Forms of Markets Forms of Markets

Chapter 11 Chapter 11 Forms of Markets Forms of Markets
Introduction Introduction
Essential features of a market: Commodity must exist Buyers and sellers There must be an area for interaction Is the internet a market?
Alternative Forms of Markets Alternative Forms of Markets

Classifying markets by degree of competition
Number of firms Nature of product Degree of freedom to enter and exit an industry
The four market structures

Perfect competition Monopoly Monopolistic competition Oligopoly
Structure
Conduct
Performance
Perfect Competition Perfect Competition

Features
Very large number of buyers and sellers Homogenous products Freedom of entry and exit to the industry Perfect knowledge of market Perfect mobility of factors of production Absence of transport costs
Very Large Number of Buyers & Very Large Number of Buyers & Sellers Sellers
Firm is the price taker
Each firm forms an insignificant part of the market No firm can influence the market price Firm is a price taker Industry is the price maker Price is given exogenously to the firm Price Line
Firm is a Price Taker under perfect competition Firm is a Price Taker under perfect competition
Price
D O
Quantity (millions)
Revenue
O
Quantity (thousands)
(a) Industry
Firm is a Price Taker under perfect competition Firm is a Price Taker under perfect competition
Pe
Price
D O
Quantity (millions)
Revenue
O
(a) Industry
(b) Firm
Firm is a Price Taker under perfect Firm is a Price Taker under perfect competition competition
S
Revenue
Price
Price Line
Pe
AR
D= AR MR =
D O
Quantity (millions)
O
(a) Industry
(b) Firm
Homogenous Product Homogenous Product

Product sold by different firms are identical Product of one firm is exactly the same as product of another firm Products are perfect substitutes Demand is perfectly elastic
Freedom to Entry & Exit Freedom to Entry & Exit

No costs attached to enter or exit industry Distinction between short and long run Short-run equilibrium of the firm
P = MC Firm can earn supernormal profits Firm can incur losses
Long run equilibrium of the firm

Firm can earn only normal profits
Short-run equilibrium of industry and firm under Short-run equilibrium of industry and firm under perfect competition perfect competition
Revenue / Costs
Price
MC
Pe
AR
D= AR MR =
D O
Quantity (millions)
Qe
(a) Industry
(b) Firm
Revenue / Costs
Price
MC
AC
Pe
AR AC
D= AR MR =
D O
Quantity (millions)
Qe
(a) Industry
(b) Firm
Short-run equilibrium of industry and firm under Short-run equilibrium of industry and firm under perfect competition Super Normal Profits perfect competition Super Normal Profits
Revenue/ Costs
Price
Supernormal Profits
MC
AC
Pe
AR AC
D= AR MR =
D O
Quantity (millions)
Qe
(a) Industry
(b) Firm
Revenue / Costs
Price
D O
Quantity (millions)
O
(a) Industry
Revenue / Costs
Pe
Price
D O
Quantity (millions)
O
(a) Industry
Revenue/ Costs
Price
Pe
AR
D= AR MR =
D O
Quantity (millions)
O
(a) Industry
(b) Firm
Revenue / Costs
Price
MC
Pe
AR
D= AR MR =
D O
Quantity (millions)
Qe
(a) Industry
(b) Firm
Revenue / Costs
Price
MC
AC
AC Pe AR
D= AR MR =
D O
Quantity (millions)
Qe
(a) Industry
(b) Firm
Short-run equilibrium of industry and firm under Short-run equilibrium of industry and firm under perfect competition Abnormal Losses perfect competition Abnormal Losses
Revenue/ Costs
Abnormal Losses
Price
MC
AC
AC Pe AR
D= AR MR =
D O
Quantity (millions)
Qe
(a) Industry
(b) Firm
Perfect Competition Perfect Competition

Long-run equilibrium of the firm
All supernormal profits competed away All abnormal losses are nullified All firms earn only normal profits
Long Run Equilibrium under Perfect Long Run Equilibrium under Perfect Competition Competition
Revenue / Costs Price
S1
LMC LRAC D1
P1
AR1
D O
Quantity (millions)
O
(a) Industry
(b) Firm
S1 S2
LMC LRAC D1
P1
AR1
D O
Quantity (millions)
O
(a) Industry
(b) Firm
S1 S2
LMC LRAC D1 DL
P1 PL
AR1 ARL D
O
Quantity (millions)
QL
(a) Industry
(b) Firm
Long Run Equilibrium under Perfect Long Run Equilibrium under Perfect Competition Competition LMC
S1
LRAC
P1
AR1
D1
D O
Quantity (millions)
O
(a) Industry
(b) Firm
Revenue/ Costs
Price
S2
S1
LRAC
P1
AR1
D1
D O
Quantity (millions)
O
(a) Industry
(b) Firm
Revenue/ Costs
Price
S2
S1
LRAC
PL P1
ARL AR1
DL D1
D O
Quantity (millions)
QL
(a) Industry
(b) Firm
Revenue/ Costs
Long-run equilibrium of the firm under perfect competition

