Business Economics Demand and Supply

Business Economics
Session 10: Market Structure Analysis - I
Session Date: 23.02.2013
EPGDIB(VSAT) 2012-13
Preview Questions
Business Economics/Session 10
1.
How do changes in market demand and supply factors influence an individual firms profits?
How does competition influence an individuals firms profits?
2.
Demand - Supply Framework

Changes in Demand factors results changes in

market prices
Demand expansion causes price hikes Demand contraction leads to price falls
Changes in Supply factors results changes in market

prices Supply expansion leads to price falls Supply contraction leads to price increases
Demand Analysis: A Review

Business Economics/Session 10 Demand curve defines how consumers respond to changes in price
P
Revenue implications of demand curve is given in TR and MR curves

TR
MR
Q MR
Supply Analysis: A Review

Cost implications of increasing supply is given by supply curve

P
MC curve above the AVC is the supply curve which defines the
incremental cost for increasing supply by one unit
MC curve is derived from the production and cost relationships
Profit Maximization
Demand and Supply factors together determine profits earned

TC TR
TC
TR
Profit Maximisation
Q*
= TR - TC d( ) = d(TR) - d(TC) dQ dQ dQ = MR - MC = 0 = MR = MC P & P & Q Q
Any change in demand and supply condition will influence profits earned by the firm
MR > MC MR < MC
Market Structure
Changes in Demand & Supply condition translates

into changes in behaviour by various firms
This behaviour is also influenced by how firm

relate to other firms in the market.
Competition
Issues

Why does competition between products differ What determines competition
Basic Characteristics of Various Market Structures

Market Structure Number of Producers Type of Product Barriers to entry Power of Firm over Price None Non-price competition
Perfect Competition Monopolistic
Many
Standardized
Low
None
Many
Differentiated
Low
Some
Advertising and Product differentiation Advertising and Product differentiation Advertising
Oligopoly
Few
Standardized or Differentiated Unique Product
High
Some
Monopoly
One
Very High
Considerable
Market Structure and Competition

Competition Increases
Competition reduces
Perfect Competition Monopolistic Oligopoly Monopoly
Perfect Competition : Assumptions

Many buyers and sellers

Buyers and sellers are price takers Product is homogeneous
Perfect mobility of resources

Economic agents have perfect knowledge
Competitive Market : Pricing Decisions
Who sets price How much freedom do firms have in the setting the
price
Depends on the demand and supply curves
Competitive Market : Nature of Demand Curve

1.
Demand curve : Industry level

P
AR
Downward sloping as P, Q Slope depends on the nature of the product i.e. price elastic (luxury), price inelastic goods (Necessities)
Contd
Competitive Market : Nature of Demand Curve

2.
Demand curve : Firm level

P
AR
Price taker : Single firm cannot influence market price. Can sell any Q at a given Price ( P ) Product is standardized large number of substitutes available. Hence, demand curve is perfectly elastic.
Determination of Equilibrium Quantity and Price : Short run

1.
Industry level
P D S
P*
Q*
Interaction between Demand and Supply factors determines P* and Q* Market demand = OQ*. Firms to decide how much of OQ* to supply
Relationship between P, AR, MR

P
5 5 5 5
Q
1 2 3 4
TR
5 10 15 20
) AR ( TR Q
TR ) MR ( Q
5 5 5 5
5 5 5
5
5
5
6
25
30
5
5
5
5
Determination of Equilibrium Quantity and Price : Short run

2.
Firm level

Industry equilibrium price is the Firms given price Profits maximized at MR = MC

PI D PF
MC
S
AR = MR = P
P*
Q*
QI
Q* F
QF
3.
Firms Profits
Firm A
Firm B
Firm C
MC AC
MC
MC
AC
AC
P = MR
P =AR =MR
Q* A
Q* B
Q* C
Depends on firms cost structure
Cost and Revenue, Perfectly Competitive Firm

Business Economics/Session 10 Units of output per period 0 1 2 3 4 5 6 7 8 Price (dollars) 20 20 20 20 20 20 20 20 20 Total revenue (dollars) 0 20 40 60 80 100 120 140 160 Total variable cost (dollars) 0 4 6 10 16 26 46 76 138 Total cost (dollars) 24 28 30 34 40 50 70 100 162 Total profit (dollars) -24 -8 10 26 40 50 50 40 -2
Competitive Market : Long Run Equilibrium

