Economics Unit 4 New

7/25/2019 Economics Unit 4 New

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Unit - 4

Market Structure

Market

It is a public place in which goods and services are bought and sold.

Market Definition

According to Benham, Market is any area over which buyers and sellers are in close touch

with one another, either directly or through dealers, that the price obtainable in one part of

the market affects the prices paid in other parts.

Basic components of a market

here should be buyers and sellers.

here should be contactbetween buyers and sellers !directly or through dealers".

Buyers and sellers should deal with the same commodity. here should be a pricefor the commodity.

Market structures

#n the basis of competition markets can be classified as$

o %erfect competition

o Monopoly

o Monopolistic competition

o #ligopoly

o &uopoly

Perfect Competition

Features and conditions of perfect competition

(!"ar#e number of buyers and sellers

'g$ (ice market

)ellers sell at market price$

*ontribution of individuals or single firm is insignificant. herefore, sellers cannot influence

market price. Individual demand is very small. herefore, buyers cannot alter price.

Both, buyers and sellers cannot fi+ the price. )ellers have to accept the price fi+ed by the market. herefore, they are price takers$

(%! &omo#enous products

%roducts are homogenous and identical !(ice"

If single seller charges high price he loses his customers.

('! Free entry and eit conditions

In short period, firms cannot enter or leave the industry.

irms are not compelled to enter or e+it !high profits - enter loss - e+it/leave".

herefore, there are large number of firms.(4! )bsence of #o*ernment or artificial restriction

0o government restriction on supply and pricing.


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If these 1 conditions are fulfilled then there is Pure competition$

(+! Perfect kno,led#e on te part of buyers and sellers

Buyers and sellers know about the market conditions.

herefore, buyers won2t offer more price and sellers won2t accept less price.

3ence, there is no need of ad*ertisement$

(.! Perfect mobility of factors of production

actors should be free to move from one industry to another, depending on the

remuneration they get.

(/! )bsence of transport cost

In perfect competition, there is a uniform price, i.e., transport costs are not includedin

price.Price determination under Perfect competition

%rice is determined by the interaction of 4 forces vi5., demand and supply !aggregate". Individual demand and supply cannot influence price.

01uilibrium Price %rice is determined by the interaction of demand and supply !&6)".

'7uilibrium price where &6).

'7uilibrium output is #M.

At e7uilibrium both buyers and sellers are satisfied.

If price2e1uilibrium price then S2D!unsold stock is disposed at lower price". hereby,

price reaches e7uilibrium. If price is belo, te e1uilibrium price D2Sbuyers won2t get the desired 7uantity. )o, they

would bid the prices up. hereby, price will go on increasing and reaches the e7uilibrium.

01uilibrium of te firm and industry under Perfect Competition

Conditions for e1uilibrium of firm and industry

!8" M*6M(!4" M* should cut M( from below

irm e7uilibrium when M*6M(6A( !price"


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B is the e7uilibrium point !both the conditions are satisfied".

0o production beyond #M8!loss" M*9M(

3ndustry e1uilibrium

!8" 0o tendency for the firms to enter or leave the industry !A*6A( 0ormal profits".!4" 'ach firm is in e7uilibrium !implies M*6M(".

(i! Sort-run e1uilibrium of te firm

#nly *ariable factorscan be varied to ma+imi5e profits. 0umber of firms is fied none of the firms enter or leave the industry.

In short:run, firms earn super-normal profits normal profits or tey may incur loss$

)ome firms earn super:normal profits %'8) and some incur loss %';BA.

(ii! Sort-run e1uilibrium of te industry


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or full e7uilibrium of the industry in short run, all firms should earn normal profits. *ondition for e7uilibrium is SMC5M65S)C5)6$

&6) e7uilibrium price #%, e7uilibrium output #M*6M(6>A*6A(6%.!4" >M* must cut M( from below.

(i*! "on#-run e1uilibrium of te industry


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ull e7uilibrium where >M*6M(6A(6%6>A* !at its minimum point".

All firms earn normal profits.

Industry e7uilibrium where &6) ' e7uilibrium.

he condition is satisfied at #% price.

here is no tendency to leave the industry.

Monopoly

Features

8. )ingle seller / %roducer !single control".

4. 0o close substitutes.

;. 0o free entry.

1. he monopolist can fi+ the prices !price makers".

?. %rice discrimination.

o 'g$ )tate 'lectricity Board !domestic and industry charges differ"

o Indian (ailways !I class and II class fares are different"

o 3industan Aeronautics >imited !3A>" has monopoly over the production of aircrafts.

o =overnment has the monopoly over the production of nuclear power.

In Monopoly, there is single seller. herefore, there is no distinction between firm and

industry.

)d*anta#es of monopoly %ossess large financial resources.

o *an spend on innovation and technological progress.

0o need of advertisement, publicity !savings on this front".

Monopoly is essential for public utilities !water supply, electricity, railways etc - large capital

investment is re7uired".

Disad*anta#es of monopoly

(estriction in supply !output price e+ploitation of consumers".

*onsumer choice is restricted !no variety".

Inefficiency or wasteful costs results in higher prices !due to absence of competition".

Price-output determination under monopoly

)im7o ma+imi5e profits

Price 8 output7&etermined where ma+imum revenue is possible.

Conditions for e1uilibrium

8. M*6M(

4. M* should cut M( from below

Sort-run e1uilibrium


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'7uilibrium where M*6M(, at '.

'7uilibrium output #oss is P)CB

"on#-run e1uilibrium

In long:run, the firm has time to ad@ust its plant si5e to ma+imi5e profits.