(SR)MC (SR)AC
LRAC
DL AR = MR
LRAC = (SR)AC = (SR)MC = MR = AR
Quantity
Perfect Knowledge Perfect Knowledge

Perfect knowledge exists between buyers and sellers Ensures uniform market price
Perfect Mobility of Factors of Perfect Mobility of Factors of Production Production

Factors can move freely in and out of the industry No transportation costs Results in uniform price across all firms
Shape of the AR and MR Curves of a firm Shape of the AR and MR Curves of a firm
Horizontal curves Parallel to x- axis
Price
Revenue
Pe
AR
D= AR MR =
D O
Quantity (millions)
O
(a) Industry
(b) Firm
Demand & Supply Curves Demand & Supply Curves

Demand curve is horizontal to the x- axis
Reflects demand is perfectly elastic
Supply Curve
Upward sloping part of the marginal cost curve
Equilibrium Output of a Firm Equilibrium Output of a Firm

Equilibrium output is where P=MC
INDUSTRY
Price Demand Supply Sold Per unit
FIRM
Price Quantity TR AR MR MC
20 40 60 80
2000 1800 1600 1400
1000 60 1500 60 1600 60 1800 60
15 16 17 18
900 60 60 960 60 60 1020 1080
50 60 70 80
60 60 60 60
Industry equilibrium at Price = Rs 60
Equilibrium Output of a Firm Equilibrium Output of a Firm

Equilibrium output is where P=MC
INDUSTRY
Price Demand Supply perunit Sold
FIRM
Price Quantity TR AR MR MC
20 40 60 80
2000 1800 1600 1400
1000 60 1500 60 1600 60 1800 60
15 16 17 18
900 60 60 960 60 60 1020 1080
50 60 70 80
60 60 60 60
Different firms will produce different levels of output based on their cost structures
Monopoly Monopoly
Defining monopoly
Single seller No close substitutes Barriers to entry
Think of some examples of monopolies in India
Single Seller Single Seller

Sole seller of the commodity Firm constitutes the industry Firm is a price maker Considerable influence on market price
Absence of Close Substitutes Absence of Close Substitutes

Consumer can not get another commodity that is closely related to the monopolists product
Eg: no close substitutes to electricity or potable water
Demand is relatively inelastic
Barriers to Entry Barriers to Entry

Types of barriers
Ownership of strategic raw materials or exclusive knowledge of production techniques Patent rights Government licensing Natural Monopolies
Ensures monopolist can earn supernormal profits in the long run Can earn supernormal profits or abnormal losses in the short run
Price Discrimination Price Discrimination

When the same product is sold at different prices to different buyers To practice price discrimination
Markets to be sub divided into different demand elasticities No interaction between different buyers
Shape of AR & MR Curves Shape of AR & MR Curves

Downward sloping curves MR is less than AR
Units sold Price 1 2 3 4 5 4 3 2
TR 5 8 9 8
AR 5 4 3 2
MR 5 3 1 -1
Revenue
AR 0 MR Output
Equilibrium Output Equilibrium Output

Equilibrium price and output
MC = MR
Cost / Revenue
MC
MR O Qm Q

MC = MR
Cost / Revenue
MC
AR
AR MR O Qm Q

MC = MR
Cost / Revenue
MC AC a
AR AC
AR MR O Qm Q

MC = MR
Cost / Revenue
Supernormal Profits
MC AC
AR AC
AR MR O Qm Q
Monopolistic Competition Monopolistic Competition

Features of monopolistic competition
Large number of buyers & sellers Differentiated product Selling Costs exist Freedom of entry and exit
Examples
Soap industry: Lux, Medimix, Cinthol, Margo etc Fan industry: Crompton Greaves, Bajaj, Usha, Orient etc
Features of Monopolistic Competition Features of Monopolistic Competition

