Market Analysis

Market Analysis

Structure – Conduct – Performance

 Market Structure
 Number of firms.
 Industry concentration.
Herfindahl-Hirschman Index - HHI: A commonly accepted measure of market
concentration. It is calculated by squaring the market share of each firm
competing in a market, and then summing the resulting numbers.
The HHI number can range from close to zero to 10,000.
four-firm concentration ratio
six- firm concentration ratio

 Technological and cost conditions.

 Demand conditions.
 Ease of entry and exit.
• There are around 69 million DTH homes and
the number has been increasing because the
players have weaned away subscribers from
cable services. There are over 86 million
digital cable households.
 Conduct
 Pricing.
 Advertising.
 R&D.
 Merger activity.
 Performance

Profitability.
Social welfare.
 The Degree of Competition
• Classifying markets
– number of firms
– freedom of entry to industry
– nature of product
– nature of demand curve
• The four market structures
– perfect competition
– monopoly
– monopolistic competition
– oligopoly
 Perfect Competition
Qualifying a perfectly competitive market :
 Large number of buyers and sellers (price takers)
 Freedom of entry
 Identical products
 Uniform Pricing policy
 Perfect knowledge
 Free mobility of factors
 Least intervention of government
 No Transportation costs
 Short-run equilibrium of industry and firm under
perfect competition

P £
S MC AC

Pe D = AR
AR
AC = MR

D
O O Qe
Q (millions) Q (thousands)

(a) Industry (b) Firm

 Loss minimising under perfect competition

P £ AC
S MC

AC
D1 = AR1
P1 AR1
= MR1

D
O O Qe
Q (millions) Q (thousands)

(a) Industry (b) Firm

 Deriving the short-run supply curve

P S £
MC = S
a D1 = MR1
P1
b D2 = MR2
P2
c D3 = MR3
P3
D1
D2
D3
O O
Q (millions) Q (thousands)

(a) Industry (b) Firm

 Perfect Competition
• Long-run equilibrium of the firm

– all supernormal profits competed away

– LRAC = AC = MC = MR = AR
 Long-run equilibrium under perfect competition
New firms enter Profits return
Supernormal profits
to normal
P £
S1
Se

LRAC
P1 AR1 D1
PL ARL DL

D
O O QL
Q (millions) Q (thousands)

(a) Industry (b) Firm

 Long-run equilibrium of the firm under perfect
£
competition
(SR)MC
(SR)AC

LRAC

DL
AR = MR

LRAC = (SR)AC = (SR)MC = MR = AR

O Q
 Perfect Competition
• Benefits of perfect competition

– price equals marginal cost

– prices kept low

– firms must be efficient to survive

 Perfect competition
• The market demand and supply equations for Plywood are given by
• Qs = 20,000 + 30P
• Qd = 40,000 – 20P
• Determine the equilibrium price and quantity

• Suppose an increase in housing starts results in a new demand equation Qd =

50,000 -20P. What is the new equilibrium price and quantity?

• The Plywood industry is perfectly competitive, and the marginal cost equation for
one firm, Greenply, is given by MC = 200 + 4Q. What is the short-run output rate
for Greenply?

• The Average Cost is given by AC= 1000/Q +200 + 2Q. In the short-run , how much
economic profit will the firm earn?

• Suppose in the long-run many firms will enter the industry and the supply would
increase to S = 24000+30P. Find out the long-run profit for the firm.
• In a perfectly competitive market supply and demand functions are
• Qs = 1000P + 500
• Qd = 5000 – 500P
• If variable cost function of a firm is VC = 103Q – 0.5Q2. Find the Profit
maximising output for the firm and the Economic profit maximising
output.

• XYZ Ltd., operating in a perfectly competitive market, sells a stationery

item at Rs.10 per unit. The cost function is given as
• TC = 4,000 + 4Q + 0.02Q2.
• Find the profit maximising output for the firm.
 Softy Cereals Inc. (SCI) produces and markets Tasties, a popular ready-to-eat
breakfast cereal. The demand and supply functions of Tasties are as
follows:
• QD = 150– 3P
• QS = 50 +10P.
• If excise tax of Rs.3 is imposed on Tasties, what is the proportion of tax
that will be borne by the consumers?
•
• Demand and supply functions for a product are:
• Qd = 10,000 – 4P
• Qs = 2,000 + 6P
• If the government imposes a excise tax of Rs.100 per unit, what will be the
new equilibrium price? What is the proportion of tax shared by the
producers and consumers?
 Monopoly
• Defining monopoly
• Barriers to entry
– economies of scale
– economies of scope
– product differentiation and brand loyalty
– lower costs for an established firm
– ownership/control of key factors/outlets
– legal protection
– mergers and takeovers
– aggressive tactics
 Defining Monopoly
• Pure monopoly is the form of market organization in which a single firm
sells a commodity for which there are no close substitutes. Monopoly is at
the opposite extreme from perfect competition in the spectrum or range
of market organisation.
 Features
• Single seller
• No close substitutes
• Entry is blocked
• No difference between firm and industry
• Price discrimination
• Downward sloping demand curve( less elastic)
 Monopoly
• The monopolist’s demand curve
– downward sloping
– MR below AR
• Equilibrium price and output
– Equilibrium output, where MC = MR
– MR = P (1+1/e)
£ Profit maximisingMC
under monopoly