1. Shifts in Supply Curve

PI P3 P2
SI
S3
MC AC
S2
PI P3 P2
Q* Q* 2 1
Q*
Entry / Exit conditions being easy, Profits induce entry of more firms into the industry market supply expand shifts Losses induce exit of firms from the industry market supply contracts. Equilibrium P = AC = MC only normal profits
Monopoly : Market Characteristics

Single seller and many buyers

No close substitutes for product Significant barriers to resource mobility
Control of an essential input Patents or copyrights Economies of scale: Natural monopoly
Monopoly Market
Does a Monopolist have complete freedom in

setting price?
P
D1
P
D2
P
D3
Monopoly Market : Pricing

1.
Nature of Demand Curve

P
Slope of the demand curve determined by the nature of the product Demand curve for firm same as industry Downward sloping demand curve firm can fix either price or quantity

2. Equilibrium Price and Quantity
P P*
MC AC
.
MR
Q*
Profits maximized at MR = MC Supernormal profits at P* & Q* Operates on the falling part of AC curve capacity conditions. (gurvi@less of cost)
excess

3. Can a Monopoly firm be an efficient producer?

MC AC MC
P*
P*
AC
.
MR MR
Q*
Q*
Profits earned depends on

Cost structure and cost efficiency of a monopolist Nature of the product
Price elastic products induces a monopolist to

operate efficiently

4. Does a Monopolist always earn profits?

P*
P*
MC AC MC
.
MR
AC
.
MR
Q*
Q*
Cost structure determines the profits of a Monopolist Entry / Exit conditions difficult
Competitive and Monopoly Markets

MC AC MC
P*
P = AR=MR
P*
AC
.
MR
Q*
Q*
Production efficiency and profit margin

R & D and Product development patents gurvi@Monopoly -Profits maximized at MR = MC Equilibrium P = AC = MC only normal profits

Business Economics Demand and Supply

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Business Economics Demand and Supply

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Business Economics

Session 10: Market Structure Analysis - I

Session Date: 23.02.2013

Demand - Supply Framework

Changes in Demand factors results changes in

Changes in Supply factors results changes in market

Demand Analysis: A Review

Revenue implications of demand curve is given in TR and MR curves

Supply Analysis: A Review

Cost implications of increasing supply is given by supply curve

MC curve is derived from the production and cost relationships

Demand and Supply factors together determine profits earned

= TR - TC d( ) = d(TR) - d(TC) dQ dQ dQ = MR - MC = 0 = MR = MC P & P & Q Q

Changes in Demand & Supply condition translates

This behaviour is also influenced by how firm

Why does competition between products differ What determines competition

Basic Characteristics of Various Market Structures

Perfect Competition Monopolistic

Advertising and Product differentiation Advertising and Product differentiation Advertising

Standardized or Differentiated Unique Product

Market Structure and Competition

Perfect Competition Monopolistic Oligopoly Monopoly

Perfect Competition : Assumptions

Many buyers and sellers

Perfect mobility of resources

Competitive Market : Pricing Decisions

Depends on the demand and supply curves

Competitive Market : Nature of Demand Curve

Demand curve : Industry level

Competitive Market : Nature of Demand Curve

Demand curve : Firm level

Determination of Equilibrium Quantity and Price : Short run

Relationship between P, AR, MR

Determination of Equilibrium Quantity and Price : Short run

Industry equilibrium price is the Firms given price Profits maximized at MR = MC

Depends on firms cost structure

Cost and Revenue, Perfectly Competitive Firm

Competitive Market : Long Run Equilibrium

1. Shifts in Supply Curve

Monopoly : Market Characteristics

Single seller and many buyers

Does a Monopolist have complete freedom in

Monopoly Market : Pricing

Nature of Demand Curve

Monopoly Market : Pricing

Monopoly Market : Pricing

3. Can a Monopoly firm be an efficient producer?

Profits earned depends on

Price elastic products induces a monopolist to

Monopoly Market : Pricing

4. Does a Monopolist always earn profits?

Competitive and Monopoly Markets

Production efficiency and profit margin

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