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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

There should be buyers and sellers.

There should be contact between buyers and sellers (directly or through dealers).
Buyers and sellers should deal with the same commodity.
There should be a price for the commodity.

Market structures

On the basis of competition markets can be classified as:

o Perfect competition
o Monopoly
o Monopolistic competition
o Oligopoly
o Duopoly
Perfect Competition

Features and conditions of perfect competition

(1) Large number of buyers and sellers

Eg: Rice market

Sellers sell at market price.
Contribution of individuals or single firm is insignificant. Therefore, sellers cannot influence

market price.
Individual demand is very small. Therefore, buyers cannot alter price.
Both, buyers and sellers cannot fix the price.
Sellers have to accept the price fixed by the market. Therefore, they are price takers.

(2) Homogenous products

Products are homogenous and identical (Rice)

If single seller charges high price he loses his customers.

(3) Free entry and exit conditions

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

Firms are not compelled to enter or exit (high profits enter; loss exit/leave).
Therefore, there are large number of firms.

(4) Absence of government or artificial restriction

No government restriction on supply and pricing.

If these 4 conditions are fulfilled then there is Pure competition.

(5) Perfect knowledge on the part of buyers and sellers

Buyers and sellers know about the market conditions.

Therefore, buyers wont offer more price and sellers wont accept less price.
Hence, there is no need of advertisement.

(6) Perfect mobility of factors of production

Factors should be free to move from one industry to another, depending on the
remuneration they get.

(7) Absence of transport cost

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

Price determination under Perfect competition

Price is determined by the interaction of 2 forces; viz., demand and supply (aggregate).
Individual demand and supply cannot influence price.
Equilibrium Price
Price is determined by the interaction of demand and supply (D=S).

Equilibrium price where D=S.

Equilibrium output is OM.
At equilibrium both buyers and sellers are satisfied.
If price>equilibrium price then S>D (unsold stock is disposed at lower price). Thereby,

price reaches equilibrium.

If price is below the equilibrium price D>S buyers wont get the desired quantity. So, they

would bid the prices up. Thereby, price will go on increasing and reaches the equilibrium.
Equilibrium of the firm and industry under Perfect Competition

Conditions for equilibrium of firm and industry

(1) MC=MR
(2) MC should cut MR from below
Firm equilibrium when MC=MR=AR (price)

B is the equilibrium point (both the conditions are satisfied).

No production beyond OM1 (loss) MC>MR
Industry equilibrium
(1) No tendency for the firms to enter or leave the industry (AC=AR; Normal profits).
(2) Each firm is in equilibrium (implies MC=MR).

(i) Short-run equilibrium of the firm

Only variable factors can be varied to maximize profits.

Number of firms is fixed; none of the firms enter or leave the industry.
In short-run, firms earn super-normal profits, normal profits or they may incur loss.

Some firms earn super-normal profits PE1ST and some incur loss PE3BA.

(ii) Short-run equilibrium of the industry

For full equilibrium of the industry in short run, all firms should earn normal profits.
Condition for equilibrium is SMC=MR=SAC=AR.
D=S; equilibrium price OP, equilibrium output OQ.
At OP price some firms are earning super-normal profits PE 1ST, some firms incur loss
PE2GF.

(iii) Long-run equilibrium of the firm

AC=AR; Normal profits i.e., no profit; no loss.

Conditions for equilibrium
(1) LMC=MR=LAC=AR=P.
(2) LMC must cut MR from below.

(iv) Long-run equilibrium of the industry

Full equilibrium where LMC=MR=AR=P=LAC (at its minimum point).