MR
O Qm Q
 Monopoly
• The monopolist’s demand curve
– downward sloping
– MR below AR
• Equilibrium price and output
– Equilibrium output, where MC = MR
– Equilibrium price, found from demand curve
 Profit maximising under monopoly
£ MC

AC

AR

AC

AR
MR
O Qm Q
 Monopoly
• The monopolist’s demand curve
– downward sloping
– MR below AR
• Equilibrium price and output
– Equilibrium output, where MC = MR
– Equilibrium price, found from demand curve
• Profit
– Measuring profit
– Supernormal profit can persist in long run
 Profit maximising under monopoly
£ MC
Total profit
AC

AR

AC

AR
MR
O Qm Q
 Monopoly
• Disadvantages of monopoly
– high prices / low output: short run
– high prices / low output: long run
– lack of incentive to innovate
• Advantages of monopoly
– economies of scale
– profits can be used for investment
– high profits encourage risk taking
 Monopoly Control
• Promoting competition
• Government Regulation
• Public Ownership
• Legal Action
• Fiscal Measures
• Promotion of Co-operation
• Publicity Drive
• Consumer Awareness
The demand and cost functions of a monopolist are
P = 800 – 10Q
TC =300Q + 2.5Q2

1. What is the Profit maximizing output and price for the

monopolist?
2. What is the economic profit earned by the Monopolist?
 The Deadweight Loss
• Because a monopoly sets its price above
marginal cost, it places a wedge between the
consumer’s willingness to pay and the
producer’s cost.
• This wedge causes the quantity sold to fall
short of the social optimum.
 The Market for Drugs
Costs
and
Revenue

Price
During
patent
life
Price rafter
patent Marginal
expires cost
Marginal Demand
revenue

0 Monopoly Competitive Quantity

quantity quantity
 The Inefficiency of Monopoly
Price
Deadweight Marginal cost
loss

Monopoly
price

Marginal
revenue Demand

0 Monopoly Efficient Quantity

quantity quantity
Welfare with and without Price
Discrimination
(a) Monopolist with Single Price

Price

Consumer
surplus

Monopoly Deadweight
price loss
Profit
Marginal cost

Marginal Demand
revenue

0 Quantity sold Quantity

• For a monopolist the total revenue function is
given as TR = 6,400Q – 80Q2 . The marginal
cost of the firm is Rs.160. What is the profit
maximizing output and price?
 Price Discrimination
• Meaning of price discrimination
– First degree

– Second degree

– Third degree (the most common form)

• Conditions necessary for price discrimination

 Price Discrimination
• Profit maximising prices and output under
price discrimination
 Profit-maximising output under
third degree price discrimination

MC

8
6
5
DY
DX MRY MRT
O 1000 O 2000 O 3000
MRX

(a) Market X (b) Market Y (c) Total

(markets X + Y)
 Price Discrimination
• Profit maximising prices and output under
price discrimination

• Price discrimination and the public interest

– competition

– profits
• Demand functions of a monopolist in two effectively
segmented markets are:
• Qa = 1,000 – 50Pa
• Qb = 800 – 25Pb
• Total cost function of the monopolist is TC = 500 + 10Q.
• If the monopolist does not practice price discrimination, what
is the sales maximizing price ?
 Price Discrimination

• A firm sells in two markets and has constant marginal costs of production
equal to $2 per unit. The demand and demand and marginal revenue
equations for the two markets are as follows:
•
• Market 1 Market 2
•
• P1 = 14 – 2Q1 P2 = 10 – Q2
MR1 = 14 – 4Q1 MR2 = 10 – 2Q2
•
• Using third-degree price discrimination, what are the profit-maximizing
prices and quantities in each market? Show that greater profits result
from price discrimination than would be obtained if a uniform price were
used.
 Monopolistic Competition
Assumptions of monopolistic competition
• Large number of firms
• Easy Entry
• Product differentiation
• Selling costs
 Short-run equilibrium of the firm
under monopolistic competition
£ MC

