in the market) Many Types of goods and services available for consumers Does the firm have control over their own prices? Is branding / marketing important? Are entry barriers zero, low or high? Does this market structure lead to allocative efficiency in the long run? Does this market structure lead to productive efficiency in the long run?

How does Monopolistic Competition differ from Perfect Competition? Number of producers (sellers in the market) Many Types of goods and services available for consumers Homogeneous Differentiated Does the firm have control over their own prices? Is branding / marketing important? Are entry barriers zero, low or high? Does this market structure lead to allocative efficiency in the long run? Does this market structure lead to productive efficiency in the long run?

How does Monopolistic Competition differ from Perfect Competition? Number of producers (sellers in the market) Many Types of goods and services available for consumers Homogeneous Differentiated Does the firm have control over their own prices? No – price takers Yes – some pricing power Is branding / marketing important? Are entry barriers zero, low or high? Does this market structure lead to allocative efficiency in the long run? Does this market structure lead to productive efficiency in the long run?

How does Monopolistic Competition differ from Perfect Competition? Number of producers (sellers in the market) Many Types of goods and services available for consumers Homogeneous Differentiated Does the firm have control over their own prices? No – price takers Yes – some pricing power Is branding / marketing important? No Yes – key non-price competition Are entry barriers zero, low or high? Does this market structure lead to allocative efficiency in the long run? Does this market structure lead to productive efficiency in the long run?

How does Monopolistic Competition differ from Perfect Competition? Number of producers (sellers in the market) Many Types of goods and services available for consumers Homogeneous Differentiated Does the firm have control over their own prices? No – price takers Yes – some pricing power Is branding / marketing important? No Yes – key non-price competition Are entry barriers zero, low or high? Zero barriers Low barriers Does this market structure lead to allocative efficiency in the long run? Does this market structure lead to productive efficiency in the long run?

How does Monopolistic Competition differ from Perfect Competition? Number of producers (sellers in the market) Many Types of goods and services available for consumers Homogeneous Differentiated Does the firm have control over their own prices? No – price takers Yes – some pricing power Is branding / marketing important? No Yes – key non-price competition Are entry barriers zero, low or high? Zero barriers Low barriers Does this market structure lead to allocative efficiency in the long run? Yes: Price = MC Not quite (P>MC) Does this market structure lead to productive efficiency in the long run?

How does Monopolistic Competition differ from Perfect Competition? Number of producers (sellers in the market) Many Types of goods and services available for consumers Homogeneous Differentiated Does the firm have control over their own prices? No – price takers Yes – some pricing power Is branding / marketing important? No Yes – key non-price competition Are entry barriers zero, low or high? Zero barriers Low barriers Does this market structure lead to allocative efficiency in the long run? Yes: Price = MC Not quite (P>MC) Does this market structure lead to productive efficiency in the long run? Yes – min LRAC No – higher LRAC

What are examples of Monopolistic Competition? grocery stores hair salons gas stations video rental stores restaurants

Oligopoly Market Structure characterized by few sellers and interdependent price/output decisions Significant barriers to entry Product could be homogenous (similar) or differentiated Potential for economic profits in the long run Incentive for illegal price setting Competition can be vigorous among the few firms

Characteristics Of Oligopoly 1. Few Sellers : An oligopoly market is characterized by a few sellers and their number is limited . Oligopoly is a special type of imperfect market. It has a large number of buyers but a few sellers. 2. Homogeneous or Differentiated Product : The Oligopolists produce either homogenous or differentiated products. Products may be differentiated by way of design , trademark or service

3. Interdependence : The most important feature of the Oligopoly is the interdependence in decision making of the few firms which comprise the industry. The reactions of the rival firms may be difficult to guess. Hence price is indeterminate under Oligopoly. 4. High Cross Elasticities : The cross elasticity of demand for the products of oligopoly firms is very high. Hence there is always the fear of retaliation by rivals. Each firm is conscious about the possible action and reaction of competitors while making any change in price or output

6. Competition : Competition is unique in an oligopoly market 6. Competition : Competition is unique in an oligopoly market. It is a constant struggle against rivals. 7. Group Behaviour : Each Oligopolist closely watches the business behaviour of other Oligopolists in the industry and designs his moves on the basis of some assumptions of their behaviour .

9. Uncertainty : The interdependence of other firms for one’s own decision creates an atmosphere of uncertainty about price and output 10. Price Rigidity : In an oligopoly market each firm sticks to its own price to avoid a possible price war. The price remains rigid because of constant fear of retaliation from rivals.

Examples Cable Television Services Entertainment Industries (Music and Film) Airline Industry Mass Media Pharmaceuticals Computer & Software Industry Cellular Phone Services Smart Phone and Computer Operating Systems Aluminium and Steel Oil and Gas Auto Industry

Oligopoly Market Structure characterized by few sellers and interdependent price/output decisions Significant barriers to entry Product could be homogenous (similar) or differentiated Potential for economic profits in the long run Incentive for illegal price setting Competition can be vigorous among the few firms