'7uilibrium output #


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Price discrimination or Discriminatin# monopoly

Price discrimination : Differential pricin#

It is selling the same product / service at different prices to different buyers.

9ypes of price discrimination

$ Personal discrimination

)eller charges different prices for different persons.

'g$ &octors !different fees from different patients".

%$ "ocal : Place discrimination

)eller charges different prices for people of different localities.

'g$ &umping !% in foreign market % in domestic".

'$ 9rade discrimination!according to use"

%rice discrimination is possible when the same commodity is put to different uses.

'g$ 'lectricity !different charges for domestic and industrial use".

Monopolistic competition

Features

$ 0istence of lar#e number of firms

>arge number of firms produce a commodity.

'ach firm act independently, on the basis of product differentiation. 'ach firm determines the price:output policies.

'g$ )oaps, pastes, shampoos etc.

%$ Product differentiation

his is the essence of monopolistic competition.

%ricing is not the problem but product differentiation is the problem and competition is not

on prices but on products.;ays of product differentiation

%hysical difference !colour, si5e, fragrance etc"


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irms under monopolistic competition produce similarbut not identical products. herefore,

the concept #roup.

.$ =ature of te demand cur*e

A( is highly elastic due to product differentiation.

If price is less more sales vice versa.

Price determination

Sort-run

Super-normal profits

A( curve is neither too steep nor too flat.

'7uilibrium point is determined where M*6M( e7uilibrium output #M, e7uilibrium price #%

Super-normal profits 5 P>6S$

&emand is more sensitive to price !small change in price large change in demand".

"oss

In short run, firms may incur loss also.

he e7uilibrium point is '8, where M*6M(, #M is e7uilibrium output.

he firm incurs minimum losses as *9(.

'stablished firms may earn super:normal profits new firms charge low price and earn low

profits !sometimes incur loss".


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hus in monopolistic competition, firms may be making either super:normal profits, normal

profits or incur loss in short period.

%A( touches the >%A*. )o A*6A(. herefore, no profit no loss !normal profits".

)ince the firms get normal profits, new firms won2t enter. herefore, the group has come to

e7uilibrium. In long run, due to super normal profits, new firms enter and they fi+ low prices. herefore,

old firms are compelled to keep prices low. 3ence, in long run, firms get only normal profits.

Criticism

here cannot be uniform costs and demand.

Defects of monopolistic competition

$ Unemployment

ull production capacity may not be used.

nemployment of resources.

%$ 0cess capacity

Monopolistic firm will not produce optimum output.

%rice and output is not determined at the lowest point of >A*, but where >A* is falling.

It results in less output and unutili5ed capacity


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'$ Failure to speciali?e

Advantages due to speciali5ation are lost due to e+cess capacity2 i.e., no advantage of large

scale production.

4$ )d*ertisin#

Caste in competitive advertisement.

It results in consumer e+ploitation !cost is included in the price".

@li#opoly

ew large firms.

hey produce homogenous or differentiated products.

o 'g$ *ement, Aluminium, %etroleum refining, ablets, Automobiles etc.

Features of @li#opoly

$ 3nterdependence

%rice:output decision of one firm will affect the other firms, they may retaliate.

irms cannot act independently in fi+ing prices.

irms are interdependent in fi+ing prices and output.

%$ 3ndeterminate demand cur*e

irms cannot forecast / predict their demand and sales.

'$ 3mportance of sellin# cost

&emand is indeterminate.

herefore, firms go in for aggressive advertisement.

4$


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%rice will be kept unchanged due to fear of retaliation and prices tend to be sticky and

infle+ible. 'ven for years together price remain rigid.

0o firm will indulge in price cutting as it would lead to price-,ar.

he reasons for price rigidity are$

o If price changes, more e+pense for revision of catalogue !it irritates the customers"o % D : %rice:cutting by rivals

o % E :(ivals will not change or increase the price. 3ence, they may lose

customers.

Pricin# under @li#opoly

Ainked demand cur*e S,ee?ys model

Finked demand curve was used by %rof. %aul. M. )wee5y.

Finked demand curve is due to price rigidity. If firms raise the price : (ivals will not follow suit

If firms lower the price : (ivals will follow it.

&%B is the demand curve.

&% - 'lastic demand %B - Inelastic demand.

%0 is the rigid price.

At %0 price, the firm produces and sells #0 output.

If price rises above %, elastic demand curve, so demand for the firms2 product falls.

herefore, profit falls !corresponding marginal revenue is M(". If price falls, other firms follow it. herefore, there is no increase in sales. %B portion of the

demand curve is inelastic and M( is negative. =ap F> - &epends on elasticity above and below the kink.

=ap is large, if elasticity is greater above the kink and inelasticity is greater below the kink.

%rice will not change in oligopoly unless there is a drastic change in demand and cost

conditions. Criticism

o %rice rigidity

Duopoly

Features

here are only 4 sellers !only 4 firms have dominant control over a market".


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he 4 firms may either resort to competition or collusion.

o *ompetition : o eliminate rivals and become monopolist

o *ollusion : o avoid cut:throat competition and to cooperate and fi+ the price

'g$ Gisa and Mastercard !they control a large proportion of the electronic payment

processing market".

'g$ Airbus and Boeing is the market for large commercial airplanes. &uopolistic market with e+actly two suppliers is not very common. 3owever, there are

number of products that have two dominant suppliers plus a few smaller ones. or

e+ample, in aerated soft drinks market, *oca *ola and %epsi represent two dominant

suppliers in many countries.

Economics Unit 4 New

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