AC

Ps

ACs

AR = D

MR
O Qs Q
 Monopolistic Competition
• Assumptions of monopolistic competition
• Equilibrium of the firm
– short run
– long run
 Long-run equilibrium of the firm
under monopolistic competition
£

LRMC

LRAC

PL

ARL = DL

MRL
O QL Q
 Monopolistic Competition
• Assumptions of monopolistic competition
• Equilibrium of the firm
– short run
– long run
– underutilisation of capacity in the long run
Long run equilibrium of the firm under perfect and
monopolistic competition
£

LRAC

P1

P2
DL under perfect
competition

DL under monopolistic
competition

O Q1 Q2 Q
 Monopolistic Competition
• Assumptions of monopolistic competition
• Equilibrium of the firm
– short run
– long run
– underutilisation of capacity in the long run
• Non-price competition
 Monopolistic Competition
• Assumptions of monopolistic competition
• Equilibrium of the firm
– short run
– long run
– underutilisation of capacity in the long run
• Non-price competition
• The public interest
 Monopolistic Competition
• Assumptions of monopolistic competition
• Equilibrium of the firm
– short run
– long run
– underutilisation of capacity in the long run
• Non-price competition
• The public interest
– comparison with perfect competition
 Monopolistic Competition
• Assumptions of monopolistic competition
• Equilibrium of the firm
– short run
– long run
– underutilisation of capacity in the long run
• Non-price competition
• The public interest
– comparison with perfect competition
– comparison with monopoly
 Oligopoly - features
• Key features of oligopoly
– barriers to entry
– interdependence of firms
• Competition versus collusion
• Collusive oligopoly: cartels
– equilibrium of the industry
– barriers to entry
– interdependence of firms
• Competition versus collusion
• Collusive oligopoly: cartels
 Cartels
• A cartel is said to exist when two or more enterprises enter
into an explicit or implicit agreement to fix prices, to limit
production and supply, to allocate market share or sales
quotas, or to engage in collusive bidding or bid-rigging in one
or more markets. Its purpose is to coordinate the policies of
the member firms so as to increase profits. Cartels are
illegal.Cartelisation is prohibited under Section 3 of the
Competition Act.

• A cartel is formal organisation of producers of a commodity.

Centralised cartels ( allocate output and profit or agreeing on
price)

• Market sharing Cartels ( each firm operates only in one area)

 Cartels often fail?
• Difficult to organize all the producers if there are more than
few producers
• It is difficult to reach agreement among the members on
how to allocate output and profit when firms face different
cost curves
• There is strong incentives for each firm to remain outside
the cartel or cheat on the cartel by selling more than its
quota at the higher price
• Monopoly profits are likely to attract other firms into the
industry and undermine the cartel agreement
 Oligopoly
• Tacit collusion
– price leadership:

– dominant Price leadership

– Barometric Price leadership

 Oligopoly
• Tacit collusion
– price leadership: dominant firm

– price leadership: barometric

 £ Kinked demand for a firm under oligopoly

Current price
and quantity
give one point
on demand curve
P1

O Q1 Q
 £ Kinked demand for a firm under oligopoly

D
P1

D
O Q1 Q
 Oligopoly
• Non-collusive oligopoly: the kinked demand
curve theory
– Assumptions of the model
1. If a firm raises prices, other firms won’t follow and the firm loses a lot of business. So
demand is very responsive or elastic to price increases.

2. If a firm lowers prices, other firms follow and the firm doesn’t gain much business. So
demand is fairly unresponsive or inelastic to price decreases.

– stable prices
 £Stable price under conditions of a kinked demand curve

MC2

P1 MC1

a
D = AR
b

O Q1 Q
MR
 Oligopoly
• Non-collusive oligopoly: the kinked demand
curve theory
– assumptions of the model
– stable prices
– limitations of the model
 Oligopoly
• Non-collusive oligopoly: the kinked demand
curve theory
– assumptions of the model
– stable prices
– limitations of the model

• Oligopoly and the public interest

 Oligopoly
• Non-collusive oligopoly: the kinked demand
curve theory
– assumptions of the model
– stable prices
– limitations of the model

• Oligopoly and the public interest

– advantages
 Oligopoly
• Non-collusive oligopoly: the kinked demand
curve theory
– assumptions of the model
– stable prices
– limitations of the model

• Oligopoly and the public interest

– advantages
– disadvantages
 Non-price competition
• Product research and development
• Better quality package and appearance
• Easier credit terms
• Home delivery
• After sale service
• Longer period of guarantee
• Advertisement and promotions