Large number of buyer & sellers
Not as large as perfect competition Firm has marginal influence over price of product
Product Differentiation
Products are closely similar to each other Colour, size, shape, taste etc Creates an impression in the minds of the buyer that the product is different to that sold by other firms

Selling Costs
Introduced by Edward Chamberlain Selling expenses incurred to create product differentiation Could be in terms of:
Sales promotion gimmicks Packaging Advertising
Could be:
Constructive: provides useful information Combative: attempts to lure customers from competition

Free entry and exit
Short run
Firms can earn supernormal profits Firms can incur abnormal losses
Long run
Firms can earn only normal profits
Equilibrium output produced by a firm

MR = MC
Short run equilibrium of the firm under monopolistic Short run equilibrium of the firm under monopolistic competition competition MC
Cost / Revenue (Rs)
AC
Ps
MR
O Qs
AR / D
Q
Cost / Revenue (Rs)
Short run equilibrium of the firm under monopolistic Short run equilibrium of the firm under monopolistic competition competition MC AC
Ps
ACs
MR
O Qs
AR / D
Q
Short run equilibrium of the firm under monopolistic Short run equilibrium of the firm under monopolistic competition competition MC
Cost / Revenue (Rs)
Supernormal Profits
AC
Ps ACs
MR
O Qs
AR / D
Q
Short run equilibrium of the firm under monopolistic Short run equilibrium of the firm under monopolistic competition competition AC MC
Cost / Revenue (Rs)
ACs Ps
AR / D MR
O Qs Q
Short run equilibrium of the firm under monopolistic Short run equilibrium of the firm under monopolistic competition competition AC Abnormal MC
Losses
Cost / Revenue (Rs)
ACs Ps
AR / D MR
O Qs Q
Long run equilibrium of the firm under monopolistic Long run equilibrium of the firm under monopolistic competition competition
Cost / Revenue (Rs)
LRMC
LRAC
PL
ARL / DL MRL
Q
QL
Monopolistic Competition Monopolistic Competition

Demand Curve
Downward sloping Relatively Elastic due to large number of close substitutes
Price
Oligopoly Oligopoly
Key features of oligopoly
Few firms Interdependence of firms Barriers to entry & exit Price Rigidity
Price wars Tacit Collusion
Group Behaviour
Firms behave as if they were one firm Retain their individuality Examples: Cartels: OPEC Price Leadership: Cement Industry

Forms of Markets Forms of Markets

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Forms of Markets Forms of Markets

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Chapter 11 Chapter 11 Forms of Markets Forms of Markets

Alternative Forms of Markets Alternative Forms of Markets

The four market structures

Perfect Competition Perfect Competition

Homogenous Product Homogenous Product

Freedom to Entry & Exit Freedom to Entry & Exit

Long run equilibrium of the firm

Perfect Competition Perfect Competition

Long-run equilibrium of the firm under perfect competition

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

Perfect Knowledge Perfect Knowledge

Perfect Mobility of Factors of Perfect Mobility of Factors of Production Production

Demand & Supply Curves Demand & Supply Curves

Equilibrium Output of a Firm Equilibrium Output of a Firm

2000 1800 1600 1400

1000 60 1500 60 1600 60 1800 60

900 60 60 960 60 60 1020 1080

Industry equilibrium at Price = Rs 60

Equilibrium Output of a Firm Equilibrium Output of a Firm

2000 1800 1600 1400

1000 60 1500 60 1600 60 1800 60

900 60 60 960 60 60 1020 1080

Think of some examples of monopolies in India

Single Seller Single Seller

Absence of Close Substitutes Absence of Close Substitutes

Demand is relatively inelastic

Barriers to Entry Barriers to Entry

Price Discrimination Price Discrimination

Shape of AR & MR Curves Shape of AR & MR Curves

Units sold Price 1 2 3 4 5 4 3 2

Equilibrium Output Equilibrium Output

Equilibrium Output Equilibrium Output

Equilibrium Output Equilibrium Output

Equilibrium Output Equilibrium Output

Monopolistic Competition Monopolistic Competition

Features of Monopolistic Competition Features of Monopolistic Competition

Features of Monopolistic Competition Features of Monopolistic Competition

Features of Monopolistic Competition Features of Monopolistic Competition

Equilibrium output produced by a firm

Cost / Revenue (Rs)

Monopolistic Competition Monopolistic Competition

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