All firms earn normal profits.
Industry equilibrium where D=S; E equilibrium.
The condition is satisfied at OP price.
There is no tendency to leave the industry.
Monopoly

Features
1. Single seller / Producer (single control).
2. No close substitutes.
3. No free entry.
4. The monopolist can fix the prices (price makers).
5. Price discrimination.
o
o
o
o

Eg: State Electricity Board (domestic and industry charges differ)

Indian Railways (I class and II class fares are different)
Hindustan Aeronautics Limited (HAL) has monopoly over the production of aircrafts.
Government has the monopoly over the production of nuclear power.
In Monopoly, there is single seller. Therefore, there is no distinction between firm and
industry.

Advantages of monopoly

Possess large financial resources.

o Can spend on innovation and technological progress.
No need of advertisement, publicity (savings on this front).
Monopoly is essential for public utilities (water supply, electricity, railways etc large capital
investment is required).

Disadvantages of monopoly

Restriction in supply (output; price; exploitation of consumers).

Consumer choice is restricted (no variety).
Inefficiency or wasteful costs results in higher prices (due to absence of competition).

Price-output determination under monopoly

Aim: To maximize profits

Price & output: Determined where maximum revenue is possible.

Conditions for equilibrium

1. MC=MR
2. MC should cut MR from below
Short-run equilibrium

Equilibrium where MC=MR, at E.

Equilibrium output OQ; equilibrium price OP.
A monopolist earns super-normal profit i.e., PRST

Sometimes in short-run, a monopolist may incur loss.

Loss is PACB

Long-run equilibrium

In long-run, the firm has time to adjust its plant size to maximize profits.
Equilibrium output OQ; equilibrium price OP where LMC=MR.
Super-normal profit equal to TPBA.

Price discrimination or Discriminating monopoly

Price discrimination / Differential pricing

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

Types of price discrimination

1. Personal discrimination

Seller charges different prices for different persons.

Eg: Doctors (different fees from different patients).

2. Local / Place discrimination

Seller charges different prices for people of different localities.

Eg: Dumping (P in foreign market; P in domestic).

3. Trade discrimination (according to use)

Price discrimination is possible when the same commodity is put to different uses.
Eg: Electricity (different charges for domestic and industrial use).
Monopolistic competition

Features
1. Existence of large number of firms

Large number of firms produce a commodity.

Each firm act independently, on the basis of product differentiation.
Each firm determines the price-output policies.
Eg: Soaps, pastes, shampoos etc.

2. Product differentiation

This is the essence of monopolistic competition.

Pricing is not the problem but product differentiation is the problem and competition is not
on prices but on products.
Ways of product differentiation
Physical difference (colour, size, fragrance etc)
Quality difference (better raw materials, chemical mixtures)
Imaginary difference (through advertisement)

3. Selling costs

Cost incurred to popularize the brand viz., advertisement.

Sales promotion by advertisement is called non-price competition.

4. Freedom of entry and exit of firms

New firms can enter and the old firms can exit the industry. Hence the number of firms is
large.

5. Group equilibrium

Chamberlin introduced the concept of group in the place of industry.

Industry Firms producing homogenous products.

Firms under monopolistic competition produce similar but not identical products. Therefore,
the concept group.

6. Nature of the demand curve

AR is highly elastic due to product differentiation.

If price is less; more sales & vice versa.
Price determination

Short-run
Super-normal profits

AR curve is neither too steep nor too flat.

Equilibrium point is determined where MC=MR; equilibrium output OM, equilibrium price OP
Super-normal profits = PQRS.
Demand is more sensitive to price (small change in price; large change in demand).

Loss

In short run, firms may incur loss also.

The equilibrium point is E1, where MC=MR, OM is equilibrium output.
The firm incurs minimum losses as C>R.
Established firms may earn super-normal profits; new firms charge low price and earn low
profits (sometimes incur loss).

Thus in monopolistic competition, firms may be making either super-normal profits, normal
profits or incur loss in short period.

Group equilibrium in the long period

Chamberlins assumption for long run group equilibrium are:

1. Products are more or less similar.

2. The firms have equal market demand. So, AR curves are similar.
3. All firms are equally efficient. So, cost curves are similar.
4. Each firm considers itself independent in the group.

