Market Analysis: Structures

Market Structures: Determinants

Number and size distribution of Sellers: Large number each firm will have less influence on price, one dominant firm or few large firms providing substantial portion of supply will have more impact on price as against firms of nearly equal size Number and size distribution of buyers: will decide the influence of buyers on price and demand Product Differentiation: with this, seller can charge different price for his product Conditions of entry and exit: ease of entry increases threat of competition; ease of exit depends whether resources can be used for alternative products, or are specialized

Perfect Competition (PC): Characteristics

Large number of small sized buyers and sellers: so none can exert significant influence over price, each is a price taker and not a price maker Homogenous Product : identical products or perfect substitutes, so buyer can switch in case of price increase by one seller wheat, potato, rice etc. Ease of entry and exit: profits attract entry and losses call for exit; resources can be easily transferred among industries Perfect knowledge of prices: so no seller can charge higher price than market price No cost of transportation Perfect mobility of factors of production: to ease entry and exit conditions

PC: Equilibrium Price

Since no single firm can influence price, it is determined by market forces of demand and supply Total demand: sum of demands of individual buyers Total Supply: sum of supply of individual firms This equilibrium price is thus given to each individual firm, it is a price taker, thus its demand curve is horizontal and is = AR= MR curve

Profit Maximising Output in Short Run

Equilibrium Output: Price is given to the firm, hence it decides profit maximising output at the level where MC=MR i.e. where MC curve intersects MR curve, which is the profit maximising point for any firm In case given price is above the SAC curve, firm makes profits In case given price is below (less than) SAC, firm makes losses However in such a case of losses, firm will still continue production in the short run if this price is above its SAVC curve, ie. when it covers its variable costs even though not all of its fixed costs, which (FCs) in any case, it has to bear Shut Down Point: If this price is below the SAVC curve also, then it will have to shut down/ discontinue operations since in this case, it does not even cover its variable costs and hence can minimize losses by stopping production

Profit Maximising Output in Long Run

In LR, entry and exit are freely permissible and all factors are variable Hence if firms are making supernormal profits in SR, then more firms will enter industry or existing will expand capacities in LR, to encash this situation This will increase supply and move the supply curve outwards, thereby reducing the equilibrium price This will continue till Price/ demand line of a firm becomes tangent to LAC curve, i.e. at its minimum, hence all supernormal profits are wiped out, only normal returns are earned In case of losses in the SR, some firms will exit the industry, thus decreasing supply and thereby increasing the price and reducing losses till again the price becomes tangent to LAC and firm starts to make normal profits Hence, LR equilibrium achieved when price line tangent to AC curve, i.e. P=AR=MR=AC=MC

Monopoly

Single seller/ producer in the market: thus can greatly influence price and the demand curve of firm = dd curve of industry and is downward sloping; firm is price maker and not price taker Unspecified number of buyers No close substitutes available, product is well differentiated Free entry/exit prohibited/made difficult: either natural or artificial restriction

Monopoly: Equilibrium Price and Output

Demand curve of monopolist is market demand curve since he is the only seller Thus profit maximising rule for him same as of others, i.e. at the point where MC= MR, i.e. where MC curve intersects MR curve He makes supernormal profits at this point, by difference between AC and AR/ P curve multiplied by quantity sold Since entry of other firms is prohibited in LR, monopolist can continue to earn supernormal profits even in the LR So LR situation no different from SR situation due to barriers to entry He can make losses if price is below his AC curve, will have to adjust plant size in LR so that his AC falls and he makes some profits

Price Discrimination

Means: charging different prices from different buyers for the same product First degree price discrimination: when each unit is sold to the consumer at a different price, maximum price for each unit, so entire consumer surplus is taken by the producer; rarely in practice; eg. Sale of T- bills by govt. Second degree price discrimination: buyers groups based on price elasticity of demand, charge higher price in less elastic group; or on slabs of quantities purchased by consumer; first range/ block at higher price, then second and so on; eg. In case of electricity Third degree price discrimination: markets are segmented based on their demand characteristics, on various factors like geographical coverage (books); nature of use (telephones: residential/ business) etc.

Equilibrium under Price Discrimination

Equilibrium determined from intersection of MC curve with aggregate of MR curves of different market segments with different elasticities This output is divided between the markets and price charged in each as per their respective AR/demand curves Thus higher price charged in market with lower elasticity

Monopolistic Market Structure

Combines features of PC and monopoly

Large number of small sellers Large number of small buyers Products slightly differentiated, product of one firm is a fairly close substitute for that of other sellers, hence each firm has some control/monopoly over the price, thus leading to downward sloping demand curve; eg. Different brands of shampoos, detergents, soaps etc. This product differentiation can be real or imaginary; thus advertising and selling strategies acquire importance in this model Easy entry and exit in the industry

Equilibrium condition

Like monopoly, downward sloping demand curve Profit maximising output and price is where MC= MR Thus there could be supernormal profits in SR However in LR, since free entry/ exit permissible, it is like PC model. More firms enter, thus reducing price, till the AR curve is tangent to LAC curve, when all supernormal profits are wiped out Incase of losses, firms exit thus reducing supply and increasing price till again AR is tangent to LAC curve, so firm makes normal profits

Oligopoly

Small number of sellers Unspecified number of buyers Important feature is interdependence amongst sellers, each firm considers reactions of other firms to its own moves and also reacts to other firms moves, hence major role of strategy here Importance of selling and advertising cost: since products are close substitutes Group behaviour: tendency to act in a group for benefit of all and avoid price wars Due to interdependence and reactions of firms, demand curve of oligopolist is not fixed and will keep changing

Cartels/ Collusions

Avoiding price wars/ competition, can raise prices and profits for everyone Hence need for cartels/ collusions/ price fixing agreements/ price leadership Collusive Oligopoly : through an agreement: formal or tacit. Can be : - Cartel: Equilibrium attained by MC=MR (combined) and then price given to the firms; each can produce output based on its cost conditions or sometimes even output quotas of each firm are decided by the cartel - Price leadership : of low cost firm, dominant firm, barometric leadership (old and experienced, quick to sense changes and initiate moves), aggressive price leadership

Kinked demand curve of Oligopolist

Demand curve of an oligopolist firm has a kink Above this, dd curve is more elastic since sales reduction for price increase very high as rivals do not follow the price increase; below this price, sales increase for price reduction not as high since rivals follow price reductions Hence, prices remain more stable/sticky in oligopoly structure for a long time even with increase in costs

Industry Analysis: Structureconduct - performance

Industry structure decides the behaviour of the firms in it which in turn reflects their performance Perfect competition : production at lowest point of LAC, hence cost efficiency is there But firms have no incentive to compete here since they are price takers and product is homogeneous; such competition is there in imperfect competition which sometimes benefits consumers More advertising and R&D expenses in imperfect competition which benefits consumers