Equilibrium is determined where LPMR=LPMC.

Equilibrium at E, OM output and OP price.
LPAR touches the LPAC. So AC=AR. Therefore, no profit; no loss (normal profits).
Since the firms get normal profits, new firms wont enter. Therefore, the group has come to

equilibrium.
In long run, due to super normal profits, new firms enter and they fix low prices. Therefore,
old firms are compelled to keep prices low. Hence, in long run, firms get only normal profits.

Criticism

There cannot be uniform costs and demand.

Defects of monopolistic competition

1. Unemployment

Full production capacity may not be used.

Unemployment of resources.

2. Excess capacity

Monopolistic firm will not produce optimum output.

Price and output is not determined at the lowest point of LAC, but where LAC is falling.
It results in less output and unutilized capacity

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3. Failure to specialize

Advantages due to specialization are lost due to excess capacity i.e., no advantage of large
scale production.

4. Advertising

Waste in competitive advertisement.

It results in consumer exploitation (cost is included in the price).

Oligopoly

Few large firms.

They produce homogenous or differentiated products.
o Eg: Cement, Aluminium, Petroleum refining, Tablets, Automobiles etc.

Features of Oligopoly
1. Interdependence

Price-output decision of one firm will affect the other firms, they may retaliate.
Firms cannot act independently in fixing prices.
Firms are interdependent in fixing prices and output.

2. Indeterminate demand curve

Firms cannot forecast / predict their demand and sales.

3. Importance of selling cost

Demand is indeterminate.
Therefore, firms go in for aggressive advertisement.

4. Group behavior

If the firms realize the importance of mutual co-operation, there is a tendency of collusion.
But, if each firm have the intention to maximize profits, it leads to competitive spirit.

5. Element of monopoly

Each firm controls a large share of market, so each firm becomes a petty monopolist.

6. Price rigidity

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Price will be kept unchanged due to fear of retaliation and prices tend to be sticky and
inflexible.
Even for years together price remain rigid.
No firm will indulge in price cutting as it would lead to price-war.
The reasons for price rigidity are:
o If price changes, more expense for revision of catalogue (it irritates the customers)
o P
- Price-cutting by rivals
o P
-Rivals will not change or increase the price. Hence, they may lose
customers.
Pricing under Oligopoly

Kinked demand curve Sweezys model

Kinked demand curve was used by Prof. Paul. M. Sweezy.

Kinked demand curve is due to price rigidity.
If firms raise the price
- Rivals will not follow suit
If firms lower the price
- Rivals will follow it.

DPB is the demand curve.

DP Elastic demand; PB Inelastic demand.
PN is the rigid price.
At PN price, the firm produces and sells ON output.
If price rises above P, elastic demand curve, so demand for the firms product falls.

Therefore, profit falls (corresponding marginal revenue is MR).

If price falls, other firms follow it. Therefore, there is no increase in sales. PB portion of the

demand curve is inelastic and MR is negative.

Gap KL Depends on elasticity above and below the kink.
Gap is large, if elasticity is greater above the kink and inelasticity is greater below the kink.
Price will not change in oligopoly unless there is a drastic change in demand and cost

conditions.
Criticism
o Price rigidity
Duopoly

Features

There are only 2 sellers (only 2 firms have dominant control over a market).

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The 2 firms may either resort to competition or collusion.

o Competition - To eliminate rivals and become monopolist
o Collusion
- To avoid cut-throat competition and to cooperate and fix the price
Eg: Visa and Mastercard (they control a large proportion of the electronic payment

processing market).
Eg: Airbus and Boeing is the market for large commercial airplanes.
Duopolistic market with exactly two suppliers is not very common. However, there are

number of products that have two dominant suppliers plus a few smaller ones. For
example, in aerated soft drinks market, Coca Cola and Pepsi represent two dominant
suppliers in many countries.